MBA 211 GAME THEORY
Battle for Foursquare- A Game
Theory Perspective
Spring 2010
Sagy Burshtein
Sonsoles Navarro
Renita Sinn
Jacqueline Yuen
Background
Foursquare (the “Company”) is a location based social network that allows users to share their location
with friends by “checking in” via a smartphone application or text message. Foursquare’s service enables
friends to communicate and make recommendations to each other and to other users about their
favorite places in a city. The users who check in most frequently at a location are crowned the “mayor”
of that location. Users compete with each other to become mayors to access special perks (e.g. free
appetizers or beverages) from their favorite business.
Foursquare launched in March 2009 and is the brainchild of its CEO and serial entrepreneur, Dennis
Crowley. Since its launch, Foursquare saw increased adoption with consumers, demonstrated by the
rapid growth in user base, which reached over 1.0 million users in April 20101. By creating a network
that encouraged users to try new things, Foursquare’s service also increased the interaction between
users and businesses. As a result of Foursquare’s popularity, companies are awakening to the potential
of a new advertising modality: location-targeted marketing. Recently, Foursquare experienced a rise in
media adoption, as evidenced by its partnerships with Bravo, History Channel, and Zagats.
Capitalizing on the relevance location based services (LBS) and potential for LBS to drive increased
revenue for businesses, Foursquare is back in the market to raise $10 million in Series B funding from
venture capitalists. Though the Company raised $1.35 million in Series A funding only a year ago,
venture capital funds are eager to participate in this next round of financing in order to secure “get a
piece of the action” for their investors.
1
Mullaney, Tim. "Foursquare Will Decide on Sale in Weeks, Crowley Says". Bloomberg.com. May 8, 2010
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aeuelc9_Qn5k
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Race to the Top – The Investor Auction Game
The game that we will focus on in this paper is a contest for who will be the lead venture capital firm
investing in Foursquare’s next round of financing. Each party (Foursquare and venture capitalists) has an
incentive (or payoff) to seeing the deal go through. In the race, are several top tier venture capitalists, as
detailed below:
Players
Foursquare
Tier 1 Venture Capitalists (“VCs”)
 Khosla Ventures
 Accel Partners
 Redpoint Ventures
 Andreesen Horowitz
Payoffs
 $10 million in funding
 Access to venture capitalist network and
operational expertise
 Executive team retains some control of the
Company
 Estimated 11% equity stake in a promising
location based mobile web application
 Estimated 2.3x return on investment
(Based on an $80 million valuation; see
Appendix A for details)
Mental Models
What are the mental models for each of the players involved? Each of them has their own interests and
motivations, leading to a different composition of the situation.
Foursquare
Dennis Crowley raised $1.35 million in funding for Foursquare only a year ago. Even though Foursquare
still has sufficient funds remaining, Crowley is in the market to raise money ahead of time. This fact
shifts power to Foursquare as the non-urgency of the financing gives them enough time to secure the
best terms.
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We believe that Crowley’s interest in raising the Series B financing is due to the fact that he wants to
preserve Foursquare’s competitive position in the LBS start-up world. In the social media space, the
company that launches a product or service first and manages to gain critical mass will become the
reference in the market. The LBS space is quickly becoming crowded with competing services such as
Google Latitude, Gowalla, and BrightKite. In addition, Facebook was rumored to be developing a similar
service. Undoubtedly, the changing LBS landscape has urged Crowley to act in order to ensure that he
has the necessary liquidity to bring Foursquare up to scale.
In addition, Crowley was not satisfied with the deal he closed with Google a couple of years ago when he
sold his previous start-up, Dodgeball for $5 million. Not long after the acquisition, Google shelved
Dodgeball, to Crowley’s disappointment. Crowley’s execution ability and ambition makes him extremely
interested in retaining managerial control of his current company. This leads us to believe that even
though companies such as Yahoo!, Microsoft or Facebook, are expressing interest in buying Foursquare,
Foursquare is willing to leave money on the table for the sake of retaining control.
Venture Capitalists
Venture capital funds in Silicon Valley are currently under a set of circumstances that they would have
never expected a few years ago. On one hand, the investors are warming up to venture capital funds
with an uptick in the economy. In February 2010, Redpoint Ventures raised a $400 million fund that will
be focused on mobile and social internet, among other areas. Similarly, Andreesen Horowitz also raised
a $300 million fund in July 2009. On the other hand, there is an imbalance between the supply and
demand for venture funding. As web development costs have decreased over the years, startup costs
have correspondingly decreased. Fewer companies need the help of VC funding to get through the start-
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up phase. Even though angel funding is also expensive, some entrepreneurs prefer it over VC funding
due to the increased flexibility that angel funding.
Added to this, experts in the internet space agree that LBS are where the social media platforms are
going towards. Currently, geo-location services such as Yelp (does not allow check in), Gowalla, and
Google Latitude are competing in the space. The LBS that (a) becomes the reference in the market and
(b) convinces other companies to use the service for commercial purposes will win the market.
VC Entrance in the Battle – A Timeline of Events
The VC battle for Foursquare started on March 18, 20102 when Foursquare started having conversations
with West Coast VCs about raising $10 million at a $40 million valuation. At this time venture capitalists
began noticing the opportunities and challenges that Foursquare faces:

