Within the vast and quickly changing world of internet technology, some of the most recent conversations include a discussion of Web 3.0, including crypto, NFTs (Non-Fungible Tokens), the metaverse and blockchain. So, what exactly is Web 3.0, and how will it impact the internet and the valuation of startup companies operating in Web 3.0? To answer this question, we begin with a survey of Web 1.0 and 2.0. We then examine Web 3.0, the startup companies operating in Web 3.0, and the knowledge and skills needed to value them.
Web 1.0 was the launchpad of the internet itself. During 1991-2004, the internet was simply a static, “encyclopedic” source of information displayed on individual Web pages. After typing a query into a search field, one was provided with various documents/articles related to a specific topic. These articles were presented in a read-only format. There was no two-way interaction like what is now ubiquitous in today’s applications.
From 2004 until the present, the internet underwent a fundamental transformation. While Web 1.0 allowed for a unidirectional means for the consumer to search for information with little interaction from the provider, Web 2.0 allows for the source of this service to gather information from the user. As individuals search on various platforms (Google, Yahoo, Facebook, etc.), these organizations catalog data about the user’s interests and queries. With this information, the organization can build an ad-based advertising business model with greater specificity to the user’s interests. This potentially increases the user’s time on a particular page and the likelihood of purchases via various online advertising formats (e.g., Pay per Click, Classic and Dynamic, and Banner Display). So, if they search for a specific topic, say dog videos on YouTube, they might begin to see advertisements for dog food or nearby kennels. Additionally, you might be presented with other related videos, such as dog training guides, allowing an individual search to be expanded beyond the user’s initial intent. Web 2.0 could be described as the era of targeted advertising, in which providers learned that they could profit from collected user information by selling it to advertising companies while offering consumers a more robust internet experience.
In contrast, Web 3.0 aims to fundamentally change the internet by giving the user complete control of the information on their server. In theory, users will have full control of the data they provide and decide when and if it will be removed. This is known as client-server architecture. For example, in a Web 3.0 version of Twitter, Twitter would not have control over what gets posted. If a user makes a post, it would appear on their server. If someone else wants to share the post with their followers, they would have to download it to their server, allowing their followers to view the post. This is made possible through the blockchain, which creates a decentralized system not controlled by one web provider but instead controlled by the individual organizations or users who create and download the content. The post would exist on servers worldwide, removing any possible issues with censorship of information by one organization. However, there may be risks regarding the postings of illegal content due to reduced centralized surveillance. Ultimately, Web 3.0 aims to transfer power away from web providers and into the hands of the users.
Companies Unique to 3.0
The unique nature of Web 3.0, with its open architecture, has created the need for new companies in the blockchain. Increased transparency and individualized control empowers users to create and control their content which is a critical privacy safeguard both for industries and individual users alike. As the technology becomes more refined and mastered, we will likely see a substantial increase in capital investments and valuations within this growing industry. The rise of venture capital investments in companies operating in the Web 3.0 space is a strong indicator of this need. According to data collected by Pitchbook, a well-respected resource for data on global capital markets, the total number of venture capital deals in blockchain-related companies has surged from 27 in 2019 to 255 in 2022. In the same period, the median invested capital in individual companies has skyrocketed by 700%, demonstrating the remarkable rise in venture capital investment in Web 3.0. Notable examples include the recent investments in Alchemy, a leading Web 3.0 blockchain developer, which builds tools that allow companies to interact with the Ethereum, Flow, and Polygon blockchains. In April 2021, Alchemy raised $80 million in a Series B funding round at a $505 million valuation. Nine months later, in February 2022, Alchemy raised $200 million at a valuation of $10.2 billion. This means the startup has seen its value increase by nearly 20 times from April 2021 to February 2022! Another company, Unstoppable Domains, is one of the leading blockchain naming system providers and recently announced the closing of a Series A funding round of $60 million at a valuation of $1 billion. These are just two of the notable Web 3.0 startups.
Startup Valuations – Risks and Considerations
In any valuation, the appraiser must understand the industry’s unique opportunities and risks. This is even more true in valuing startup companies that lack a financial history and in Web 3.0, where the entire industry is new.
Critical factors considered when valuing a pre-revenue company are indications of value implied from equity rounds of financing, the demand for the product/customer base, marketing effectiveness, the industry’s growth rate, and the barriers to entry. For an early-stage company, a valuation can be inferred from a recent arm’s length equity financing round. The demand/customer base may be the most crucial factor as if there is little interest in the product/service the startup offers, there will likely be little value in the company. When a company reaches the point where it can project future cash flows, the risks of achieving those cash flows are factored into the Weighted-Average Cost of Capital to determine the company’s value.
Of the issues mentioned above, the final three that need to be considered are the company’s marketing team, the expected growth rate of the industry, and the barriers to entry. First, the effectiveness of the company’s marketing team will determine how efficiently new buyers/users can be acquired. Further, investing money into marketing is inevitable for every company, but a key to growing a business is having a low cost of customer acquisition so that the advertising dollars results in higher cash flows. Second, the expected growth rate of the industry is a significant driver of the projected cash flows that the company can generate in the future. If technology continues to advance in a way that allows the industry in which the startup operates to grow, it will bode well for the company if it can harness this innovation and use it to its advantage. Third, the barriers to entry will determine how much competition the startup will encounter in the present and the future. For instance, a company operating in the retail clothing industry deals with a more competitive market, as it does not require a significant investment to enter the space. In contrast, a company operating in Web 3.0 will encounter much less competition, as the cost of investing in related technology, obtaining skilled workers, and acquiring information on the space is significantly higher, providing great opportunity for companies able to compete in Web 3.0.
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How Withum’s Valuation Team Can Help
Those above are just a few of the many factors that should be considered in valuing a pre-revenue startup company. The valuation of such companies may be necessary in assessing future fundraising, employee compensation, and international transfer of intellectual property. As there are no historical cash flows to support future growth, much of what the analyst uses to support the valuation conclusion may be difficult to quantify. This poses to be very risky, making it even more important to consult with a certified professional in the field to obtain the most accurate valuation for your company.
For more information on this topic, please contact a member of Withum’s Valuation Services Team.