Two days ago, workplace chat startup Slack was reportedly raising money at a valuation of $2 billion. Today, a new report said it was raising money at a valuation of $2.8 billion.
Five months ago, that number was $1.1 billion.
So did Slack suddenly become more valuable by $800 million in a few months?
No, it did not.
[seealso slug=http://sale-online.click/2014/11/11/year-of-incredibly-large-numbers/%5D%3C/p%3E%3Cp%3EPatrick Mathieson, of venture capital firm Toba Capital used Slack's cartoonish luck at raising money to explain on Quora how venture capital works. Mathieson's fictional dialogue hews close to Slack founder Stewart Butterfield's real, quirky voice; he is known to say offbeat things like, "Yes, it’s arbitrary because it’s a big round number," about why he wanted to raise money at a $1 billion valuation. Mathieson's post was so convincing that a couple of reporters at major news outlets thought it really was Butterfield speaking.
Butterfield's confirmed Quora account seemed to like it too, upvoting the post. Here it is:
Read Quote of Patrick Mathieson's answer to How is Slack's rumored $2.76 Billion valuation calculated? on Quora
What Mathieson highlights is that startups routinely raise venture capital then trumpet the astronomical value of their companies, as judged by "valuation."
There's a key difference between valuation, however, and a company's actual worth. If a company is worth $2.8 billion, that is an agreed-upon value in a market that could include hundreds, thousands or even millions of people.
A valuation, on the other hand, means that a limited number of people have invested enough in a company in which the accumulated value of their money is around $2.8 billion.
This raises the question: why does that small group of people think a company is worth billions of dollars?
The answer: raising money from VCs is not a science. It's a negotiation between a startup's executives and a limited group of investors. As such, valuation is subject to all the quirks of negotiations that could change the price: a sense of urgency, a sense that the deal is a rare one, the charisma of the executives. Almost anything could influence it.
This also speaks to the risk of venture capital. As the Wall Street Journal article and the author of the original Quora post point out, Slack might only make $11 million per year. VC firms are investing with an expectation that that number will increase dramatically in the next few years.
If they are right, Slack could go public, selling stock on the open market for anyone to buy.