@Twitter #IPO: Startup Economy 101 and Internet Billionaires

September 18, 2013 Updated: September 18, 2013

Twitter announced its plans for an IPO last week and ignited a maelstrom of news stories—and tweets—trying to predict its revenue, IPO valuation, share prices, and market valuation.

Whatever those numbers are, it is clear that Twitter will have one of the largest IPOs in recent history, eclipsed only by Facebook a few years ago. And some of its founders and early employees will become billionaires, and some millionaires.

And a question could be asked: how do Internet companies like Facebook and Twitter grow so fast and produce Internet billionaires in just a few years? 

IPOs and Acquisitions

Most Internet startups these days gun for one of two “exits” to happen: grow really, really big (like Facebook, Twitter, or LinkedIn), and file for a multi-billion dollar IPO, or grow large enough and get enough traction for a several-million dollar (or maybe billion dollar) acquisition. Of course, there are smaller IPOs as well, as well as companies that want to simply do the traditional thing that companies are supposed to do: make revenue slowly and steadily.

The startup Internet economy is especially helped by easy access to capital from angel investors and venture capitalists (VCs). Fueled by a frenzy of increasing use of consumer and enterprise web-based software in day-to-day life and the ease of attracting a large customer base on the Internet with smaller capital, investors and VCs are flocking to fund the Next Big Thing.

Here’s how it works: let’s say a couple of college kids in dorms start up an Internet project (either customer-facing like Facebook or enterprise-facing like Salesforce). The project is nicely done and is easy to use and starts to get traction and a growing number of users. At this point, the founders have a choice: keep growing it with their own money (bootstrap) or get funds from investors: in the range of $100,000 to $1 million from angel investors at the start, and anywhere from $1 million to $10 million in funding in future rounds from VCs. Most founders would happily take the money and dilute their ownership because the money helps them grow their team and company far faster than they could do without access to capital.

And if the product is really popular and made a splash in the media, VCs are probably falling all over themselves at this point to fund the company. But why would anyone be happy throwing money at a startup—especially a company that in its early years is likely to be burning cash?

Billion-Dollar Exits

The biggest reason the Internet industry (especially Silicon Valley) is flush with capital backing startups is due to company ownership and exits that are multiple times that of the initial investment.

Say that it is 2006, and a founder named Ev Williams e-mails Charles River Ventures asking for $250,000 in funds to start up a company called Twttr (yes, it was indeed called that), in exchange for a 1 percent ownership in the company. You, Charles River Ventures, do a background check on Ev Williams, and find that he’s just sold his previous startup, Blogger, to Google for a small sum. Great, you think, this guy’s legit startup material, so you approve the funding and get the 1 percent ownership. (Your VC probably also has several million dollars in funding to fund other companies.)

And Twttr (now Twitter) grows bigger. And bigger. And bigger! And finally goes public with an estimated 300 million users and $500 million annual revenue at a $10 billion valuation. 

Whoa, your one-percent ownership is suddenly worth $100 million dollars! That’s a 400x return on investment! It doesn’t matter if you invested in 19 other companies for $250,000 each, and those companies all failed—Twitter’s still given you an overall 20x return on investment!

Ev Williams and his co-founders are probably not doing badly, either, eh? True, they got the initial money from angel investors and VCs to build the company, but they still did most of the work building the team and product, and own a majority of stock. Assuming Twitter founders Ev Williams, Biz Stone, and Jack Dorsey each own between 10 percent to 20 percent of the company, they are still worth anywhere from $1 billion to $2 billion each at this point.

And that’s what fuels the mad dash to build the next big Internet startup—as well as to fund it. Startup founders with a gleam in their eyes and with a product that can gain traction can quickly build products in Internet time that can scale massively and get a large audience and users, and savvy investors looking to get in on the action early and looking for a massive return on investment can make small investments in 10 or even a 100 companies, and hope that one single sparkling success—whether through an acquisition or public offering—will get them a huge return on investment.