Tech Startups Woo Investors with Unconventional Financial Metrics

http://www.wsj.com/articles/how-tech-startups-play-the-numbers-game-1433903883

by jrs235 • 11 years ago

71 36 11 years ago

dang3• 11 years ago

Url changed from http://www.theverge.com/2015/6/10/8756837/startups-tech-bubb..., which points to this. Yes, I know it's behind a paywall, but this is an important article, it hasn't had a discussion here yet, and the standard trick for reading articles like this appears to work.

foobarqux2• 11 years ago

HN should just create an option to allow people to filter paywalled articles (or on title substrings more generally), that would satisfy everyone.

hayksaakian• 11 years ago

[Paywall] in the title would do it

smtddr• 11 years ago

FWIW, even the changed link on HN ( http://www.wsj.com/articles/how-tech-startups-play-the-numbe... ) didn't work for me, I still had to Google it first.

A referer Request Header thing maybe?

foobarqux2• 11 years ago

The link wasn't changed to evade the paywall.

xiaoma• 11 years ago

Articles behind a paywall are at odds with the entire experience of collaborative link sharing on an aggregator. That's why I flag them.

I'm just an ordinary user but I'll do what can to make improve the site by pushing them down in the rankings, especially given that others feel the same: https://news.ycombinator.com/item?id=9329810

dang3• 11 years ago

Thanks for being concerned for the quality of HN! We're grateful for users like you. But please don't flag stories only because of a paywall. Accounts that repeatedly do so lose their flagging rights. You should flag stories because of content, not provenance.

The HN guidelines explicitly call for original sources. We want the best, most substantive version of a story. Other things being equal, we all prefer non-paywalled articles, but when things are not equal, substance should win. Compare the WSJ piece to the originally submitted URL in this case (it's mentioned upthread). There's no question which one belongs on HN.

When there are standard workarounds to read the content, paywalls are just an inconvenience.

The more this comes up [1], the clearer it gets that we shouldn't ban paywalls. The NYT, New Yorker, Economist, WSJ, and others are major sources. HN would be poorer without them.

1. https://hn.algolia.com/?sort=byDate&prefix&page=0&dateRange=....

colinbartlett• 11 years ago

Obligatory paywall workaround link:

https://www.google.com/search?q=tech+startups+woo+investors+...

devbug• 11 years ago

Why has no one created a bot for this?

jrs235• 11 years ago

Fear of prosecutorial discretion and the U.S. Legal systems inability to differentiate between criminal hacking and violation of TOSes?

jessriedel• 11 years ago

https://news.ycombinator.com/item?id=9531941

scriptman• 11 years ago

This was indirectly discussed here: https://news.ycombinator.com/item?id=9705832

... and included a link that discusses the WSJ article about half way down under the heading "Revenue": http://mattermark.com/important-financial-indicators-for-sta...

mathattack• 11 years ago

Run rate isn't an awful metric for a hypergrowth company. Billings or bookings isn't too bad for a SaaS company, to highlight which revenue was earned the most current year. The challenge is the terms aren't defined by GAAP, so company to company comparison is difficult.

The metric I've seen most abused is the Adtech example they've highlighted. Companies report "Managed" or "Gross" revenue, of which they only keep 15% "Net" to pay their bills. The latter is more meaningful.

In the end, any one metric can be gamed. This is why it's important to look at the metrics in total. Of course if someone is really cooking the books, they'll just make up all the #s. That's the hardest nut to crack.

rmason• 11 years ago

I started a b2b during the last bubble. It was common then if you brokered say a $10,000 sale to claim the entire value as part of your gross sales instead of just the commission you earned for facilitating it.

I fought it, never felt comfortable representing my company's financials that way. When the bubble burst it disappeared. Now sixteen years later this type of accounting has returned.

Brad Feld blogged today about something that was also very common in the late nineties:

“people don’t talk about what they’re making. all anyone talks about is raising money”

http://feld.com/archives/2015/06/get-information-entrepreneu...

There may not currently be a bubble, but a lot of the bad stuff from before is becoming standard practice once again.

wjnc2• 11 years ago

Are that kind of practices legal under US GAAP, or any accounting regime? Or are there just no accountants on board?

(Got around the paywall: C-level execs are taking huge compliance risks by giving unauditable statements before and during flotation.)

With regards to a quote in the link: "Our purpose here isn’t to make money. Our purpose is to acquire and serve customers. Making money is the logical consequence of doing our jobs well, but it isn’t our purpose."

I am baffled. Think about what stakeholders you can service if making money is a (possible) consequence of doing your job well, but not your purpose. In my Peter Drucker-inspired econoverse, that's a pretty short lifespan you've got ahead of you. One day or another, that bottom line catches up with you.

Brushfire• 11 years ago

Private companies do not have to follow or care about GAAP. They should, but there is no "legality" here.

bsbechtel• 11 years ago

>Are that kind of practices legal under US GAAP, or any accounting regime? Or are there just no accountants on board?

