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Is Snapchat really worth $19 billion?

Snapchat has been in business for less than four years, and it is already one of the most valuable startups in the world.

The company, whose photo-messaging app lets users send images, videos and instant messages that disappear within seconds, is hoping to raise $500 million in venture capital in a round that would value it at up to $19 billion, according to published reports. That would be on top of the $648 million Snapchat has raised in previously raised.

At first glance, that might seem like crazy money for a company that has only been around since 2011, gives its products away for free and has yet to attract much in the way of paid advertising. Adding to Snapchat's challenges, its head of business and marketing partnerships, who left Facebook (FB) last year to join the company, resigned in January.

Such issues are fairly standard for any startup, of course, especially in the Internet arena. And major investors, including blue-chip Silicon Valley venture firms, are clearly betting that Snapchat is worth the money. Here's why those backers expect Snapchat to flourish:

  • Audience -- A big draw for investors is the size and youth of Snapchat's audience. The company reportedly had 100 million users in the summer of 2014 when it was said to be in discussions over a potential funding round at a $10 billion valuation. So not only does Snapchat have a large user base, but they tend to be young, a big drawing point for investors.
  • Sector -- The Internet business has been a breeding ground for richly valued startups. Facebook's market valuation was $104 billion when it went public in 2012, while Twitter's (TWTR) 2013 initial public offering valued it at nearly $25 billion. In high-tech, there is an expectation that high-profile companies will attract investors once they go public, supporting high valuations.
  • Facebook's interest -- In 2013, Snapchat turned down a $3 billion acquisition offer from Facebook. It was a public sign that the world's most important social networking firm saw enormous value in Snapchat, reinforcing the view that this was one startup that is going places.
  • Growing privacy concerns -- Whether because of government spying, corporate prying or high-profile security breaches at major consumer companies, many people are increasingly concerned about online privacy. Snaphat's technology, which allows people to send messages that disappear, seems to tap into that zeigeist (although recipients can capture the transmissions for greater permanence).
  • Fear of missing out -- Big investors know that not every hyped company will ultimately do well -- but some will. The perpetual fear is of missing out on another Facebook or Google (GOOG). So investors roll the dice, betting that the profits from the winners in their portfolio will far outstrip the losers.

Startup valuations are predicated not directly on how the company performs, but on how the stock might do in the future. They are the result of speculation and are unavailable to all but the largest and best-connected investors. And, as has been proven time and again, the value of a company that doesn't make sales and, eventually, profit can at some point come crashing down.

But by that time, the insiders who built up the share price have usually cashed out with their capital gains secure.

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