Why many companies are now raising HUGE amounts of money

Recently we see many companies raising huge sums of money based on amazingly high valuations. I am talking of course of facebook, twitter, groupon, etc.

This post is not about the companies’ valuations. Whether it is a bubble or not, history will judge best.

This post is about why do such companies need so much money, so quickly. I know the rule of “raise when you can and not when you need it” and generally I agree. But I also think that there is some limit to what companies need.

The simple answer is greed. Since valuation is now high companies can get much money for very small portion of equity.

However, if the companies believe that their valuation is real and will continue to grow, what’s the rush?

I think that there are other phenomena that can explain this

Examples:

• Everyone realizes that facebook changed the Net and our lives. However, I do see that many of my friends invest less and less time in facebook or even stopped using it. I see people are less responsive and that “thrill threshold” is  getting higher, while I do see business that market themselves more and more and spam my wall.
  
  In addition, it is clear that facebook changed their focus from finding what they are and helping us people into monetizing in any way they can. Why is that? What’s the urgency?

• Groupon affects much on how people are buying and even more how local business advertise. It is really nice, but what’s the real value to a local businesses that offered coupons? Does it really make an impact in their ability to make more money? Still hard to say.

I think that these companies are now in such a unique time that the success potential still seems freakishly high. The money generation mechanisms reflect (at least in the short term) their ability to demonstrate real income and not just eyeballs model and "this is a new economy... this is not a bubble ...". Then, they capitalized on this potential and can get their hands on very large investments.

Their urgency is stemming from their own realization that their model might collapse.

Facebook still has no real user locking mechanism. Users can abandon it pretty fast if a better social network with better targeted content, friendlier UI and less spam evolve (Skype has shown us how fast people are moving with their friends when they find new value).

Groupon is in a rush since when statistical analysis about their model will become public knowledge, it might prove that the promise is phenomenal. In such a case their value will decline pretty fast. This is not to say that they will not be a good company but they might not become the great next big company that changes demand/supply and advertisement habits.

These companies are very smart to create cash buffers for rainy days. This money is not just for growth, this money is to allow them to find the real model that will help them survive should their promise will not be as expected (and we should expect that).

And we, we are the stupids that provide such ridiculous amount of money for so small an equity jumping in without thinking and hoping valuation will raise infinitely.

Amir

To think or not to think? This is the question

Let's admit it. Most of us human beings are lazy in terms of thinking really hard. We like simple problems. How many times do you face a riddle and when you cannot solve it in 5 minutes you ask for the answer or put it aside?

However, we also like to think of ourselves as smart. We look for data, we read a lot before we take a decision. But this is not thinking. Most of the times we simply bury ourselves with tons of irrelevant information. We do not really analyze it.

When it comes to rely on consultants, this is even worse. We tend to quote what others that are considered professionals say. This is not only dangerous in terms of not thinking, but it also means that it is okay be wrong because we follow some "smart" person. This is just ass-covering in disguise.

I'll share with you a personal anecdote. When I was 10 years younger I founded my first startup (today called invoke.com). In its early days it was about education. My partner and I put together a detailed business plan and we quoted a famous analyst claiming how the online education market is about to grow exponentially.

Then we needed to check how people respond to it. Luckily for us a good friend of my father is Dr. Eli Goldratt who founded Theory of Constraints and he was willing to listen to us boys. So we presented Eli with our plan. Men, he killed us. One question he asked is "how do you know the market will grow?" With a broad smile we showed him the slide with the analyst's opinion. His response was "the starting point of his analysis was also valid last year, so how come the market did not grow last year?". Oops, we haven't thought about that.

Next he told us "never quote someone without really checking his/her logic, otherwise if he says something stupid, you are even more stupid to follow!" Eli became my mentor, he made me work hard then I have ever imagined I can.

Another example is not the use the lessons from the book called "built to last" without thinking. Please, don't get me wring, I really appreciate this boo and I think any entrepreneur and business person must read it. However, using lessons from this book is dangerous for two reasons:

1. It contains only correlations and not causality.
2. The correlations are not perfect so it means that they have inherent flaws in them.

One of the correlations of the book is that great companies must have a CEO that comes from the company itself (do not bring an outsider). I think this is a good rule in general. But think whether IBM would still exist today if their board was not courage enough to bring Lou Gerstner to revive the company when it was about to die.


Thinking is difficult. We are not used to really analyzing. We are used to sift through data and opinions of others and postpone decisions and when it is almost too late to quickly decide. We feel much better at execution mode rather at logical analysis mode.

Each one of us should have someone like Eli Goldratt on his tail to force them to think until it becomes our natural mode of operation. By the way, This critic can be anyone as long as they ask "Why is this true?" and not let go until they get a real good simple answer.

Amir