An investor earning a return generally requires that present value does not account for all of the future profits. The parent I replied to claimed the exact opposite, that a valuation is based on all future profits.
For the investor ideally none of the future profits are captured in the present valuation. It's the battle between that position, and the company's desire to get as much capital for its equity as possible, that reaches the valuation.
Maybe what he meant is: If the future profits of AirBnB were known perfectly now, then their valuation should be the present value of all future profits as otherwise there is an arbitrage opportunity.
Since the future profits are not known perfectly, investors assume some risk, so the valuation is lower than the present value of all future profits, so that investors get rewarded for assuming this risk.
That first paragraph is what I meant. But the second paragraph is not quite how I understand it.
The risk is entirely down to the accuracy of the estimation of future profits. If there are only two VCs in the market and they both estimate the same cashflow, rational economics says they will both out bid school other down to the last cent of Present Value.
Of course that is not a realistic scenario, but I just want to be clear, and maybe folks were not implying it, but there is no "reward for risk taking". There is only a difference in estimated cashflow and a market that does or does not have high competition.
The more competition, as in SV VC world it seems, the closer a VC must pay to the estimated future cashflow. Which in cases of Uber or airbnb is frigging vast or nothing.
I think nothing to be quite honest but that's another post.
> If there are only two VCs in the market and they both estimate the same cashflow, rational economics says they will both out bid school other down to the last cent of Present Value.
Is this true in the presence of other investment opportunities. Suppose I estimate the present value of AirBnB's future profits as $30B plus/minus $10B, and I'm given a chance to invest at a $25B valuation. I also estimate the present of Dropbox's future profits as $30B plus/minus $1B and I'm given a chance to invest at a $25B valuation. Are you saying that I should be indifferent to which investment I choose?
Well no, but that does not change the game in whichever bid you do choose to participate in (and let's assume you will participate in at least one bid somewhere, and that bid will also have competitors)
At some point you will compete for the asset, and you and your competitor will have estimates of future cashflow and you will logically be willing to go down to the last cent before giving up (well the last cent, discounted etc etc)
The point is, profit is not a right of investment.
But the game investors play isn't "choose a company/asset class to invest in, and then compete with other bidders". While I'm competing with the other bidders I can take my money and invest it elsewhere.
So if we're really competing over the last cent an investor would logically think "my expected profit on this investment is now low enough that it makes more sense to take my money and buy government bonds instead, which offer the same expected profit but lower risk".
I see your point now. I respectfully suggest that the valuation of a company is intended to represent the discounted summation of future cashflow, and in a highly competitive marketplace that valuation is intended to reach the summation of those market place participants who estimate the cash flows to be the highest (without presumably deliberately intending a loss to themselves)
I cannot see any other way to price it (well lots of ways to estimate future cashflow and even define cashflow) but there is not some agreed amount of discount for risk out there. Yes people will always want such a discount, and can walk away. But the discount does not start with a figure and work downwards. It's only a discount in hindsight as it were.
Imagine if you will a hotel in NY that has one room, 100 USD per night and is going to be knocked down in 100 days time. I would only expect to pay a maximum of 10000 USD to buy the hotel. Any more would be obviously foolish. Present value plays some part but mostly estimated occupancy drives the expected cashflow.
But also if I demanded a discount for the risk that the hotel might not pay back my investment, there is likely to be some other investor who has a different view on the Hotel scene in NY. Especially for the "ultimate in boutique experiences". No one will pay more than 10,000 but how close we come is (should be?) determined entirely by investors estimates.
I do not think that the main driver of valuation is that between VCs and the founders. That is admin work. The driver of the price paid by a VC is how much other VCs are willing to pay instead.
That seems a good thing to me.
Thank you for the comments - good to think these through.
For the investor ideally none of the future profits are captured in the present valuation. It's the battle between that position, and the company's desire to get as much capital for its equity as possible, that reaches the valuation.