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The Complexity of Valuing Emerging Technology Startups

Understanding Valuations: The Challenges of Early-Stage Tech Investments

When discussing valuations of emerging technology, determining what a figure like $10 billion is based on can be elusive. Early-stage technology investments often involve a significant degree of uncertainty. There’s a leap of faith where potential returns might suggest a startup could grow from a modest valuation of $150 billion to something as remarkable as $2 trillion, akin to industry giants like NVIDIA or Facebook. It’s a difficult scenario to evaluate, especially as traditional valuation methods fall short at these early stages.

Key Metrics to Evaluate Startups Without Cash Flow

In your book, you detail how early-stage companies often lack cash flow, making revenue multiples less reliable. Instead, metrics like gross merchandise value (GMV) become essential. For example, if a consumer buys a $100 item on Amazon, that’s the GMV. Amazon might only see a 10% profit from that sale. High GMV does not always translate to profitability. Red flags emerge when investors extrapolate revenue growth indefinitely without solid profit projections. Such assumptions can create a false sense of security in valuations.

The Emotional Undercurrents of Investment Decisions

Experience shows that investment trends often sway with herd mentality. This response can resemble impulsive behavior, even among seasoned bankers who are expected to analyze investments with cold precision. Emotional reactions to investments, regardless of market position, remain a constant challenge. Drawing on historical lessons, Charles Mackay’s work illustrates how investors have fallen into frenzy with speculative bubbles, such as the infamous tulip mania and the railroad speculation in 19th-century England. Personal anecdotes from nearly 40 years in the market confirm that even experienced investors can get swept up in the excitement.

The Shift from Public to Private Markets

The differences in market behavior illustrate key shifts. Unlike the tech boom of the early 2000s, when companies were taking on enormous valuations without revenue, today’s market shows more discipline despite some frothiness. In 2021, there were around 1,100 IPOs, with nearly 600 being SPACs. Many of those SPACs faltered, underscoring the risks involved. History suggests it can take years for the IPO market to recover from such missteps. A company like NVIDIA, currently trading at 35-40 times earnings, reflects a more rational approach than the exorbitant valuations seen during earlier market cycles.

Why Private Market Investment Trends Lag

Private markets may experience more pronounced bubbles than public ones. Investors often feel regret not over unsuccessful investments but over missed opportunities that yielded extraordinary returns. Leaders in venture capital, such as Masa Son, are recognized for their ability to identify emerging trends, especially in sectors like AI, which is rapidly changing productivity in the enterprise setting. However, skepticism remains regarding the transformative potential of AI at the individual user level, a notion still in development.

Investing in AI: The New Frontier

Technology investors like Warburg Pincus demonstrate the need to focus on sectors with significant potential for growth. With limited avenues for investment in AI, making calculated, strategic decisions is crucial as the landscape evolves. For venture capitalists, missing the opportunity to invest in transformative technology is a risk linked to the rapid pace of innovation.

Assigning Value to Intangible Futures

Valuing future innovations, especially ones linked to concepts like the singularity, is challenging. While the excitement around these ideas is palpable, determining an exact price tag remains elusive. The journey through investing, particularly under the vision of leaders like Masa Son, emphasizes an idealistic approach in technology investments, seeking a balance between optimism and pragmatism.

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The Visionary Genius of Masa Son: A Legacy of Innovation and Investment

Redefining Technology for Human Wellbeing

Once a pioneer in technology, Electric was founded by Thomas Edison. Its impact on modern life, such as through light bulbs, is undeniable. Masa Son echoes this sentiment, emphasizing technology’s potential to enhance our lives. His discussions on happiness may lean philosophical, yet they reflect a core drive to harness tech for the greater good. I recall the first time I met him; he introduced me to Pepper, an AI-driven robot designed to serve as a companion in Japan. This initiative addresses a critical issue of loneliness in an aging population, illustrating a commendable effort to improve lives.

The Complex Nature of AI Relationships

Recently, I spoke with Nate Silver, who likened AI to an elaborate casino. The use of robots like Pepper highlights a growing trend where people form emotional bonds with AI, reminiscent of the film “Her.” As we explore investments, I wondered whether our criteria extended beyond financial returns to include their contributions to societal happiness. Did those aspects arise during preliminary evaluations or only during the final investment discussions?

Masa Son: A Forward-Thinking Investor

To put it briefly, no, happiness metrics were not part of our investment process. However, Masa Son is a unique figure; he proclaims himself a “crazy guy living in the future.” Unlike traditional investors, he doesn’t equate investing with gambling. He instead perceives risk through a forward-thinking lens. His track record speaks volumes; he supported Alibaba by understanding the potential of e-commerce in China. One of my favorite Masa Son stories illustrates his brilliance. In 2005, well before the iPhone’s release, he sketched a concept for a smartphone and shared it with Steve Jobs. While Jobs initially dismissed him, their casual discussion eventually led to Son investing nearly $20 billion in a struggling Japanese company. When the iPhone launched in 2007, Son received the exclusive rights to sell it, leading to incredible profitability—nearly $40 billion when the company went public. Other successes include $100 billion with Arm and $75 billion with Alibaba, showcasing his knack for spotting opportunity in the tech landscape.

