The debut of Facebook was supposed to be the rising tide to lift all ships, spurring more investments in Silicon Valley at even loftier valuations.
Then Facebook went public on May 18, and those expectations fell. Shares of Facebook closed on Monday at $26.90, more than 29 percent below the offering price.
As painful as it must be for Facebook’s new investors, it is also a black eye for Silicon Valley’s start-ups, hoping to raise capital. In the leadup to Facebook’s initial public offering, several start-ups raised tens of millions of dollars at high valuations. Quora, the question-and-answer site founded by a former Facebook executive, Adam D’Angelo, raised $50 million in May at a $400 million valuation — despite a lack of profits.
Though Facebook has been public for less than a month, several top industry players are warning that easy money may not be so easy anymore.
In a letter to founders posted on Hacker News on Tuesday, Paul Graham, the co-founder of Y Combinator, an influential start-up incubator,cautioned entrepreneurs to brace for strong headwinds.
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Guy Calaf/Bloomberg NewsPaul Graham, the co-founder of Y Combinator, an influential start-up incubator, warned entrepreneurs about fund-raising.“No one knows yet how much,” Mr. Graham said, referring to the effect of Facebook’s I.P.O. on the fund-raising market. “Possibly only a little. Possibly a lot, if it becomes a vicious circle.”
According to Mr. Graham, a pullback in valuations for initial funding rounds would not be devastating, since recent valuations were pretty high on a historical basis. Instead, he is more concerned by the overall fund-raising environment. Simply, will money be harder to raise? And will more companies have to raise money in so-called down-rounds, or at lower valuations from their previous rounds?
“It’s more important than ever to be flexible about the valuation you expect and the amount you want to raise,” he said in the letter.
In response to the letter, Fred Wilson, a partner of Union Square Ventures, theorized on his personal blogthat most of the effect would be on the “late-stage and secondary markets where most of the I.P.O. valuation speculation is happening.” While he did not refute Mr. Graham’s assertions, he took a more glass-half-full tack, pointing out that Facebook’s stock price might be deflated but it was still worth plenty.
“If speculators are disappointed with the performance of the Facebook I.P.O. it is because they had ridiculous expectations of what rational investors would pay,” he said in his post. “The market has put a premium valuation on a great company and we should be happy about all of that.”
So what is a start-up to do in these murky times?
Mr. Graham’s parting advice in his letter holds true in good times and bad: practice discipline. If you raise a lot of money, don’t spend recklessly. Think about profitability.
“The best solution is not to need money,” he said.