Does LBS have appeal beyond hip urban guys going out?

Are direct competitors such as Facebook or Twitter stepping into the location game?
However, a mere one week later3, the battle for Foursquare was official: Accel Partners, Andreessen
Horowitz, Khosla Ventures and Redpoint Ventures were interested in being the lead investor for the
startup’s Series B financing. The final pre-money valuation will likely be between $60 and $70 million,
and with an expected raise of $10 million, Foursquare will be worth approximately $80 million on paper.
On April 6th 4, the Yahoo! M&A team valued Foursquare at $100 - $125 million. It was said that Crowley
was using discussions with Yahoo! and other big companies to increase the valuation of the venture
capital funds. However, because of the lack of confidence in the value of this hot startup, some VC firms
2
18th March - www.businessinsider.com – “Hot off SXSw foursquare raising 10m at 40m valuation rumor”
25th March – www.techcrunch.com – “four-vc-firms-battle-for-foursquare-valuation-goes-stratospheric”
4
6th March – www.businessinsider.com – “Yahoo considers buying Foursquare at $100 million”
3
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started backing out at this point. Among them were Redpoint Ventures and Andreessen Horowitz.
Moreover, by April 27th5, Accel Partners also bowed out, leaving Khosla Ventures as the only firm
interested in funding Foursquare at a pre-money valuation of $80 - $100 million.
The battle for Foursquare has been outrageous up to now and, it looks like it will continue for some
weeks. Is the conclusion of the combat something we could have anticipated using game theory? Could
have the VC firms have changed the game earlier on?
Dennis Crowley- Expert Game Theorist in Designing the Auction
The founder of Foursquare recognized that many factors would help drive up the valuation of his oneyear old startup. Even though Foursquare has sufficient reserves, it was an opportune time to pursue
Series B funding given the cash-rich VC environment, the immense momentum around the Company,
the hype over mobile LBS, and potential acquirers on the prowl. Game theory illustrates how Crowley
was able to design the auction to his advantage:

Outside option: Foursquare sought out Yahoo! to create an option value that could influence VC
valuation.
Although an acquisition is vastly different from soliciting Series B funding, it
established a high reference point for Foursquare’s valuation that the VCs could not ignore. In
addition, the media helped established Yahoo!’s offer as a credible acquisition threat. For
instance, Carol Bartz, Yahoo!’s CEO, provided an external signal through interviews with
technology blogs where she emphasized the synergies of Foursquare with Yahoo!’s overall
strategy, proving how serious Yahoo! is about acquiring Foursquare.
5
27th March – www.businessinsider.com – “Foursquare will take funding from Khosla Ventures – Informed
speculation”
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
Number of bidders: Crowley recognized the supply and demand imbalance between promising
startups looking for cash and VCs looking for investment opportunities during this time. With
multiple VC’s looking to invest in Foursquare, Crowley created a competitive environment
among bidders. Game theory reminds us that this would drive up the valuation. This is because
if all venture bidders calculate bids in the same fashion, in equilibrium everyone bids a fraction

(n-1)/n
of their value. Thus, as “n” grows large, Foursquare captures the increasing surplus.

