Lessons from the Twitter IPO: Cost of building an advertising funded startup

Posted by | November 10, 2013 | Entrepreneurship | No Comments

So you want to build a tech company based on an advertising model?

It can cost a *lot* to focus on building users before you monetise with advertising.  It’s a high stakes game and you better have deep pockets yourself or have access to other people’s money to support potentially years of losses.

Let’s look at some of the learning’s from details released as part of Twitter’s IPO listing (see listing documents up on the US SEC website).

Summary of activity to date

Twitter was born on March 21, 2006 with a simple idea:
Share what you’re doing, 140 characters at a time.

People took that idea and strengthened it by using @names to have public conversations, #hashtags to organize movements, and Retweets to spread news around the world.

7 years later, Twitter defines its core value proposition’s as:

  • Public. Users express themselves publicly to the world.
  • Real Time. Users tweet about live events instantly.
  • Conversational. Users communicate with friends & family, but also in conversations with other people from around the world, in ways that would not otherwise be possible.
  • Distributed. Tweets go everywhere both online and offline.

Twitter was incorporated in April 2007, in time for it’s first round of external investment with $5 million being raised in 2007 (see Investment Timeline below).

Twitter’s strategy has been to build it’s user base and for the first 3 years of it’s life the company was focused on building the technology, the user experience and increasing the number of users.

With around 30 million Monthly Average Users (MAUs) (see Metrics that Matter) Twitter introduced Promoted Tweets and Promoted Trends in April 2010.

Twitter’s availability on a “second screen” complements traditional media, enhancing the overall experience of an event.  Hashtags allows advertisers to directly target and engage with self-selecting users by interest.  Integrating these hashtags allows advertisers to extend the reach of offline advertising through continued conversation on Twitter.  Advertisers aren’t just addressing target markets – they are accessing target moments.

Supported by increasingly large investment rounds, Twitter has invested in further development of advertising services per the below roadmap, and now has more than 200 million MAUs and processes more than 500 million tweets per day.

Twitter Advertising Launches

Twitter IPO By the numbers

Twitter has raised more than $1.1 billion (yes, that’s with a “b”) but is still not profitable.

So how are they doing and where is the money going?

From the financials included in the SEC filing, I put together the following table for the last 3 years.  Some key points we can see from this are:

  • In 2010 before advertising really kicked in, Twitter was earning $20 million  through selling anonymised data about its users – 74% of total revenue.  By 2012 when advertising was well and truly underway this has reduced to 15% of total revenues.
  • In 2010, cost of revenue (running the data centres and operations basically) was running at 158% of revenue, they were investing 104% of revenue in R&D with a further 82% on Sales, Marketing & Advertising (SG&A).  Yes, that add’s up to 295% of revenue and obviously where investment was needed.
  • In 2011, R&D was at 75% of revenues while by 2012/13 it was sitting around 40% – still massively higher than the traditional 10% spent by business but part of Twitter’s ongoing R&D commitment.
  • Sales & Marketing expenses remained around 20-30% throughout.
  • G&A was at a high 60% of revenues in 2010 as backroom systems, processes and teams were being established settled down to a more normal 14% by 30Jun13 as operations became fully systemised.
  • 2011 was the first full year of revenue following introduction advertising services and showed how successful this has been in 2012 and 2013.

As can be seen, Twitter remains unprofitable from operations going into its IPO but the trajectory of users and advertising revenues has it poised for further growth – at least that’s the story!Twitter financials

Investment Rounds and Founders shares

From Crunchbase data you can see that Twitter continued to raise bigger and bigger rounds each year to support its ongoing investment in the technology and driving a larger user base:Twitter capital rounds

It’s also worth noting in passing that in order to continue raising this level of investment the Founders, including Jack Dorsey, increasingly had to dilute their shareholding.  According to the SEC Filing, Founders hold 23.6% with Jack Dorsey holding 4.9%.  This is a perfectly normal part of capital raising that inexperienced entrepreneurs sometimes stuggle with.  With some analysts talking about a likely $50 per share price point when it opens on the market Jack Dorsey’s “small piece of the bigger pie” is set to be worth more than $1 billion.

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