Can you imagine losing $119 billion in a single day?
That Fateful Day
The year was 2006.
A relatively small company – they had a little over 100 employees at the time, and skimpy revenues – was presented with an offer to be acquired. The price tag?
The potential buyer?
One of the largest Internet companies in the world.
Initially, the press made it sound like the smaller company declined the offer. But recently, the truth came to light. In fact, they accepted the offer, and were ready to move ahead with the merger.
One ill-fated day, however, at the very last minute, the potential acquirer got cold feet. They decided to lower their offer by $200 million.
The smaller company walked away.
If you haven’t guessed it already, the big company was Yahoo! (YHOO) and the small company was Facebook (FB).
The Short-Term Perception Trap
Yahoo! was ready to buy Facebook for a billion dollars.
To some, $1 billion for a company doing $30 million in sales and losing gobs of money seemed downright insane. But Yahoo! – initially anyway – stood behind its offer.
Then, one day in 2006, Yahoo’s stock price took a hit. Their board got scared about making $1 billion bets. They revised their offer for Facebook. They tried to value it in terms of what it was worth at that exact moment, not what it could become in the future.
This is a classic early-stage investing mistake: the short-term perception trap.
They decided to lower their offer to $800 million.
Meanwhile, unlike Yahoo!, Facebook’s perception of the future wasn’t clouded by short-term fluctuations in stock price.
They believed the world needed a new way to connect and share information. They believed in the power of social networking. And more than anything, they believed they could be the #1 social network in the world…
Although the $1 billion offer proved too tempting for Facebook to decline, the revised offer for $800 million seemed to splash water on their face and wake them up. It reminded them that if they became the #1 social network in the world, they’d be worth a whole lot more than $800 million or $1 billion.
And if Yahoo! hadn’t fallen into the perception trap – thinking in terms of days, weeks and quarters instead of decades –they might have acquired Facebook, currently a $120 billion asset, for a measly billion dollars.
A “loss” of $119 billion. That has to hurt.
Have a Vision
If there’s a lesson here, it’s this: when you invest in startups, come to the table with a new framework.
It’s not like investing in the stock market. There’s no ticker to tell you when a company is undervalued or overvalued. There aren’t cashflow models you can use to determine fair value for the business.
When you invest in a startup, you’re not investing in what the company is today – you’re investing in what it could become in the future.
If Facebook had sold to Yahoo! for $1 billion (or even $800 million) they would’ve generated a fantastic return for their initial investors.
But by playing a “long hand” and executing on their vision, Facebook unlocked over $119 billion in additional value for its shareholders.
So before you invest, always ask yourself:
- What’s the company’s vision? Do I share it?
- If this vision comes to fruition, what will its business look like?
- Do I believe the company has the right team to execute on this vision?