I was on LinkedIn one evening and see an unpronounceable company called SNYK get a $150 million funding round. Very cool!
As many do, I Googled it a bit. That is where things got very interesting.
The company is reported to be about 5 years old.
Owler says it has most recent revs of $11.8 million.
The company says it is “leveraged” by over 400,000 developers. Why would one say “leveraged” instead of “we have 400,000 customers?”
Then I get to the article on the newest valuation: Over $1 billion!
Holy Cow! A company that sells a security product or service of some sort, “leveraged” by 400,000 users, with $11.8 million in revenue, with a billion-dollar valuation. Immediately I looked to see if this was a division of WeWork? Or Theranos?
Good valuation if you can get it. Congrats.
Unfortunately, VC valuation is not the same as what the employees, stock option holders will get. They get what someone will pay for the place. There are only three paths to liquidity.
First, the company can blow revenues out the door every quarter to hundreds of millions a year. Then they can pay dividends, reward employees and founders.
Oops, forgot, they are VC-backed. That possibility is now closed as a VC-backed company can only get its dough out if they sell the place or do an IPO.
OK, cool. Let’s do the IPO math. (Initial Public Offering = go public)
A security software company should IPO at some multiple of earnings, or sales. That is what the earnings per share math is on your 401(k) Research tab.
The company does not appear to be profitable. How could they be if they have had to raise $250 million? Likely no profit here. Probably won’t be for a long time.
OK, so let’s take a multiple of sales.
$11.8 million? Is that real? Sounds like a mistake, but it is all we have.
OK, they came up with that $1 billion valuation somehow.
Doing some simple math, that is 84.75 x sales. Cannot multiply by earnings, as there do not appear to be any.
Does anyone really think an IPO market would support a valuation of 85 times revenue for a security company that does opensource stuff? Only if they are also personally invested in a cannabis deal and daily test their product.
What’s the unit of sale? Maybe there is a cool metric there?
SNYK says they are “leveraged” by 400,000 dev people. $11.8 million in revenue divided by 400,000 means each one of those hardy developers has $30 of skin in the SNYK game?
That ASSUMES those hardy 400,000 actually paid for the stuff. But most of these opensource companies allow you to download some of the stuff for free. So how many are paying and how many are free?
Does this seem right? Let’s look a little bit closer at what SNYK’s Marcom types say. The secret to many of the most intractable valuations can be found in what the Marcom (marketing communications if you are not a software type) people say in deliberately twisted word phrases.
The first one is “leveraged” vs. customers.
Clearly SNYK does not have 400,000 paying customers or they would say so.
Again, try the math: 5 years old – 400,000 leveraged = 80,000 leveraged a year. Wow! If anyone can get 80,000 paying customers a year, they ought to surely get a billion!
How many is that a month? That’s 1,300 paying customers a month! Even if they are from the same company, what a user base!
Now think about it! With 20 working days in a month that’s 65 paying customers a day. Wowee zowee! This should be the poster child for viral marketing. Unless, perhaps, leveraged whatevers and paying customers mean something different. Ugh!
Think of all the logo-wear, T shirts and Whiffle Balls with SNYK logos they had to make. Now I can see where that $250 million in invested capital went. Phew!
Marcom types would post it on highways in Kansas if they had a 400,000 paying customer base. So, maybe leveraged means something a bit different. So how many paying customers does SNYK really have?
Maybe “customers” to them means people who downloaded their stuff from the web site, maybe use it, maybe not. That is pretty typical of opensource companies. Did 400,000 people pay for their stuff? Who knows? Just asking.
Major customers like Google, Salesforce ….
Aha! Here we encounter the “fallacy of composition.” That generally means, in Philosophy 101, Logic Section, that if you see a big hotel it must have big rooms. It is a fallacy, if you did not get it, that a really big hotel may instead have many small rooms.
Did Google standardize on SNYK or did some developers buy a license or two?
Time to revisit that fallacy of composition here.
Let’s go back to the Marcom stuff.
“Revenue up over 400%”
If revenue is up 400%, why not tell us what the revenue is? Why do we have to sneak (not SNYK) to Owler for that information? Remember the basic rule of Marcom: “any news is good news, all good news is fantastic, great news is awesome!”
If that revenue line was good news, look for the billboard along the Kansas highway.
No billboard.
But the Marcom types are all about the 400% revenue growth. OK, 400% up to $11.8 million. So that means it was $2.95 million before? That’s pretty healthy growth, from $3 million to $11 million is nothing to sneeze at. BUT, as the Marcom types well know, it will not come anywhere near supporting a $1 billion valuation.
There are local restaurant chains with 7 Jaliscos TexMex locations that bill $11 million a year. They aren’t worth a billion.
What does a billion dollar valuation mean in VC land?
It means that is the level at which the last guy invested. And the last guy, by paying this, got all the earlier guys a very good review on their quarterly reporting to their funds.
Here’s how it works.
A VC has customers, called investors. Every quarter, the VC needs to tell the investors what their (the customer’s) investment is worth. Every quarter can be pucker time if you are the poor VC representative who has a company where you valued it at $250 million and it only delivered that $2.95 million in revenue. Like these SNYK guys last year.
You need to get that number up. Not the revenue number, the valuation.
