Understanding marketcaps and valuations

[paxmao]

Valuations of this kind must be carefully understood. For example, you call unicorns to new companies that reach a valuation of 1 Billion. That does not mean that someone has actually paid 1 billion for it, as the fact of reaching a marketcap of 1B does not really mean that someone would buy 100% of the project for that price.

How does this really work then? Easy to understand with this example:

You create a company with venture capital. The owners and the team have 100% of the shares and there is no real valuation of the company at that point. Your company is doing great in growth, but, as usual, it is burning through money. The owners decide to raise more money. It could by by floating, IPO or a financing round - does not matter for our example.

The owner manage to get a deal selling 5% of the company for 50M USD. The valuation of the full company at this point, since there is only one deal, is set at 5% for 50M, thus 100% (all the company) is valued at 1 Billion. That´s it, it is "an unicorn".

You have probably noticed that this is not fully true. This means that someone has effectively valued the company at 1B and paid a 5% of the share at that price, but this does not mean that anyone would be ready to pay 1B for it or that other people would offer the same valuation.

This is the same when a project floats a small amount of crypto. The price may get very high if there is not that much liquidity and many people want to a have a bit, but saying that is the real value is a long shot.

[arabspaceship123]

People new in cryptocurrency can jump in when they're following the hype but they don't always understand the economical circumstance. I'm sure your post will be helpful for new investors in cryptocurrency.

[Zilon]

You create a company with venture capital. The owners and the team have 100% of the shares and there is no real valuation of the company at that point. Your company is doing great in growth, but, as usual, it is burning through money. The owners decide to raise more money. It could by by floating, IPO or a financing round - does not matter for our example.

Valuation must first be built buy a team with dedicated effort and fund sourcing to keep the dream burning. But after creating this venture capital how would this each participant take a share in ROI.

The owner manage to get a deal selling 5% of the company for 50M USD. The valuation of the full company at this point, since there is only one deal, is set at 5% for 50M, thus 100% (all the company) is valued at 1 Billion. That´s it, it is "an unicorn".

You have probably noticed that this is not fully true. This means that someone has effectively valued the company at 1B and paid a 5% of the share at that price, but this does not mean that anyone would be ready to pay 1B for it or that other people would offer the same valuation.

You mean the valuation depends on the bid price of the biggest investor at the moment how about the other small players don't their share add value to the market capitalization as well?

[just_Alice]

Great explanation. The important thing that can be derived from here is the danger that comes with too high valuations. Greedy businessmen like to set very high valuations because they only think of the number they see, but don't think of the difficulties it would take to reach that number.

Initially, the high valuation might create hype and some investors would buy it, though the serious ones will most likely be skeptical. But along with that, high expectations come and if the company doesn't fulfill the hopes - everyone will start to look at the company as a failure and, at this point, attracting new investors will be very difficult.

[paxmao]

You create a company with venture capital. The owners and the team have 100% of the shares and there is no real valuation of the company at that point. Your company is doing great in growth, but, as usual, it is burning through money. The owners decide to raise more money. It could by by floating, IPO or a financing round - does not matter for our example.

Valuation must first be built buy a team with dedicated effort and fund sourcing to keep the dream burning. But after creating this venture capital how would this each participant take a share in ROI.

The owner manage to get a deal selling 5% of the company for 50M USD. The valuation of the full company at this point, since there is only one deal, is set at 5% for 50M, thus 100% (all the company) is valued at 1 Billion. That´s it, it is "an unicorn".

You have probably noticed that this is not fully true. This means that someone has effectively valued the company at 1B and paid a 5% of the share at that price, but this does not mean that anyone would be ready to pay 1B for it or that other people would offer the same valuation.

You mean the valuation depends on the bid price of the biggest investor at the moment how about the other small players don't their share add value to the market capitalization as well?

Mmm.. more or less. Valuation is not really value, but rather the price that someone puts to having a share on a company or project. Value is the intrinsic utility or the increment in utility over that of the raw components (value added). So the team, the community, the apps, even the hype builds value, but not the valuation.

So I mean that assigning a price to a company or project based only of the highest bid for just a partial acquisition is not really correct, that is irrespective of small or large players.

... everyone will start to look at the company as a failure and, at this point, attracting new investors will be very difficult.

Certainly, that is a problem in these cases, because many times the buyer includes a clause by which the stock cannot be later sold to others at a lower price.

[The Sceptical Chymist]

Paxmao, I understood your example but I'm afraid people reading it might come away with the impression that this is the case with every company--and it's not.  It could be the case that only 5% of shares in a privately held company could give that company a $1 billion valuation, but there are companies whose valuation is lower than what they're actually worth--and those are the types that investors like Warren Buffett likes to invest in (and invariably they're not the "unicorns" of Silicon Valley that I think you were referring to). 