Navigating High-Stakes Relationships

Meeting Masa was facilitated by a mutual friend, Nikesh. Understanding his genius requires a keen intuition. In my role as a banker, making wealthy individuals feel valued and understood is crucial. CEOs often prefer genuine conversation over sales pitches. My strategy is to engage them in a casual manner, allowing them to express their thoughts while I listen attentively, hoping they leave feeling connected.

The Dynamics of Collaboration

With Masa Son, the need for persuasion is minimal; his visionary thinking speaks for itself. He once challenged my approach, urging me to adopt a more assertive, ‘hunter’ mentality instead of my more methodical style. I recognized that many people around him act as facilitators, supporting his expansive vision. This unique quality of foresight is something I admire but cannot replicate, making me view him with a blend of skepticism and reverence.

The Illusion of Power in Investment

My book discusses power and its complexities. While wielding control over billions may seem powerful, I contend that real power can often be illusionary. I recount an encounter in London’s Claridges Hotel, reminding two executives that control is fleeting at best. My experiences with Masa Son also underscore this notion, particularly during the controversial WeWork investment, where I felt overwhelmed by the persuasive nature of Adam Neumann. It raised questions about the true nature of influence in high-stakes environments.

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The Ripple Effects of SoftBank’s Investment Strategies

Analyzing Masa Son’s Approach to Venture Capital and its Impact on the Industry

Ricky Mulvey: Recently, I faced personal challenges, losing both my parents and my dog in a short span. This experience reminds me that the belief in controlling our lives is often an illusion, a reflection on life rather than a financial insight. Shifting to the case of WeWork, Adam Neumann presents a captivating narrative. A film has even been made about him, starring Jared Leto, who delivers a compelling performance. Neumann himself acknowledged that he holds more blame in the matter than anyone else might. In venture capital (VC), losses are inevitable. Although SoftBank reportedly lost $10 billion on WeWork, which is significant, they made $100 billion on Arm. In the end, that trade-off seems worthwhile.

Ricky Mulvey: I’d like to focus on the philosophical angle for a moment. There are different types of power to consider. One form is the inability to control natural events, such as illness. Then there’s the power derived from causing others to act, exemplified by the billions invested in WeWork and chip companies. When these investments translate into perks like free Uber rides, it’s evident that SoftBank’s influence is considerable, shaping the market profoundly.

Alok Sama: Absolutely. SoftBank’s impact on investment practices in Silicon Valley is monumental. In my book, I discuss how Sequoia Capital has dominated the landscape, supporting major tech success stories. I’m an avid golfer, and I liken a meeting with Doug Leone, Sequoia’s managing partner, to Bobby Jones witnessing Jack Nicklaus play—an inspiring moment that highlighted the transformative nature of Masa Son’s Vision Fund. Before Masayoshi Son’s entrance, billion-dollar VC funds were scarce; Sequoia’s largest fund was around $2 billion. Suddenly, when the $100 billion fund emerged, it dwarfed the previous year’s total VC investments of $70 billion. This shift was indeed groundbreaking. We earlier touched on OpenAI and how these large funds necessitate substantial capital deployment, influenced partly by SoftBank and current economic theories about money supply.

Ricky Mulvey: The relationship between Sequoia and SoftBank wasn’t always smooth. Sequoia expressed frustration regarding SoftBank’s inflated valuations and the competition for funding smaller companies. This might seem beneficial on the surface—more money usually equals higher valuations—but it’s not always that straightforward.

Alok Sama: True. Sequoia’s concerns were rooted in issues of power and control. Traditional VC investments involve closely monitored capital allocation through board participation and milestone-based funding. Masayoshi Son adopted a different philosophy, treating entrepreneurs like cherished partners. He would go so far as to attend weddings of founders like Radesh, reflecting a deep, personal approach to investment. Son’s perspective introduced a level of engagement that many traditional VCs found difficult to navigate.

Ricky Mulvey: Let’s discuss the aspect of selling in investment, which many of our listeners ponder. You noted, “While Masa had an impressive track record investing ahead of technology mega trends, he frequently held on too long.” What led you to this observation, and what lessons does it convey about investment timing?

