Skip to content

2,400+ Clients since 2001 • $4.3+ Billion Raised

Rise of the $3.4 Billion Taxi Service, and Other Valuation Tales

The $3.4 billion uber-valuation that Uber – the on-call taxi and limo service – received recently in its latest round of financing has eyes popping and tongues wagging. Uber is expected to reach revenue of $125 million in 2013, implying a valuation of almost 30 times revenue. A number of other taxi-hailing startups such as Lyft and Hailo are also revving their engines to get into the highly regulated livery service business.

Valuation of Uber Taxi Startup

Economists tell us that valuation bubbles happen periodically. The Internet Era has shortened the time between the occurrences of valuation bubbles. The last Internet bubble, as some of us remember, was in 1999. (Cue Prince’s “Party Like It’s 1999.”)

Of course, runaway valuations are nothing new. As recently as 2010, Groupon was the “it” company with pre-IPO valuations gyrating between $3 to $5 billion. It reportedly rejected a $3 billion buyout offer from Yahoo, and a $5.3 billion offer from Google. It went public in November 2011 at an astronomical valuation of $12.8 billion. Most recently in September 2014, it has been trading at a valuation of $6.8 billion, about half of its IPO value.

Most pre-IPO companies do not have earnings. Therefore, traditional valuation methods, such as price-to-earnings ratios, are not applicable. So how do VCs value startups?

The answer varies, depending on whom you ask. VCs are notoriously silent about their processes. Each VC firm is different and has its own methodologies. In general, VCs are looking for unique ideas with novel business models, led by a founding team with talent, passion, and commitment. They want to see early market traction before they make their investments. On Cayenne Consulting’s website, there is a high-tech startup valuation estimator that can help you gain insights into the factors that contribute to startup valuations.

However, one key idea to understand is that VCs invest in a portfolio of startups. They expect most to fail, and one or two to become blockbusters. The National Venture Capital Association estimates that about 30% of venture-backed businesses fail totally, according to a recent article in the Wall Street Journal. Three out of four startups fail, the article says.

As a general rule of thumb, for every 10 startups a VC firm invests in, three or four will fail completely. Another three or four will fail but return the original investment. And the lucky VC firm will have one or two blockbusters.

In an insightful report titled “We Have Met the Enemy…And He is Us” published in 2012, the Ewing Marion Kauffman Foundation analyzed its 20 years of experience of investing in venture capital firms. It states that only twenty of 100 VC funds generated returns that beat a public market equivalent by more than 3% annually, and half of those funds were formed prior to 1995. It goes on to say that the majority of funds (62 out of 100) failed to generate returns exceeding those available from public markets.

The Kauffman Foundation found that its best returns came from VC funds smaller than $400 million in committed capital. However, since most VC firms work on the 2% annual expense and 20% carry (i.e. share of the profit on its investment kept by the firm) model, they have a vested interest in raising large funds. The large size of funds necessitates large investments, thus inflating a valuation bubble.

Add buyout funds to this mix, and you get an even bigger incentive to make big bets. Buyout funds worldwide manage about $670 billion of capital, according to a study by Prof. Andrew Metrick of Yale University and Prof. Ayako Yasuda of University of California, Davis. On average, buyout funds tend to be four times larger than VC funds. They have a lot more capital to put to work. This creates a unique situation of too much money chasing too few deals.

Interestingly, the most recent financing round for Uber that raised $258 million at a reported pre-money valuation of $3.4 billion was led by Google Ventures and TPG – a buyout fund. The combination of venture capital and buyout funds is a heady mix, likely to raise valuations to stratospheric levels.

All Uber has to do now is to grow into the uber-valuation it already has.

Learn more about our business valuation services..

Shyam is a consultant and mentor to entrepreneurs. He has over 3 decades of international technology industry experience. He earned his MBA from Oregon State University, and Bachelor of Technology from Indian Institute of Technology. View details.

This article was last updated on
Back To Top