Slack is overvalued and that is totally understandable

For me the team collaboration service Slack has been one of the biggest names of the Internet year 2014. It looks as if the company’s remarkable rise will continue in 2015, at an increasing pace. At least that’s what the investors think.

Last week Slack announced a $160 million funding round. The valuation rose to $2.8 billion. Even in these times, in which major tech startups based at the U.S. West Coast are pretty much swimming in venture capital, this is quite an astonishing increase in assumed value. Only less than 6 months ago Slack had reached the milestone of a $1 billion valuation. Worth noting is also that this fresh funding does not even seem to be needed, as the outspoken Slack CEO Stewart Butterfield explained in an interview last week. That fact does not come as a surprise: The company’s previous financing round of $120 million took place not even half a year ago. Most of that cash still sits in the bank. Slack had been previously dubbed the “fastest growing enterprise SaaS company ever”. Investors seem to be more than eager to jump on that train before it is too late. 

Considering the exploding valuation, many observers are wondering whether we are witnessing just another sign of a hopeless overheated tech sector, or whether there is enough substance and potential that would justify such a development at Slack.

In general one has to keep in mind that the sky-high valuations that high profile U.S. tech companies and venture capitalists regularly agree on these days do not say anything about the actual value of these startups. The actual value would be hard to measure anyway. The partly insane amounts that one can often read about essentially show the investor’s confidence in a future mega exit, nothing else. An exit like when Facebook bought WhatsApp for $19 billion, or a really huge IPO.

Furthermore, these investors are not necessarily acting rationally. There are a bunch of emotional factors that could influence their decisions. Worth mentioning are fear of missing out (FOMO), competition between big egos, prestige thinking and group think. About a dozen old and new investors participated in Slack’s recent round. If everyone wants to put money into this one company, they can’t be wrong, right?! …

In the case of Slack, I would assume that some VCs felt the pressure of basically having to invest in this company no matter what, thus making very generous offers. That would be in line with Butterfield’s remark that “it would be almost imprudent” for him “not to accept $160 million bucks for 5-ish percent of the company when it’s offered on favorable terms”.

That’s why a discussion about the valuation of Slack does not lead anywhere. Based on today’s key performance metrics, the company is highly overvalued. Like most other “Unicorns” (industry lingo for exceptionally fast-growing startups valuated at more than $1 billion) these days. But as described, these valuations do not mean too much anyway. They are pure speculative and based on expected events in the future. And considering that Slack in fact is quite an exceptional company, it would be strange if the industry players and investors would choose Slack of all companies to show moderation and self-restraint.

In the long run, I have no doubt that Slack could become a giant that generates billions of dollars of revenue and huge profits. In the sea of vast growing, hype-fueled tech companys, Slack is rather an outlier.

First, it is not targeting consumers, instead focusing on the enterprise. The enterprise market is traditionally characterized by cumbersome software, ugly user interfaces and a complete neglect of user needs. Slack managed to change all this with its product. Probably for the first time in history, an enterprise product created large amounts of passionate users. The market ahead of Slack, if captured, is worth billions over billions.

Second, for a startup that is not even 2 years old, Slack is already generating nice revenue. The freemium pricing model is designed so that bigger teams who want to use Slack in a serious way will have to choose one of the paid accounts. Of the 750.000 daily active users, 200.000 are on paid accounts according to the company, meaning that a team admin pays for their usage. The lowest monthly fee per user is about $7. Even if growth would stop today, this would generate almost $17 million in annual recurring revenue (ARR). Now, obviously growth has not stopped – on the the contrary. And not all paid users are on the cheapest plan. So the ARR has to be significantly higher than $17 million. On the cost-side, an employee count of about 100 helps to keep the burn-rate down.

Again: For a company that has not even celebrated its second birthday yet, the results are already substantial. And that despite a big a number of rivals such as HipChat , ChatGrape or Stackfield. Who really is surprised that investors throw money at Slack?!

The crucial question for the future progress of Slack is whether the company will be able to attract customers in industries and markets that are less tech-savvy and less curious about improving internal communication. But with the company’s official aim to replace email, a catchy product promise that is suited to engage company leaders and managers in any sector or country, the starting position does not look bad. Even if the challenges to enter more conservative industries are numerous.

Judging from what the company has accomplished so far, I am optimistic about the future of Slack. So it is not too hard for me to understand the VCs who inject large amounts of money into Slack for little equity. That being said, the unsustainable explosion of startup valuations will have to backfire sooner or later. It can’t continue forever. But if it happens soon, Stewart Butterfield will still be able to sleep well at night.