WhatsApp is a cross-platform messaging service that is available on Internet-enabled devices. The app allows users to send messages via the Internet to other users of the app. The big selling point is that it costs 99 cents per year, with no added charges no matter where in the world a user sends a message. Apple, Blackberry and Samsung have similar systems in iMessage, BBM and ChatOn, respectively. Although those apps are included on the phones free of charge users can only send to other users with the same type of device without a fee.1 With iMessage, users can send messages to non-Apple customers but will be charged a text message fee.2 WhatsApp allows users to avoid these fees or additional texting plans, and this money-saving ability just landed WhatsApp’s creators a massive sum of money when Facebook purchased WhatsApp last week.
The creators of WhatsApp were not the only ones who celebrated upon the news of this massive buyout. Sequoia Capital, a large venture capital firm, stands to make an impressive profit off this deal as well. The initial reports indicate that the entire sale was for $19.8 billion dollars, of which Sequoia Capital will receive approximately $3 billion dollars.3 What makes this transaction all the more impressive for Sequoia Capital is that it is getting a return of approximately 50 times its investment in less than 4 years because of a bet it made a few years ago that has paid off substantially.4 Sequoia’s initial investment in WhatsApp was $8 million dollars in 2011.5 They upped that investment to $60 million in 2013.6
This deal exemplifies the incredible upside of a venture capital investment. Sequoia was able to spin a $60 million investment into a $3 billion dollar stake in Facebook.7 Venture capital is a part of investment that is unknown to a lot of people. They have heard the term yet they do not know exactly what these firms do and how they make their money. It is a common mistake in the media and among the general public to use venture capital and private equity interchangeably. It is crucial to understand what exactly a venture capital firm does in order to understand the WhatsApp deal.
Venture capital is the process of a firm putting seed money into a startup with the hope that startup one day, either goes public or gets bought out, and the venture capital firm gets a huge payday.8 A venture capital firm such as Sequoia Capital will seek out startup companies that they believe have huge growth potential.9 The startup will need seed money to realize its potential and that money will come from the venture capital firm.10 The venture capital firm then retains a large ownership of the startup.11 It bets that the company will eventually have a successful IPO or get bought out, thus netting it a massive return on a fairly small investment. Many venture capital firms assume leadership positions in startups so that they can control the companies closely.12 Venture capital firms will make many investments that are relatively small in size with the hope that one of every bunch of deals they make will be profitable.13 According to Fred Wilson, a New York based venture capitalist, out of the 20 to 25 companies his firm will fund, he expects 5 to 10 to fail, 1 to be a home run, 4 or 5 to make solid returns and the rest to be a wash.14 Venture Capital is extremely risky because the companies are unproven; however, as the WhatsApp deal shows, it can reap huge benefits.
Another interesting dynamic has also emerged out of this deal. In 2004 when seeking funding for a secondary company Wirehog, Mark Zuckerberg gave a joke presentation to the board of Sequoia Capital.15 Knowing full well that he was not going to accept money from Sequoia Capital, Zuckerberg still showed up late and gave a presentation on why they should not invest in his company.16 Now after a massive deal that sent $19 billion dollars from Facebook to WhatsApp, Zuckerberg finds himself once again entangled with Sequoia capital. The purchase was made with $12 billion in stock, $4 billion in cash and $3 billion in restricted shares and therefore Sequoia capital is now a very large shareholder in Facebook.17 So in addition to reaping incredible financial awards Sequoia sits in a very strong position with Facebook, whose owner spurned the company nearly a decade ago.
Recently, due to the success of WhatsApp, both BBM and ChatOn have become available as Apps for download on different servers so that customers can reach anyone with the app for free ↩
This fee is covered if you have a text allowance built into your plan, but the plans do not cover international texts ↩
William Alden & David Gelles, In WhatsApp Deal, Sequoia Capital May Make 50 Times Its Money, DealBook (Feb. 20, 2014, 10:22 AM), http://dealbook.nytimes.com/2014/02/20/in-whatsapp-deal-sequoia-capital-may-make-50-times-its-money/. ↩
Valerie Thompson, Sequoia Knows WhatsApp When It Comes to Finding the Exit, DealMarket Blog (Feb. 20, 2014), http://www.dealmarketblog.com/sequoia-knows-whatsapp-when-it-comes-to-finding-the-exit/. ↩
Brian DeChesare, Private Equity vs. Venture Capital, Mergers & Inquisitions, http://www.mergersandinquisitions.com/private-equity-vs-venture-capital/ (last visited Feb. 27, 2014). ↩
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Nicholas Carlson, The Story of Sequoia Capital’s $6.4 Billion “Revenge” on Mark Zuckerberg, Slate (Feb. 20, 2014, 12:43 PM), http://www.slate.com/blogs/business_insider/2014/02/20/facebook_whatsapp_and_the_return_of_sequoia_capital.html. ↩
Ari Levy, et al, Sequoia Capital Set to Make 3.5 Million Backing WhatsApp, SFGate, (Feb 20, 2014, 2:33 PM), http://www.sfgate.com/business/bloomberg/article/Sequoia-Capital-Said-to-Make-3-5-Billion-Backing-5253171.php. ↩
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