Startup general interest

Om Malik on why valuations defy metrics

By June 20, 2014 No Comments

Yesterday Om Malik reminded us that predicting the future is hard. That’s true, but in the startup industry we have to do it every day. Both as investors and entrepreneurs.

When companies attract high valuations their investors are predicting the future too – either that the business will trade in M&A at a ‘strategic multiple’ or that they will generate big cash flows. For larger valuations it is the latter. Om had this to say on why predicting cash flows has become difficult:

Today we live with new realities and new technology companies, which end up with opportunities and growth curves that can’t be predicted (in either direction.) A lot of traditional metrics of business don’t account for the changed metabolism and velocity of business due to presence of the network and, more lately, the concept of anywhere computing.

The most important of the ‘new realities’ that Om refers to are that products are digital rather than physical, allowing them to grow friction free and that computing is now ubiquitous. Put those things together and the possibilities for never-seen-before growth and equally rapid collapses.

Investors are left with the exciting prospect of betting big on highly uncertain outcomes. For those that get it right the rewards are rich. But predicting the future is hard, and many more investors will get it wrong than get it right. Moreover, as computing becomes more ubiquitous and software eats the best companies will grow ever faster and their future cash flows will be even harder to predict. There are no new metrics or valuation methodologies on the horizon, so expect to see more hard to understand valuations. Even in the absence of a bubble.