The talk around the water cooler last week was all about Microsoft trying to snag a 5% stake in Facebook for $500 Million, which would in effect put Facebook’s valuation somewhere around $10 billion. Lots of rumors began swirling around that Google would come in and offer more for that same 5% in order to lock MS out of the action, this could make strategic sense, but we’ll see about its validity. So you must be thinking, “$10 Billion????!?!?!?! HOLY S#!T OMG WTF,” because to many that seems like an astronomical number for a 3 year old company with maybe a hundred and fifty million in revenue.

So how does a company like facebook get a $10 billion, thats billion with a “B,” valuation? Well the same way Google gets a $170 billion valuation or Microsoft gets $276B. These valuations are based on premiums and future potential, not on current revenues. So when you see a stock take a hit for poor quarterly earnings, investors are usually downgrading it because they fear it could impact future performance more than anything. So how does $150Million in revenue translate into $10 Billion? Easy: its about the potential here more than anything. If facebook started cranking up the targeting of their ads, and figured out more ways to engage users and companies, their revenue could quadruple in a year, and possibly double the following year (assuming growth rates stay constant, etc.).

But aside from revenue, why is facebook worth ten billion? Its about the interaction and the user base. Facebook’s developer platform is also a good reason its worth so much. By creating this ecosystem where anyone can come in and build onto the utility of facebook, facebook effectively made it possible to keep themselves leagues ahead of the competition in terms of features. Additionally by dumping that $10Million into the FBfund the other day, they threw fuel into the fire to speed up the already fast pace of the developer community on their platform. So facebook has proven that they can add thousands of features to their site in under four months at effectively no cost to them. That leaves them wide open to build core value into their product and compete with others while the others are distracted by playing catchup to the new feature set on facebook. That right there my friends is why Facebook is worth billions.