The Information this morning reported that Headspin, a network performance software provider, restated its revenues — down from $100 million annual recurring revenue to $15 million ARR after an internal audit. It had fired its co-founder and CEO, Manish Lachani. Headspin was also returning $95 million, a hefty chunk of capital it had raised during its most recent financing round. The company’s valuation – $1.16 billion – was going to be revised downwards, to $250 million.
Wow! That is some jaw-dropping revelation and Enron-style skullduggery. And it also reveals rot in the Silicon Valley ecosystem that is far worse than this one company. It also shows that some folks know how to exploit Silicon Valley’s one real Achilles heel — Fear of missing out or FOMO. Here what we have is a scenario that occurs all too often.
Say, you have two or three well-placed people talking up a deal (or a founder.) They tell their network of investor friends to take a look at the company for a potential investment. The words start to fly. And if those two well-placed deal sources have a good track record — aka if they have made some good investments and referrals — the words take on an urgency. The deal gets momentum, and more often than not, investors get overcome with FOMO.
They know that others are knocking on the company’s door with a pot of gold, so they better hurry up. The FOMO leads to looser diligence and bending of rationality. More often than not, the deal gets done by capitalizing on the vanity of the founders. These days Silicon Valley has been afflicted by lunacy, affectionately named after a fictitious being, unicorn. A unicorn in Silicon Valley parlance is a company valued at over a billion dollars. No matter how rational, smart, or intelligent, every founder wants to be the head of a unicorn. Never mind that unicorns are mythical and non-existent in real life.
Since the emergence of the iPhone (and later the smartphone,) we have seen the Silicon Valley ecosystem grow by multiples. Uber, Spotify, Airbnb, and more have upended the old way of doing things. This success has not gone unnoticed by financiers who are always looking for an opportunity to make money.
Whether it is Softbank, Saudis, or hedge funds of all colors and hues — they all see the future, and it is in Silicon Valley. This has resulted in a significant influx of new cash into the system. Add to the mix, a much larger pool of money available to the establishment investors, Silicon Valley ecosystem is awash in cash. Let’s face it. Silicon Valley is growing up and it isn’t the cottage industry of Don Valentine and Arthur Rock. For most of its history, the Silicon Valley ecosystem has worked on a system of trust. Trust as a governor only works when everyone in the ecosystem knows each other and has dependencies.
However, that isn’t the case anymore. The complexity of the ecosystem and divergent incentives means that we have to stop thinking about the old way of doing things and instead come to a basic understanding that Silicon Valley (as a notion) is an asset class. Like all asset classes, it needs to develop a much more rigorous approach to measuring and valuing the companies.
Time and again, we have seen public markets value unicorns — SNAP, Pinterest, Uber, and others — much lower than private markets. It is because they valued these companies using data and audited metrics. If we are going to see more billion-dollar-plus valuations for startups, perhaps there is a need for a more rigorous approach to data and diligence.
If we don’t, what we are seeing with Headspin won’t be a solitary case. Rush to be a unicorn, an excessive amount of cash, too few companies that look like good bets, and FOMO is a witches’ potion of delusion, that often leads to situations like Headspin.