What Entrepreneurs Should Learn From WhatsApp

Facebook’s acquisition of WhatsApp for $19 billion has dominated all news in Silicon Valley for the past 48 hours.  Yesterday, I was at a urinal, and a group of people asked me what I thought.  Most of the discussion seems to be around whether Mark Zuckerberg was crazy to pay so much for a relatively simple messaging app.

To save time, here’s my take on the WhatsApp acquisition, and perhaps more important, what entrepreneurs can learn from it.

1. Is Mark Zuckerberg crazy to pay $19 billion for WhatsApp?

I’m not sure.  $19 billion is a lot of money for a simple messaging app, even if it has 450 million active users.  According to what I’ve read, WhatsApp had revenues of $20 million in 2013.  That means Facebook paid 950 times trailing revenues for WhatsApp.  In case you’re wondering, Facebook trades at 22 times revenues.  It will take a lot for WhatsApp to justify that acquisition price.

2. Why did Zuckerberg pay so much for WhatsApp?

Here I’m on firmer ground.  I understand both why Zuckerberg was willing to pay, and why he was willing to pay so much.

Zuckerberg was willing to pay for WhatsApp because he couldn’t afford to let Google acquire WhatsApp.  Google’s social initiatives are dead in the water, and aside from Android, so are its mobile initiatives.  Acquiring WhatsApp would instantly have placed Google in a powerful position in social, mobile, and photos.  Zuck wasn’t afraid of WhatsApp as an independent company, he was afraid of WhatsApp as a part of Google.

Don’t forget, Google was criticized for paying $1.6 billion for YouTube.  But doing so kept any of its rivals from owning online video, and if Google were to spin out YouTube today, it would probably sell for well North of $19 billion.

Zuckerberg was willing to pay so much for WhatsApp because WhatsApp held the advantageous ground in the negotiation.  WhatsApp’s revenues were $20 million in 2013, and were going to skyrocket in 2014 (more on that later).  It also had tens of millions of Sequoia’s cash still in the bank.  It didn’t need to sell.  That meant that if you wanted to buy WhatsApp, you needed to make an offer they couldn’t refuse, and preferably an offer that would preempt a bidding war.

Google had already offered $10 billion for WhatsApp; $19 billion represented a “Godfather” offer that WhatsApp would take without shopping around.

3. What lessons should entrepreneurs learn from WhatsApp?

A. Traction is everything.

WhatsApp, as many developers had repeated to me in a dazed voice in the past few days, is a simple messaging app.  Its technology is nothing special.  It’s valuable because it has 450 million active users and a monetization strategy that seems to be working.

B. Don’t raise money until you have to.

While WhatsApp raised a healthy $58.3 million from Sequoia, the bulk of that came last year, after the company had already demonstrated traction.  WhatsApp raised $250K as a seed round, then $8 million in a Series A 18 months later.

As a result, the founders Jan Koum ($6.8 billion) and Brian Acton ($3.2 billion) owned over half the company at the time of the sale.  A more typical stake after raising multiple rounds might be 10-20% for all the founders.  That would still leave the founders as billionaires, but it’s way less than what they earned thanks to their careful capital efficiency.

C. Stay lean.

WhatsApp had 55 employees.  Why would they need to bloat themselves with more?  And staying lean allowed them to conserve capital and show the path to profitability that forced Facebook to overpay.

4. WhatsApp’s $19 billion business model

The thing that impresses me the most about WhatsApp isn’t the acquisition price, but the fact that they may have pioneered a new business model.

WhatsApp is free for the first year, and $1/year thereafter.  That means that with 450 million active users, they were going to see their revenues skyrocket from $20 million into the hundreds of millions in 2014.

This is a brilliant new business model for mass consumer apps–it’s effectively free, because no one cares about paying $1 a year from now, but it also provides a great deal of revenue certainty.

$1 is small enough that no active user will hesitate to pay, but large enough (given the adoption) to build a massively profitable business.

It wouldn’t surprise me to see this business model get adopted by a lot of future consumer apps!

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