To date investors have put $125M into the company, most recently infusing it with $85M more in September 2011 at a valuation of over $800M.

The company started selling ads in May 2012 and revenue was reported at $13M for the year. Tumblr’s source of advertising revenue is the logged in user “dashboard” where sponsored posts are displayed in the sidebar via Tumblr Radar, while recommended posts are injected directly into the feed by Tumblr Spotlight..

Tumblr claims 120M+ daily impressions on Tumblr Radar, which equals 3.6B+ monthly impressions. Assuming $10 – 20 RPM (revenue per thousand impressions), which is within the normal range for premium brand advertising, the total revenue opportunity for Q1 was $108 – 216M. Based on this calculation, at an annual run rate of $15M ($3.75M quarterly revenue) Tumblr is selling 1-4% of its total monthly inventory. If you think about this operationally it sounds reasonable, as the company is just beginning to ramp its ad sales.

Tumblr may also be enticing early advertisers by selling inventory for a fraction of the price it eventually hopes to charge. At $1 RPM $3.75M in revenue would have paid for 30% of the available impressions, and in order to sell 100% of its inventory in Q1 Tumblr’s average RPM would have had to drop to $0.35. Compared to Reddit advertising, which offers $0.75 CPM, and sub-$1 rates for Tumblr CPMs sound plausible.

Red Flags

There were signals of a possible revenue ramp miss in the first quarter of 2013 with the resignation of Rick Webb, who was brought on board just 10 months earlier to focus on revenue growth and work closely with Tumblr CEO David Karp. He is the latest in a string of senior executive departures characterized by Beta Beat as a “leadership vaccuum”.

The shutdown of Tumblr Storyboard in early April was another worrying signal. The project was touted as a “journalism experiment” but was more likely an experiment in figuring out how to work with brands to create effective content marketing on Tumblr’s advertising platform. The production value of the content and high profile editorial team likely cost the company millions but ultimately it “didn’t work” according to Karp.

The Initial Offer

The initial offer from Yahoo! is $1.1B in cash, but according to TechCrunch it may not be accepted:

“Tumblr employees feel that Yahoo’s $1.1 billion offer is “too low” and view it as “only a first offer,” according to sources close to acquisition talks.” – TechCrunch

Employees’ opinions aside, the lack of cash on hand and lack of trust in leadership to hit revenue milestones are likely having a negative impact on Tumblr’s negotiating position, which is probably contributing to what some consider a “lowball” offer.

Setting the Purchase Price

In an acquisition the purchase the price is usually set as a multiple of existing revenue or expected near-term revenue. For media companies a 10x multiple on revenue is quite steep Edit: but does happen (AOL paid $315M for Huffington Post, which exited with $30M in revenue), and with only $15M of revenue in 2013 that would put a Tumblr acquisition price tag at just $150M.

My first reaction was that Yahoo! or whoever else was involved in the acquisition talks was about to massively over pay. But Yahoo! isn’t stupid, so what’s going on here? Clearly this is about expected value, not actual revenue. If Tumblr were to hit their own stated $100M revenue target a 10x outcome would be $1B – but employees are saying this is a lowball offer. Why?

Looking at our numbers from earlier, at $10 – 20 RPM and 3.6B dashboard impressions a month (and growing) the annual revenue potential for Tumblr ranges $432M – $1.44B.

Why sell a company with such a substantial revenue opportunity on the low end of the range?

Pencils Down, Time’s Up

While employees hold onto the hope that the company will be valued on it’s ability to drive billions in revenue, the reality is that Tumblr didn’t pull it off in time. The vast majority of that potential was not realized in time.

It wouldn’t be a problem that Tumblr is lagging in revenue production if the board felt the odds of the company capturing this expected value were good, and that was probably the thinking when they invested $85M in 2011.

The path to keep the company independent would probably involve finding a replacement CEO, or at the very least hiring a COO to be Tumblr’s own version of Sheryl Sandberg and drive the company aggressively toward revenue. It would also mean raising a boatload more cash at significant dilution to everyone involved, cutting expenses, and buckling down to operate like a serious business generating meaningful ad sales revenues in the next 18 months.

Outcomes

In choosing to sell the company and hand Tumblr over to a professional management team with a track record for monetization through media properties, the board is implying that they do not feel putting more money into the company would enable the management team to achieve a better outcome in a reasonable amount of time. Investors who participated at the $800M valuation are probably welcoming the prospect of a $1.1B exit in cash – assuming some liquidation preferences were put in place they’ll get their customary 2x-3x late stage return, and the deal won’t negatively impact their respective fund’s overall IRR.

Selling now may also allow David Karp to remain in a leadership position at Yahoo! where he can continue his work to revolutionize advertising – maybe even leading Yahoo! to a more competitive position vs. Google for brand advertising and giving them a reason to drop the underperforming partnership with Microsoft in the long term. And if things don’t work out with Karp Yahoo! doesn’t seem to have any problem firing acquired founders who no longer fit with the company’s plans.

In the end Tumblr won’t see a bigger exit because they didn’t prove they could monetize their massive traffic before time (and money) ran out.

But would you have? Really? Massive changes in how we build things, operate our companies and think about technology have often taken place gradually, and met plenty of resistance along the way. Even visionaries miss great things all the time, just look at the Bessemer Venture Partners anti-portfolio, read Dustin Curtis’ “What a Stupid Idea” reflecting on early looks at Pinterest and Vine, or the long list of VCs who didn’t invest in Facebook early on but then made a late stage play to add the Facebook logo in their portfolio.

Echoes From the Past

Limited partners (LPs) complain that their venture capital investments haven’t had returns that were as good as in the 90s. Venture capitalists complain that companies founded today aren’t as innovative as they used to be or that valuations are higher than they used to be. And the press? Writers who have never been anything remotely close to entrepreneurs will continue to bitch about everything.

“Company ABC would never do that” – says who, Company ABC is like 4 years old? “I’m not a sales guy” – you’re a 22 year old computer science graduate, you’re not really anything yet! “Startups who tried that in the 90s totally bombed” – yeah well it is 2013 now, might be time for another go. “I wish we could invest, but founders who fit our profile have computer science degrees” – your profile is 20 years old, the Internet has gotten a lot more programmable since you were in school.

Fighting for the Future

Listening to these complaints and excuses for not doing something (e.g. changing strategy, trying sales, trying a model that previously failed, investing despite lack of founder credentials) is like hearing parents complain that the kids’ music is too loud, and rock was so much better in their day. And the worst part is that they try to dress all this up as some version of “pattern matching”, which is the one of those terms you can throw out to make people nod and stop arguing with you. One of these days I’d like to jump up from the boardroom table and shout, “screw your pattern matching, I saw the results and I don’t believe you!” just to see what happens.

Boardroom fantasies aside, people who are really great at pattern matching don’t get distracted by inessential details like what founders are wearing on 2nd street this week, what kind of parties they throw, the alma mater of the software engineering team, what Dave McClure said at a conference, or even whether the company is raising at a $5M or $12M pre-money valuation out of Y Combinator this batch. These are things that might matter for a moment in time, but quickly fade into the past. What matters most is trying to understand how a combination of past knowledge combined with present action will ultimately generate a favorable result.

Fight for the future, or get out of the way.

P.S. I’m not claiming I am some great visionary, but I’ve been placing some bets so we’ll see in 10 years or so.