But you cannot just value it yourself, no matter how much you would love to do so. You need some other guy to come in and say, hey, this $11.8 million revenue, opensource security software company, with cool T-shirts is really worth a billion.
Why?
Because I say so. And I am willing to invest my customers’ dough at that level!
Done!
SNYK is now a billion-dollar company. Valuation, not revenue.
The hapless early round VCs are just crazy happy because they can go to their investors and say “Yo! Look here! Your investment in SNYK is now worth a ton more.” That is a pretty fun time for the VC.
Everyone is happy here. The employees are counting their options, dividing them into a billion and making yacht buying plans. Some are planning that trip to Mars with Elon. Others, a simple retirement in Palo Alto in a cozy $7 million bungalow.
But not so fast!
Just because the VC says the company is worth a billion does not make it so. Don’t believe me?
Meet WeWork who just went from a $47 billion valuation that the VCs said it was worth to front page headlines on how about $40 billion or more of that valuation just went away. Literally disappeared.
Ever heard of Theranos? Sure you have. If not Google it. That was another multi-billion dollar darling where things did not turn out so well for their remarkable founder. And they had a lot more revenue than SNYK. There are hundreds of these stories.
OK, back to that valuation thing. Focus here people. We are at $1 billion and the employees are dividing their options into that number. But, wait, it gets better. Much better.
The last investor is a VC. I recall they are called Stripes. Really, that is their name.
They went in at a billion dollar valuation but they have to go to that quarterly meeting and tell their customer, who invested in them, SNYK was a good investment. They will show all kinds of charts, graphs, Gartner Quadrants, growth charts built by recently graduated MBAs who never ran a business. Everything will be a 45 degree angle up and to the right!
Remember, a VC wants to make 10-X their money in 36 – 48 months.
That means our Stripes boys need SNYK to become a $10 billion valuation. Really!
So now the prescient stock option holders at SNYK can divide their options into $10 billion. Bigger yacht. Maybe a downtown SF condo. Why stop at Mars?
Let’s step back.
Let’s look at this from a distance.
Every VC invests in 10 companies knowing 8 of them will fail or the investment will break even or deliver a small loss. The hope is that one will be the 10 X which will make it all up.
The question for a SNYK option holder, is whether SNYK is one of the 8 or one of the 2.
SNYK is in a crappy market – security. It is one of the most crowded markets on the planet. It is in the sector called open source. That is where the buyer is typically a 25 – year old who buys the product with his or her credit card and expenses it. The kid in the next cubicle may pick one of the 14 other competitive products that generally does what SNYK does.
Most of this opensource stuff is downloaded for free. Then some sales types call and try to get the “customer” to add some feature and thus have to actually PAY for it.
There is no strategic story here. This is a transaction level market where every day is a grind of dialing for dollars, downloading white papers, SPAM email trying to get more of those “leverages” which for another company might be a real paying customer.
This is where people download stuff from the website, maybe use it, maybe not. Maybe pay for it, maybe not. Welcome to the opensource market.
Look at the adjacent category – DevOps. That is the other side of what this opensource stuff is supposed to do. Build apps faster than before.
Look at Chef, Puppet, XebiaLabs all opensource companies who raised massive amounts of money, then just never could get out. No wet exit for them. Just long, slow, death.
But death with great salaries for their CEOs and VPs of Sales who changed every 18 – 36 months. These guys always fail forward.
Chef, Puppet, XebiaLabs and a hundred others were also “opensource” darlings. Now they are a wasteland where they cannot go public, are too expensive to buy and still have not turned a profit. And many of them are over 10 years old. Welcome to the future, pal.
Massive valuations touted by their Marcom teams. But, today, they are just limping along, employee option holders virtually wiped out.
Don’t believe me? Read this article from a major VC who points out that even a $100 million in revenue is not enough.
https://www.forbes.com/sites/valleyvoices/2017/10/23/when-100-million-is-not-enough/
Clearly SNYK and an IPO are not going to wed. Their revenue cannot ever support that more than $1 billion valuation the Stripes guys need.
They have to dump the place to someone really stupid enough to pay $ 10 billion for a company with pretty minor revenue.
CA and HP were the usual candidates to do really stupid stuff and buy companies at valuations that made late-to-the-game VCs look great. They are pretty much out of the game today. So now what?
Look for lots of synthetic “best of” awards. Fastest growing company in East Wherever. Gartner leader in some niche within a niche within a niche. Most fun place to work. Best company culture for dogs running around the HQ.
These are the kind of awards you get when you have a marketing budget that rivals a Department of Defense procurement project. Everyone gives you awards as long as you write checks.
Let’s go back to that 400,000 “leveraged” number. If 400,000 gets us $11.8 million in revenue, and we want to massively grow, let’s grow 10 X. That means we grow to $110.8 million in revenue now leveraging 4 million developers.
People, pretty soon we run out of Node.js developers or developers of any sort.
Welcome to fantasy land. As long as you don’t do basic arithmetic, it all seems so much fun.
The management and early investors will find a way out, via preferences and allocations. They will move on calling this baby a huge success. Management failed forward before and they will do so again. Profitably.
The employees will get screwed on stock options just like the opensource darlings at Chef, Puppet, Xebia and a hundred other opensource companies.
Welcome to opensource. Never quite seems to work out for the hapless employee.