Regardless of the legality, responsibility should ultimately fall on the shoulders of the investor to require financial reporting be done in a way that is acceptable to that investor, before they hand over money to the company. This may not be as true in publicly traded companies, where many amateur investors are participating in the market. The same goes for angel investing, if only because many companies at that stage may be pre-revenue or even pre-product. However, at the VC level, millions of dollars are invested to scale supposedly sound businesses. VCs should be sophisticated enough to manage this risk, and if I were an LP looking to put my money in a VC fund, I would be very concerned about putting my money in a fund that didn't have some sort of required standard financial reporting practices for all portfolio companies.

craigjb• 11 years ago

It's not a bubble! This time is different!

cm21872• 11 years ago

Exactly. And that often goes with the other truth: "real estate never goes down".

notNow• 11 years ago

There's some truth to this though. As long as the population numbers are going up, real estate would eventually catch up with them

gchokov• 11 years ago

Sometimes I am just thinking of opening SHORT sales for all these "amazingly good companies"...

notahacker• 11 years ago

I'm reminded most of Groupon, which repeatedly lied about being profitable, even trying to get their alternative metric of profitability (which deferred most of their cost of sale) past the SEC for the IPO.

I'm assuming that VCs are savvy enough to understand the financial metrics. The bigger problem is when firms start to use made-up metrics whilst crowdfunding from retail investors that aren't savvy and don't have the right to ask to see the real figures

jonlucc• 11 years ago

I wonder if that kind of thing could lead to the crowdfunding marketplace doing some basic due diligence, though I suspect they don't want the risk.

jackgavigan• 11 years ago

Well, they could require that companies raising money get an audit done. That way, the crowdfunding platform isn't doing the due diligence - they're simply requiring that the company gets an accountants firm to do it. Auditing companies is a fairly common and well-understood process. I would imagine that the market for such services is fairly competitive, so the cost shouldn't be unreasonable.

I think that a problem with GAAP is that, while it's designed to represent a standardised view of a company's accounts, it can be quite complex and isn't necessarily particularly easy to understand, which can end up being counterproductive.

For example, out of curiosity, I went and looked up Hortonworks' Q4 2014 results[1] to see if they had, indeed, reached a $100m run rate by the end of 2014. Two revenue numbers are listed. GAAP revenue was $12.7m and "non-GAAP" revenue was $16.7m. The $4m difference turns out to be a "contra-revenue" booking relating to a Yahoo! warrant (effectively options that were issued to Yahoo!) that became exercisable when the company IPO'd (which was during that quarter). It appears that the Yahoo! warrant was granted as part of a deal in which Yahoo! committed to being a client Hortonworks and, hence, GAAP required that the $4m in cumulative revenue that Hortonworks had received from Yahoo! as a client, be deducted from the revenue for that quarter (even thought that revenue was generated over the course of several years), and that the rest of the $52m "cost" of the warrants (they effectively allowed Yahoo! to buy 3.25m shares for $0.01 per share, versus an IPO price of $16, yielding a "fair value" of just under $52m) be recorded as a cost of sales for that quarter, turning a non-GAAP gross profit of $6m into a GAAP gross loss of $46.2m.

I'm not an accountant but I did do introductory courses in financial accounting and management accounting as part of my MBA, and it took me a good half an hour to fully get my head around that particular adjustment - it's not until you dig into the numbers that you realise that the GAAP loss is the result of a one-off accounting adjustment, and doesn't fully reflect the underlying business. I can imagine that your average retail investor would be somewhat bemused when faced with two very different P&L numbers.

1: http://hortonworks.com/press-releases/hortonworks-reports-fi...

beat• 11 years ago

This entire article is premised on flawed ideas.

First, it assumes that traditional cash flow models of publicly-traded companies are the appropriate measure for startup investment. But seed and VC investors aren't looking for current revenue - they're looking for potential revenue. They're gambling, and quite explicitly so. Most companies will fail to deliver the dream. Investors know this, which is why they limit their exposure in this high-risk field to what they can afford to lose.

Second, it assumes that investors are not savvy, and are easily manipulated by bogus numbers. Every decent investor I've seen has a pretty good bullshit detector. It's one thing to sell them a dream, it's another to sell them snake oil. And if you try to sell snake oil, you'll be passed over in favor of other companies with plausible stories.

rockinghigh• 11 years ago

Valuation models for publicly-traded companies do not use current earnings, they use forward looking indicators based on analysts' estimates like earnings forecast, earnings growth and target price. This is why companies like Amazon, Tesla or Linkedin have such high current price to current earnings ratios. The difference with startups is that future earnings are harder to predict. However, the valuation models should be the same once you've predicted future earnings.

Tech Startups Woo Investors with Unconventional Financial Metrics

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