Alok Sama: That statement emerged around the midpoint of my observations. For instance, Masa’s stake in Yahoo peaked at $30 billion, but he ultimately sold it for only $7 billion— a substantial loss. The same happened with Alibaba, where the peak stake was near $200 billion, but he sold it for $75 billion. These are still incredible success stories, but timing can dramatically change outcomes, revealing that trading skills differ from other investment strategies.

Ricky Mulvey: Conversely, we should consider Nvidia. SoftBank initially missed an opportunity to invest but later realized significant returns. What influenced the decision to sell Nvidia?

Alok Sama: That’s an insightful question. Looking back to early 2017, Masa sought to acquire Nvidia for $80 billion. However, regulatory hurdles prevented that deal due to security concerns, as acquiring a key AI player raised alarms. Instead, he invest in the fund. This approach, though lucrative, highlights a shift in mindset; if he’d held onto the investment directly, the potential returns could have multiplied beyond four or five times.

Ricky Mulvey: Did the fund’s structure, including the 7% dividend payout to investors, contribute to the decision to sell Nvidia? This is uncommon for technology investments that typically aim for major growth.

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Insights on Investing Strategies from Alok Sama

The Role of Limited Partners and Dividend Pressure

Alok Sama: The division fund was truly unique because it included a layer of leverage from the limited partners. Mainly investors from Saudi Arabia and the United Arab Emirates contributed capital through mezzanine financing. This arrangement provided a 7% cash dividend, requiring the fund to pay out cash, thereby exerting pressure to realize liquidity. Therefore, when liquidation opportunities arose, it was in the fund’s best interest to act quickly.

From CFO to Senior Advisor: A Shift in Power Dynamics

Ricky Mulvey: Earlier, you mentioned being labeled as a cook rather than a hunter during a dinner conversation. Your position at SoftBank changed significantly around 2019 when you transitioned from president and CFO to senior advisor. When did you first notice your role diminishing?

Alok Sama: That change happened rather quickly. Once I became a senior advisor, it felt like I was pushed out. The negotiation to exit the vision fund was essential for me. Although I was excluded from the fund’s exciting developments, I remained involved in several other projects. For example, I oversaw the merger of Sprint with T-Mobile. Despite my engagement elsewhere, SoftBank’s attention was fixed on the vision fund. This situation certainly marked the beginning of my feeling sidelined.

Lessons Learned in Timing the Market

Ricky Mulvey: Shifting gears, what insights did you take from your time at SoftBank about when to sell? How have these experiences shaped your current investing strategy?

Alok Sama: I’ve learned that while bulls and bears can profit, greedy investors may face losses. When I see gains of two or three times my initial investment, I usually exit. However, in the technology sector, that mindset may not be beneficial. Successful tech investors should aim for extraordinary returns, sometimes envisioning potential growth of 100 times their initial investment. Take Masa Son and the Alibaba venture, for example; starting with a $40 million investment and realizing $75 billion is remarkable. Criticizing him for not reaching $200 billion would be unjust. Personally, my conservative perspective stems from planning for retirement. For tech investing, it’s critical to back your successful ventures. This is why firms like Sequoia created separate funds, allowing investors to hold their positions longer, instead of cashing out prematurely.

The Creative Journey Behind Writing

Ricky Mulvey: Let me mention your book, “The Money Trap: Lost Illusions Inside the Tech Bubble.” You wrote it without a ghostwriter. It’s incredibly well done.

Alok Sama: Contrary to what some might think, I didn’t set out to write this book initially. I have a passion for writing and spent two-and-a-half years at New York University to earn an MFA. My writing process started off as an exploration, and ultimately, this book emerged from that journey. It’s been a project I deeply care about.

Final Thoughts and Gratitude

Ricky Mulvey: It’s beautifully written, filled with engaging stories. I’ve gained valuable insights for my investing approach. Many business figures delegate their memoirs to ghostwriters, but your book feels personal and authentic. Thank you for sharing your time and insights.

Alok Sama: Thank you, Ricky.

Mary Long: As always, individuals on the program might hold interests in the stocks discussed. The Motley Fool may have specific recommendations for or against these companies, so don’t rely solely on this discussion for investment decisions. I’m Mary Long. Thank you for listening. See you next week, Fools.

Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool’s board of directors. Suzanne Frey, an executive at Alphabet, is also on the board. Mary Long holds no positions in any mentioned stocks. Ricky Mulvey owns shares in Meta Platforms. The Motley Fool has positions in and recommends Alphabet, DoorDash, Lemonade, Meta Platforms, Microsoft, Nvidia, Opendoor Technologies, and Uber Technologies. They also recommend Alibaba Group and suggest long January 2026 $395 calls on Microsoft and short January 2026 $405 calls on Microsoft. Please refer to The Motley Fool’s disclosure policy for more details.

The views and opinions expressed herein are solely those of the author and do not necessarily reflect those of Nasdaq, Inc.