Market Valuation 101

Caught up with the heated debate on Facebook’s market valuation (courtesy of GigaOM)

So is Facebook really worth $23 billion, or $33 billion? The short answer is that it depends on what you mean by the term “worth.” David Heinemeier Hansson, co-founder of software developer 37signals, argues in a blog post that it’s absurd to say that the social network is worth that kind of money in any real sense, because it isn’t publicly traded the way that stocks such as Google are, so there’s no easy way to determine its actual value as a company. He also argues that the company’s worth is vastly inflated based on the revenue people estimate that it’s pulling in.

In a heated response at Y Combinator’s Hacker News site, however, software entrepreneur Joel Spolsky takes issue with Hansson’s argument. There is a very active market for shares of Facebook, he notes, through services such as SecondMarket, which specialize in trading the restricted stock of private companies such as Facebook and Zynga (which is reportedly worth as much as $5 billion based on the activity in that market). So Facebook is worth $33 billion in the same sense that Google is worth $165 billion, Spolsky argues (there’s also a lot of back-and-forth in the YCombinator comments about the relative merits of Chicago — where 37signals is based — vs. Spolsky’s home of New York, but we’re leaving that part out).

In reality, of course, every economist knows that things are only worth what people will pay for them, and since no one has actually paid $33 billion for Facebook, we shouldn’t really say that it is worth that much, or that Zuckerberg is worth $6.9 billion. But then, no one has paid $165 billion for Google either. The fact is that market valuations — whether private or public — are really just a convenient method of tracking what some people are currently willing to pay for a small chunk of the company. It may not be totally realistic (in fact, an acquirer would likely have to pay much more than just its $165-billion market cap in order to buy Google), but it is the way things are done, and by that rationale, Facebook has just as much claim to its “worth” as Google does.