For early investors in social-media companies, the past year's high-profile initial public offerings have generated epic windfalls. Since early 2011, venture capitalists and executives have cashed out to the tune of billions of dollars. The most prominent insider so far is Peter Thiel, an early investor in Facebook, who sold some 20 million shares--worth about $400 million--after the three-month lock-up period preventing insiders from selling their shares ended. That brings Thiel's total Facebook cash haul to over $1 billion.
For public investors who participated in the IPOs, however, these social-media giants haven't been anywhere near as lucrative. Following the insider cash-outs, Facebook shares are worth half their IPO price. Zynga shares have plunged by nearly 70%, and Groupon shares have plummeted by more than 80%. Wall Street giant Morgan Stanley was the lead underwriter in each of these IPOs.
So what explains the massive post-IPO declines? The market for technology stocks has changed dramatically since the dotcom crash of 2000. Start-ups are raising more money, in several rounds of investment, right up until they go public. With each round, a stake in the company gets more expensive, boosting valuations to sky-high levels. Facebook went through no fewer than 10 angel-investment and venture-capital rounds; Zynga had seven; Groupon, six.
Those early investors can then trade their insider shares before the IPO on private exchanges like SecondMarket, open only to accredited investors who make over $200,000 a year or are worth $1 million or more. The rise of these pre-IPO secondary markets has caused valuations to soar even higher.
By the time Facebook, Groupon and Zynga went public, their valuations were so high that there was no more upside for public-market investors. All the upside had already been captured by deep-pocketed insiders. There was, however, plenty of remaining downside.
Not every hot social-media company goes public. The microblogging service Tumblr, for example, remained private even after reaching a valuation of $800 million. It seems intent on taking a slow-growth path and cultivating its legion of loyal users. Instagram positioned itself to get "acqui-hired" by a bigger company. Facebook acquired the photo-sharing service for $1 billion early this year and, as part of the deal, hired its top execs.
App.Net, on the other hand, took its case to the people. The social-networking service raised $500,000 in less than a month through crowdfunding, with member fees from thousands of users going to finance its early development. Designed to be free of ads, the service is a reaction against Facebook. If it succeeds, its financing could be as well.