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What Facebook's IPO Debacle Means for Startup Funding The disastrous Facebook initial public offering isn't likely to damp venture-capital interest in tech startups.

By Peter S. Cohan

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What Facebooks IPO Debacle Means for Startup Funding

Facebook defied expectations of a boffo IPO. But does its disastrous outcome spell doom for startups seeking funding? Not at all.

Facebook stock has lost 25% of its value since it went public May 18 at $38 a share. Investors took a look at its price/earnings ratio of 104 and decided that since its earnings had fallen 14% in the quarter before and General Motors had decided to pull its $10 million advertising account, Facebook was not worth $104 billion.

If its earnings grow at the 22% forecast over the next five years, the stock is worth $8 a share -- at May 29's $28, that leaves plenty of money for short-sellers to scoop off the table.

And even though Facebook did not soar to $100 on its first day, venture-capital firms that invested early made billions in profit. Top-dog Accel Partners took in an estimated $1.8 billion that day. So there is even more money sloshing around Silicon Valley looking for a home in a rapidly growing start-up with a great chief executive.

Facebook's busted IPO is at worst a cautionary tale for other companies that would aspire to an IPO. And the lesson is to set the offering price low enough so that investors in the IPO can make money after the first day of trading.

And following the busted Facebook IPO, two companies decided to pull their IPOs but two others are still on track. One of the on-track ones, Palo Alto Networks, offers a winning product in an attractive industry – and that's what IPO investors want. The ones that postponed their IPOs -- Kayak and VKontakte -- may have realized that they are not yet ready to meet the higher standards that Facebook's busted IPO has signaled, meaning a well-developed business model reflected in solid revenue and profit growth. (By the way, VKontakte's CEO recently delighted in watching people fight over the money-paper airplanes he tossed out his St. Petersberg office window.)

Pricing even a hyped IPO low enough for investors to profit on the first day of trading can be done. In 2004, for example, Google went public at $80 and closed the day at $100. Thanks to triple-digit earnings growth, that was still a low price. Google ended 2004 at $196.

Related: What the SEC Crackdown on Secondary Markets Means for Startups

So how can your start-up get a piece of that cash? As I write in my forthcoming book, Hungry Start-up Strategy: Creating New Ventures with Limited Resources and Unlimited Vision, you must persuade a VC that your venture targets a market that's small now but will get big fast. To do that you have to answer these four questions in the affirmative:

  1. Can the start-up offer competitively superior customer value and generate revenues?
  2. Will rapidly growing technologies, business models, or social changes boost demand?
  3. Do potential customers have a big problem that no companies are solving?
  4. Are leading companies and technologists working to solve the problem?

What's more, you'll need to show that your company will dominate that market because you are a great CEO. To do that you must persuade the VC that you:

  • Have superior industry knowledge and a compelling vision for your start-up's future.
  • Have a winning track record and the passion to keep winning.
  • Are smart, curious and a doer of frugal, fast experiments.
  • Can identify and manage business risk.
  • Have charisma, integrity and the ability to attract, hire and motivate top talent.

If you can do this, all you have to do is get a "warm introduction" to the VC -- through an intermediary who the VC trusts and who knows you well. Then you need to survive a rigorous screening process that gives you a two in 1,000 chance of winning a share of that VC cash.

Related: What Makes Facebook Worth So Much

Peter S. Cohan

President of Peter S. Cohan & Associates

Peter Cohan is president of Peter S. Cohan & Associates, a management consulting and venture capital firm. He is the author of Hungry Start-up Strategy (Berrett-Koehler, 2012) and a full-time visiting lecturer in strategy at Babson College in Wellesley, Mass.

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