How social media's plunge could punish start-ups

The Twitter logo is seen on coffee mugs inside the company's headquarters in San Francisco.
David Paul Morris | Bloomberg | Getty Images
The Twitter logo is seen on coffee mugs inside the company's headquarters in San Francisco.

If the love affair between the public markets and social media companies is over, there's plenty of pain to be felt down the line.

Investors have spent years pouring money into companies somehow described as social media. According to data compiled by DataFox, the number of such U.S. companies to receive funding jumped 24 percent in 2014 to 411 from a year earlier, and another 111 have raised capital so far this year. Back in 2010, the total number was 122.

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So watching Twitter, LinkedIn and Yelp each lose more than one-fifth of their value in the same week is a shock, albeit one that many market watchers have been predicting for months. All three companies delivered quarterly results that fell short of analysts' estimates.

Add to that the decision this week by anonymous messaging app Secret to close its doors and there's perhaps a certain reality setting in. Money really does matter. Fads don't mean sustainable revenue. Millions of users don't equate to business models (Secret had 15 million at its peak).

LinkedIn going through growing pains: Pro
LinkedIn going through growing pains: Pro   

But more important than the short-term market correction is the long-term consumer trend, said Ethan Kurzweil, a partner at Bessemer Venture Partners. Stock market fluctuations are perfectly normal.

"The thesis that social media is important and worth hundreds of billions in market cap is proven out," said Kurzweil, whose firm bet early on LinkedIn and Yelp. "The fact that they're valued rationally now on earnings validates the concept."

While there's plenty about today's market that differentiates it from the dot-com madness of the late 1990s, venture investing is at levels not seen since then. Web-related investments in venture-backed companies jumped 86 percent last year to $33 billion, the biggest outlay since 2000, according to the National Venture Capital Association.

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And CB Insights data show that seven tech companies raised private capital at a valuation of $1 billion or more in the first quarter, while only one went public at that price.

For growth-hungry investors to cash in on those bets, they need a healthy IPO market and lofty stock prices so that public companies have equity to spend.

LinkedIn and Twitter are just digesting their biggest deals ever. In April, LinkedIn spent $1.5 billion on Web learning company, and Twitter said this week that it bought online marketing start-up TellApart for $533 million.

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Those acquirers today have $14 billion less in equity value than they did a week ago.

Google and Facebook have been the bigger buyers among Internet companies, and those stocks are both down more than 3 percent this week.

None of this is to say the sky is falling, but venture capitalists are definitely paying attention.