With a company that's gone public, it's pretty simple.  The market cap is the value of all the outstanding shares, and that's how most people put a valuation on the company.  But there are other ways to do so, e.g., by looking at its breakup value, or how much money could be gotten out of it by breaking it up and selling off the pieces.  That's what the corporate raiders did so often in the 1980s, and again, they usually did it because the market value was below the breakup value.

Anyway, with crypto none of this applies except for market value--and that makes things a hell of a lot simpler, if you even care about such a statistic.  Personally I think it's meaningless.  If you're looking to corner the market in a coin (and I have no idea why anyone would want to do that), then it might be useful but otherwise it's a piece of data that gets way more attention than it deserves.

[cabron]

Could we say that although Bitcoin's marketcap is way higher than what altcoins have, the real price of BTC could be less than its current price?

Since the impression it gives is that marketcaps are base on the bid price, it means that volume will really have to be considered when analyzing the technical analysis not just to Bitcoin/USD but to altcoins you trade.

[Darker45]

Yeah, of course. Demand dictates everything. The same applies to cryptocurrencies. There are so many altcoins out there whose valuations and market caps are actually well beyond their real worth.

A certain shitcoin, for example, may have a market cap of $1 million for a circulating supply of 1 million tokens. In which case, the valuation is $1 per token. However, for instance, the developers are holding half of the circulating supply. Without a strong and sustainable demand, sufficient liquidity, and so on, their tokens have actually much lesser value than they appear on paper.

The market of their token couldn't even absorb the sell pressure if they decide to sell just a quarter of their holdings. Selling just a quarter could even translate to the valuation of their token falling down to $0.001.

[yhiaali3]

This is an understandable example. Yes, the owner of the company can raise the stock price of his company by buying some shares at a high price on the stock exchange, which makes the market value of the stock very high, but this is fake and unreal.
The same thing happens for coins when they are included in the exchanges and there is no liquidity. Some people deceive people by buying small quantities at high prices, which raises the price of the coin in an illusory way because there is no liquidity.
Unfortunately there are some traders who do not have much experience of falling into this trap as they buy at a high price and get stuck in the currency unable to sell it or have to sell it at the end at a low price and lose their money.

[tyz]

The owner manage to get a deal selling 5% of the company for 50M USD. The valuation of the full company at this point, since there is only one deal, is set at 5% for 50M, thus 100% (all the company) is valued at 1 Billion. That´s it, it is "an unicorn".

You have probably noticed that this is not fully true. This means that someone has effectively valued the company at 1B and paid a 5% of the share at that price, but this does not mean that anyone would be ready to pay 1B for it or that other people would offer the same valuation.

You've successfully identified that you can kick the market cap numbers to the curb for most projects. Exactly for the reason that the quantity in circulation is sometimes extremely scarce, which leads to such high valuations. Even with Bitcoin, the market cap also includes coins that no one actually has access to anymore or that are no longer available. Various analyses assume that up to 1/3 of the existing Bitcoins have been lost and should therefore no longer be included in the market cap, even though they are theoretically still there.

[teosanru]

Valuations of this kind must be carefully understood. For example, you call unicorns to new companies that reach a valuation of 1 Billion. That does not mean that someone has actually paid 1 billion for it, as the fact of reaching a marketcap of 1B does not really mean that someone would buy 100% of the project for that price.

How does this really work then? Easy to understand with this example:

You create a company with venture capital. The owners and the team have 100% of the shares and there is no real valuation of the company at that point. Your company is doing great in growth, but, as usual, it is burning through money. The owners decide to raise more money. It could by by floating, IPO or a financing round - does not matter for our example.

The owner manage to get a deal selling 5% of the company for 50M USD. The valuation of the full company at this point, since there is only one deal, is set at 5% for 50M, thus 100% (all the company) is valued at 1 Billion. That´s it, it is "an unicorn".

You have probably noticed that this is not fully true. This means that someone has effectively valued the company at 1B and paid a 5% of the share at that price, but this does not mean that anyone would be ready to pay 1B for it or that other people would offer the same valuation.

This is the same when a project floats a small amount of crypto. The price may get very high if there is not that much liquidity and many people want to a have a bit, but saying that is the real value is a long shot.

If this is not a valuation then what actually is a valuation according to you? I think this really is the best way to value any startup or in fact any Company! Obviously the value of anything changes from person to person there is no universal value for anything around the world. If you argue in this way even the stocks that are listed are merely representative values because if the person holding even 5% starts to sell all of them stock price would tank a lot in a day.

Valuation or Value of anything is best measured by "The last price paid by a buyer to purchase it". You obviously can make up your own value-based on your own usage of that asset but someone might value it even less based on his usage. If Bitcoin's price is $34000 today, if someone holding 5000 bitcoins decides to sell it, he might be able to get just $30000 for most of his bitcoins.

