<p>There was a time when valuing a company involved a few dull things, such as revenues, profits and cashflows. Debt was frowned upon and the future was discussed with caution, usually by people wearing sensible shoes and a jacket. That was before the modern private market arrived, carrying kombucha, and using words such as ecosystem and optionality. These words have done great service to mankind. They have allowed companies that lose money to be valued at several billion dollars, while those of us still attached to the vulgar concept of profit sit unpretentiously in the corner, ashamed of our limited intellect. </p> <p>The confusion is not that loss making companies are valued highly. There can be perfectly sound reasons for that. A young company may be investing ahead of revenue. It may be acquiring customers and constructing the foundations of a large future business. The money lost today may be the price of a moat tomorrow. The problem is that the same argument has also been used by many companies that did not become great and, in some cases, did not survive long enough to finish the investor presentation. </p> <p>This is what makes private market valuation such an elegant mystery. It is not a straightforward statement of what a company is worth today. It is a bargained expression of what a small bunch of investors believes the company might be worth tomorrow. None of this means that private market investors are irrational. On the contrary, the better ones understand risk very well. Venture investing is not like buying a sensible manufacturing company, but more like sponsoring ten ambitious children, knowing that most will return home with poetry degrees, but one may build a rocket company. </p> <p>This is where the ordinary reader becomes confused. He is told that profits do not matter yet. Then he is told that losses are narrowing and eventually told that the company is on a path to adjusted profitability. This phrase is one of the great inventions of modern finance. Adjusted profitability is profit after removing the things that prevented profit. If revenue continues to grow while costs stabilise, the arithmetic can change dramatically. The spreadsheet is sometimes ahead of its time. The most famous example is Amazon. </p> <p>The truth is that both sides have a point. The believers are right that conventional profit measures can understate the value of a company that is building something large and difficult to replicate. The sceptics are right that not every loss is noble. Public markets are less romantic. They are willing to admire vision, but only for a while. Eventually they ask rude questions – where is the margin? This does not make private valuations meaningless. They may capture possibilities that current accounts cannot. But they are not facts in the same way that profits are facts. They are arguments where some become Amazon. Most, however, become footnotes. </p> <p>Consequently, the sensible position is not cynicism but humility. Despite the temptation, we should not mock every loss making company that receives a high valuation. Nor should we accept every valuation as wisdom, merely because it has been blessed by people in sneakers, hoodies or fleece jackets. The private market is pricing the future, while the rest of us are struggling to understand the present. </p> <p>Your columnist remains simple minded. He still believes that a company should, eventually, sell something for more than it costs to provide. But he accepts that eventually can be a long word in business. The great companies prove that patience can be rewarded magnificently. The failed ones prove that patience can also be an expensive way of postponing arithmetic. That is the mystery of modern valuation. It may be genius but it may also be gobbledygook. Only cashflows can settle the argument. </p>
<p>There was a time when valuing a company involved a few dull things, such as revenues, profits and cashflows. Debt was frowned upon and the future was discussed with caution, usually by people wearing sensible shoes and a jacket. That was before the modern private market arrived, carrying kombucha, and using words such as ecosystem and optionality. These words have done great service to mankind. They have allowed companies that lose money to be valued at several billion dollars, while those of us still attached to the vulgar concept of profit sit unpretentiously in the corner, ashamed of our limited intellect. </p> <p>The confusion is not that loss making companies are valued highly. There can be perfectly sound reasons for that. A young company may be investing ahead of revenue. It may be acquiring customers and constructing the foundations of a large future business. The money lost today may be the price of a moat tomorrow. The problem is that the same argument has also been used by many companies that did not become great and, in some cases, did not survive long enough to finish the investor presentation. </p> <p>This is what makes private market valuation such an elegant mystery. It is not a straightforward statement of what a company is worth today. It is a bargained expression of what a small bunch of investors believes the company might be worth tomorrow. None of this means that private market investors are irrational. On the contrary, the better ones understand risk very well. Venture investing is not like buying a sensible manufacturing company, but more like sponsoring ten ambitious children, knowing that most will return home with poetry degrees, but one may build a rocket company. </p> <p>This is where the ordinary reader becomes confused. He is told that profits do not matter yet. Then he is told that losses are narrowing and eventually told that the company is on a path to adjusted profitability. This phrase is one of the great inventions of modern finance. Adjusted profitability is profit after removing the things that prevented profit. If revenue continues to grow while costs stabilise, the arithmetic can change dramatically. The spreadsheet is sometimes ahead of its time. The most famous example is Amazon. </p> <p>The truth is that both sides have a point. The believers are right that conventional profit measures can understate the value of a company that is building something large and difficult to replicate. The sceptics are right that not every loss is noble. Public markets are less romantic. They are willing to admire vision, but only for a while. Eventually they ask rude questions – where is the margin? This does not make private valuations meaningless. They may capture possibilities that current accounts cannot. But they are not facts in the same way that profits are facts. They are arguments where some become Amazon. Most, however, become footnotes. </p> <p>Consequently, the sensible position is not cynicism but humility. Despite the temptation, we should not mock every loss making company that receives a high valuation. Nor should we accept every valuation as wisdom, merely because it has been blessed by people in sneakers, hoodies or fleece jackets. The private market is pricing the future, while the rest of us are struggling to understand the present. </p> <p>Your columnist remains simple minded. He still believes that a company should, eventually, sell something for more than it costs to provide. But he accepts that eventually can be a long word in business. The great companies prove that patience can be rewarded magnificently. The failed ones prove that patience can also be an expensive way of postponing arithmetic. That is the mystery of modern valuation. It may be genius but it may also be gobbledygook. Only cashflows can settle the argument. </p>
