I love this video from Derek Sivers, founder of CD Baby:
Attend a startup conference and you'll find that people there seem to believe that the mark of a successful company is the amount of money it's raised, not the amount of money it makes. Naturally, by this metric, Color is the greatest company in the world (spoiler: despite $41 million in the bank, it bombed). It shouldn't surprise anyone that Techcrunch, a recent AOL acquisition that has somehow managed to pass itself off as an authority on such matters, gushed about the company when that number was disclosed.
I have to imagine that the trend of comparing valuations arose because it was difficult to boast about negative earnings. The truth is, there's nothing wrong with negative earnings - in the absence of arbitrage, a startup's upfront cost should be greater than its early profits. But it's not just startups - even mature companies that still attract the Techcrunch set (read into that what you will) are reporting bogus "earnings before costs" numbers, as Dealbook reports.
Is there a rationale for valuation comps? Sure, since it's a measure of how much value a company has created. Strike that: it's a measure of how much value a company has convinced a small set of investors that it has created. So when we compare valuations, we're really comparing the perceived ability of venture capitalists to properly measure and allocate capital according to value. I have yet to see any evidence for that ability. Outside a few lottery tickets, venture firms tend to lose money -- and anyone with a true finance background can tell you that a positive track record characterized only by a few outliers is garbage. A recent update to Cambridge Associates' venture capital index revealed that the median return to venture investors has not been positive since 1998. That seems beyond absurd to me -- especially because the IPO bubble wouldn't end for two more years! The very best funds have averaged less than 6% IRR's, and those were launched in 2001 -- in other words at the bottom (one might speculate by chance rather than by design).
Derek's video is poigant because it cuts to the chase: you either have a good idea, or you don't. An efficient market will allocate capital accordingly. But in the current funding bubble, capital is being over-allocated to under-thought ideas. Valuation has become more important than value -- a textbook bubble. As if to force the point home, most of the links I found to this video came from Techcrunch-esque blogs who missed the "good idea" point and instead used it to argue that people should start companies because "it's easy and free!"
For further details, please see my recent post.