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Instagram with zero revenues was valued at $1 billion. Understanding Valuations by Flyboat.

Yes! When Facebook acquired Instagram people across the world were baffled as Facebook was paying a billion dollars for a company that had no revenues also making Facebook look crazy to many. Seemly surprising, the valuation seems to make sense now, 2018, with Instagram valued at USD 100 billion. There are many reasons why that value seems justified by Facebook.

A true valuation is a convergence of business and market understanding

Fundamentally, the valuation of private equity is based on deriving the intrinsic value. Intrinsic Value traditionally refers to the value of a company determined through fundamental analysis without reference to its market value. But, with the shifting paradigms, the definition of valuation not just remained to attain value using DCF or any one single approach, but startups and investors are moving to a more comprehensive approach which takes into account multiple factors influencing a business. This is mainly because, previously, the focus was only on profitability. With deep analysis, it is possible to capture qualitative aspects of a business like the scalability of products, capabilities, and capacities of the management team; and competition, etc. this has pivoted valuation into a mix of Science and Art rather than just science. Instagram is just one example of the many such valuations in recent times. New age valuations need in- depth understanding of business, context and market validations.

Of the many reasons for Instagram’s valuation, an important factor is the Product - Mobile application of Instagram, minimum viable product, which was built and placed in the market. Along with product placement, other prime factors are traction and growth the company has seen. Especially in the case of Instagram, the metric that was driving Facebook’s valuation was not cash flows or revenue but user base and user growth, and on this front, since its launch, the app has seen exponential growth, from 1 million users during the first two months on the market and generating over 30 million users in its first two years of operations. This ad-free platform had never before seen acquisition and usage statistics. With such strong traction and growth indicate the power of the business idea and commercial business viability. Couple this with the non-exclusive content rights for all data coming in, this company was riding the future of digital media.

Facebook's acquisition of Instagram benefits the Facebook in three important ways: It better positions Facebook to reclaim the teen demographic, a key group of users who have grown disinterested in Facebook, it allows Facebook enter into photo sharing market, one of the hottest markets and it presents Facebook with a big growth opportunity. And for Instagram as Kevin Systrom the CEO of Instagram said "we got to pair up with a juggernaut of a company that understands how to grow, understands how to build a business, has one of the best, if not the best, management team in tech and we got to use them as our resource”. Not to forget, Instagram was once a rival of Facebook, but this acquisition could kill competition and reinforce dominance in social-networking. These synergies have been the core reasons for such valuations.

We at Flyboat believe that valuing a pre-cash flow technology venture is one of the most difficult responsibilities to hold. Given the little factual information available and the abundance of subjective optimism, hope and promises to be the ‘next big thing’ can often be misunderstood. It needs cognizance about the market and understanding of organization economics. That’s why people say “Valuation is a mix of Science and Art”.

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