How long can DST disrupt venture economics?

Russian investment firm throws silicon valley investors for a loop, lengthening the road to IPO.

Financial trends and news by Matt Bowman
April 26, 2010 | Comments (5)
Short URL: http://vator.tv/n/f3d

In December, the venture-capital pundits said that in 2010, IPOs would be up and fundraising down in the tech startup world.

However, the exact opposite has turned out to be true for the hottest private tech companies. Facebook, Zynga, Groupon all have closed monster fundraising rounds recently and are in no rush to go public this year.

Why? Three letters: DST. Digital Sky Technologies, the Russian investment firm, is pouring hundreds of millions of dollars into hot web companies at valuations and terms that US-based venture capitalists would normally never accept. On Friday, Kim-Mai Cutler explained how the firm structures its deals: it takes no board seats, offers huge sums for tiny slivers of ownership, and doesn’t push for rights normally granted to later-stage investors, rights like the ability to block an IPO or reaping proceeds of an IPO before other investors.

The investments have changed venture economics in the short term. Without DST-style infusions of cash, late-stage tech companies in need of capital would be forced to either go public earlier or give up more control to venture capital firms and other investors through the secondary market.

The Russian firm has Silicon Valley on its toes, wondering just how long they’ll be able to disrupt the venture landscape. It is not known how much money DST has in its coffers, but it does have deep ties to Russian oligarchs that could presumably keep money flowing into the company for a long time.

Last week, Chinese holding company Tencent paid $300 million for a 10.26% stake in DST.

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Comments

Lorenzo Carver, on April 27, 2010

Nice piece Matt. I think DST is essentially the market maker for social media related companies that have achieved scale. However, I think there's also a lot of confusion over the "valuation" of these transactions. Not on the part of DST, they appear to know exactly what they are doing with respect to valuation. The Tencent transaction speaks clearly to that. But more confusion on the part of people that simply divide the amounts DST invests in companies with complex structures by the percentage of ownership they get and say “that's the value of the company. “

Matt Bowman, on April 28, 2010

Thanks Lorenzo. I think that distortion is one reason these companies are willing to take the cash--an inflated valuation is great for brand image. I wonder, though, if that could mess with IPOs when these companies hit the reality check of the public markets. What do you think?

Lorenzo Carver, on April 28, 2010

Thanks Matt. But to confirm, I don't believe the DST valuations are distorted. It's the interpretation of those values by media, certain investing professionals and so forth that need a bit of correction. DST's strategy, and what they get for what they pay, seems perfectly reasonable to me.

Matt Bowman, on April 28, 2010

I think we agree. I'm not suggesting DST is getting a bad deal, but that the valuations for the private companies as calculated (by media) based on DST's investments are inflated. You also suggest the valuations need correction--don't you mean they generally need to be corrected downward, or am I misinterpreting?

Lorenzo Carver, on April 28, 2010

Yes, we agree, but for different reasons :)

The press and 90% of VCs in fact think that pre-money/post money value is close to company value (or enterprise value). That’s only true if an IPO is eminent, and even then the VC pre-money calcs are totally different than the i-Bank pre-money calcs. Because of this, they (press/certain VCs/others) often simply say $X amount invested divided by fully diluted % acquired = company value. There are literally thousands of ways to prove that's not true. A great example is Groupon. Look around the web and you'll see a ton of press reports on Groupon's "$1.3 billion +- valuation." It's not the company that's valued at $1.3B, it's the investment of $135MM that is, of course, valued at $135MM on the date that money comes in. So then the equation becomes "If Last Round = $135MM in value, what's the sum of the other security values in the company on that date?" Unless the company did an IPO, I can guarantee you that each of the other securities are valued (on a per share basis) at something less than that last round (but certainly something more than what those prior investors paid in this particular case).