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It is March and the NASDAQ, the second largest stock market exchange in the world, breaks through the magic number of 5,000. It is a great time to be selling shares of private companies since demand for newly listed technology stocks is as easy as selling ice cream on a hot summer day. Many new companies are lined up for an Initial Public Offering (IPO). Their managements are ready with their optimistic sales pitches about growth and disruptive new business models. I am having lunch with one of my friends at Pershing Café on 42nd and Park Avenue. You should really try their braised short ribs but let me stay focused. My friend started his own technology company two years ago and in order to raise money he has been selling new shares in his company to friends and private investors in what is called financing rounds. Every new round, he sells shares at a higher price than the previous providing a paper profit for himself and earlier investors.
You can compare the process by stepping into a one-way elevator with the IPO resembling the roof exit. He is the founding shareholder and thus stepped into the elevator from the ground floor up. He reports, with a big smile on his face, he now is worth $60 million based on the last round of financing. I am very impressed and start to wonder if we should order a nice bottle of wine to celebrate. He is surely picking up the tab, right? Well, there is a small problem, the bottle of wine and the braised short ribs can only be exchanged for cash and his $60 million are locked into the shares he owns. “It is paper money Vincent, so can you please pay for lunch?”, he asks… The year is 2000 and we are about to see a lot of elevators dramatically fail.
It is March 2015 and the NASDAQ, still the second largest stock market exchange in the world, breaks again through the magic number of 5,000. Yes, it took only fifteen years to get back to the future. It is again a great time to be selling shares of private companies since demand for newly listed technology stocks is again as easy as selling ice cream on a hot summer day. You have heard of Uber, Airbnb, Snapshot, Dropbox and Pinterest, right? The last round of financing values Uber at $41 billion and Airbnb at $20 billion. Not bad if you can get it. Especially for a company that just operates a mobile-app-based transportation network and a company that is just a real estate rental portal. Lunch anyone?
To get an idea of what you should pay for these companies, let’s try to IPO yourself. Let’s pretend to sell 10% of your future earnings power to the public and list your shares on the NASDAQ. What would you sell yourself for? If you can sell yourself as the next Bill Gates or Warren Buffett you will do good but most of us will probably not come further than promising earnings of around $500,000 after taxes over a 40 year productive life. Any value over $50,000 would therefore constitute a great sale by you and a bad investment for the buyer. Now apply this to the IPO candidates of 2015 and tell me what you think of their earnings power over the next 40 years. If you want to be able pay for lunch, I suggest you take the stairs.