Paxmao, I understood your example but I'm afraid people reading it might come away with the impression that this is the case with every company--and it's not.  It could be the case that only 5% of shares in a privately held company could give that company a $1 billion valuation, but there are companies whose valuation is lower than what they're actually worth--and those are the types that investors like Warren Buffett likes to invest in (and invariably they're not the "unicorns" of Silicon Valley that I think you were referring to). 

With a company that's gone public, it's pretty simple.  The market cap is the value of all the outstanding shares, and that's how most people put a valuation on the company.  But there are other ways to do so, e.g., by looking at its breakup value, or how much money could be gotten out of it by breaking it up and selling off the pieces.  That's what the corporate raiders did so often in the 1980s, and again, they usually did it because the market value was below the breakup value.

Anyway, with crypto none of this applies except for market value--and that makes things a hell of a lot simpler, if you even care about such a statistic.  Personally I think it's meaningless.  If you're looking to corner the market in a coin (and I have no idea why anyone would want to do that), then it might be useful but otherwise it's a piece of data that gets way more attention than it deserves.

You are right, even in the case of publicly traded companies, no one obviously is willing to buy 100% shares of that company on the total market capital. If we look at it this way the concept of valuation would cease to exist.

A very important concept here is Synergy It would make more sense for an IT Company to pay an even higher price for a blockchain startup because it would get synergical benefit from it which an automobile company might not get.

[paxmao]

Could we say that although Bitcoin's marketcap is way higher than what altcoins have, the real price of BTC could be less than its current price?

Since the impression it gives is that marketcaps are base on the bid price, it means that volume will really have to be considered when analyzing the technical analysis not just to Bitcoin/USD but to altcoins you trade.

Yes and no. Crappy answer.

In companies or crypto that have a significant float and significant trade volume (e.g. bitcoin), I would say that marketcap is quite in line with that total value of outstanding shares or coins, unless you try to sell many thousands of bitcoins in a day.

Companies with little float and little liquidity are the ones that may not be correctly valued. e.g. Coinmarketcap tell you that token "X" is bought at 1000. Now, if you try to sell 100 of those you will notice that the first one may be sold at 1000, but the rest will be at .00001. In those cases I could argue that the cap based on the highest bid is not realsitic.

[el kaka22]

In companies or crypto that have a significant float and significant trade volume (e.g. bitcoin), I would say that marketcap is quite in line with that total value of outstanding shares or coins, unless you try to sell many thousands of bitcoins in a day.

Companies with little float and little liquidity are the ones that may not be correctly valued. e.g. Coinmarketcap tell you that token "X" is bought at 1000. Now, if you try to sell 100 of those you will notice that the first one may be sold at 1000, but the rest will be at .00001. In those cases I could argue that the cap based on the highest bid is not realsitic.

That's the correct way, because in bitcoin type of places selling and buying as one person will not change anything unless you are Elon Musk, which means that trading doesn't change much daily that way, of course in the smaller marketcap places that changes a ton, why? Because it has such a low volume that you yourself could change it and then the bid price becomes the real price and that is the problem.

This is why I never go with low volume stuff, there is nothing you can do that would make it enseemable, it is just going to impact the price a ton whenever there is a low volume coin. I have seen it with my own eyes in many places, coins with 200-300-400 dollars or so and one person destroying the whole price and so forth. That is why there is nothing in the world that can make me invest into those type of coins, but bitcoin, ethereum, bnb and the likes? Those are awesome, I can trade my whole portfolio back and forth everyday all day and I wouldn't be able to change a thing.

[magneto]

Of course not. Market cap is really just a theoretical concept that has very little bearing on reality.

This is why you see M&A transactions for target companies typically being done at prices that exceed the current market cap - there is simply no way to get shareholders to forego their stock any other way, since if one bought on the open market then they would slowly bid prices up.

Similarly, a very small precedent transaction at an IPO shouldn't be taken as an accurate predictor of the company's size or whatnot, especially if the initial float is low. Just doesn't work that way.

[jaysabi]

Great explanation. The important thing that can be derived from here is the danger that comes with too high valuations. Greedy businessmen like to set very high valuations because they only think of the number they see, but don't think of the difficulties it would take to reach that number.

Initially, the high valuation might create hype and some investors would buy it, though the serious ones will most likely be skeptical. But along with that, high expectations come and if the company doesn't fulfill the hopes - everyone will start to look at the company as a failure and, at this point, attracting new investors will be very difficult.

Businessmen don't set valuations, the market does.  And it's determined by the buyers, not the sellers.  The sellers would always want to maximize the selling price, but what someone is actually willing to pay for the company is what determines the valuation.