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Behind Snapchat's disappearing valuation

December 12, 2013: 11:59 AM ET

Snapchat_logoWhy Snapchat just raised a lot less money, and at a lower price, than anyone had expected.

FORTUNE -- Two months ago, we reported that Snapchat was in talks to raise around $200 million in Series C funding at a $4 billion valuation, most likely to be led by a large strategic investor like China's Tencent. Then came word yesterday that it had raised $50 million from U.S.-based tech investment manager Coatue Management at a valuation shy of $2 billion. So what happened?

Here's the explanation I'm hearing:

Founders of hot young startups like Snapchat usually want big valuations to satisfy either their egos or their dilution concerns (or both). The problem with the former, however, is that it can cause problems if the company also plans to hire a lot of new folks. After all, would you prefer to join a growing company with a valuation of $2 billion or $4 billion? Unless you're allergic to upside, it's the former. Moreover, internal employee schisms can be exacerbated if early employees already have their paper millions and later employees don't see a reasonably viable path to such riches.

So you take a lower valuation, albeit still significantly higher than the $800 million Snapchat received for its $60 million Series B round just five months ago. Then you raise fewer actual dollars, to satisfy the aforementioned dilution concerns. This runs counter to the notion of grabbing every last cent available, but perhaps the fact that Snapchat raised its last round so recently means that the new money gives it extra-long runway. And you do it quickly with a nearby financial investor like Coatue, which had tried to get in on your last round, rather than with a large foreign strategic like Tencent (which comes with lots of extra baggage, both positive and negative).

Or, put another way, the Snapchat founders are acting prudently.

It is worth noting, however, that there may be an less glowing explanation for Snapchat's smaller raise. It goes like this:

Perhaps Snapchat had a giant deal in place with Tencent at a $4 billion valuation, but something went bad at the last minute. So Snapchat put its tail between its legs and went to Coatue – which had wanted in on its Series B round, but lost out – at a much more amenable price. And perhaps it had already burned through lots of that prior round, and had to get new money in the door very quickly (reflected by the lack of pro rata from existing backers and the fact that all $50 million was primary).

I'm guessing the former is much more likely than the latter, particularly since Snapchat could have just sold to Facebook (FB) if it was actually desperate, but would have been remiss in not presenting both theories.

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About This Author
Dan Primack
Dan Primack
Senior Editor, Fortune

Dan Primack joined Fortune.com in September 2010 to cover deals and dealmakers, from Wall Street to Sand Hill Road. Previously, Dan was an editor-at-large with Thomson Reuters, where he launched both peHUB.com and the peHUB Wire email service. In a past journalistic life, Dan ran a community paper in Roxbury, Massachusetts. He currently lives just outside of Boston.

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