Timing: Venture capitalists are looking to capitalize on the mobile social networking craze,
which has taken off with the rapid adoption of smart phones. If “checking in” becomes a
mainstream activity, it could energize mobile advertising, which is now just a small percentage
of overall spending on online ads.6 Crowley expertly uses this momentum to fuel media hype
around his Company and emphasize the value of location-based mobile services that Foursquare
offers.
Expected Valuation of Foursquare Using Game Theory
Although Foursquare did not run a formal auction process, the process of soliciting valuations from VCs
is equivalent to an English auction. The bidder pays the second highest value plus a nominal increment.
The valuation game is equivalent to an equity auction.
E(V) = (Range)*(n-1)/(n+1)
Where n = number of bidders and range= distribution of valuations
6
Guynn, J. (2010, April 19). Foursquare tops Silicon Valley's most-wanted list. Retrieved May 6, 2010, from Los
Angeles Times: http://latimesblogs.latimes.com/technology/2010/04/foursquare-tops-silicon-valleys-mostwanted-list.html
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According to the timeline, initially, VC valuations ranged from $40 million to $70 million.
Range = 70-40 = 30
E(V) = 30*(4-1)/(4+1) = $18M
E(Valuation) = 40 + 18 = $58M
Thus, the valuation Foursquare could reasonably assume for the four VCs competing for the Series B
round is approximately $58 million.
It’s a Wonderful Life- Value of Yahoo! as the Outside Option Yahoo!
As mentioned before, using inward thinking, Yahoo! valued Foursquare at $125 million given the
synergies that the Company would have with Yahoo!. Using game theory, this new upper bound on the
distribution affects the valuations of the VC bidders:
With Yahoo! as an outside option, valuations now range from $40 million to $125 million
Range = 125-40 = 85
E(V) = 85*(4-1)/(4+1) = $51
E(Valuation) = 40 + 51 = $91M
The new expected value is closer to $91 million now, which explains why the VC valuation (Khosla
Ventures) eventually rose to $80 million. Accounting for the risk that a VC would take on, without the
synergies of an actual acquisition, it seems reasonable that Khosla Ventures would temper their
valuation from an expected value of $91 million to $80 million.
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While Yahoo!’s valuation is being used as a signal to the VC firms as to what their valuation should be, it
is not entirely comparable. Yahoo!’s valuation is based on the “it’s a wonderful life” concept, where
Yahoo! looks at its current properties and then estimate how integrating the Foursquare services,
technology and user base will affect the number of Yahoo! users, their behavior and therefore its
revenues and stock price.
The VC funds’ method of valuation is quite different, and consists of two methods. First, they look at the
Company as a standalone - how many users can it attracts, how much revenues will be generated, and
how does it compare to current and future competitors. The second method that VCs employ is “it’s a
wonderful life” method of valuation. They look at potential acquirers, such as Yahoo!, Microsoft and
Facebook, and estimate what kind of exit they can achieve if one of those companies purchases
Foursquare. As a result, they also estimate how much the Company will be worth for the potential
buyers, and can base their current valuation on that.
In addition, VCs factor two things into their valuation process. First, the Company remains in the hands
of its founder, who is keen to retain control, and therefore should be willing to accept a lower price for
it. Second, since the expected returns are so far ahead, unlike if the Company was bought by Yahoo!, the
VCs are taking on much greater risk and will therefore prefer to lower its valuation to hedge against that
risk. Other risks that the VCs consider are changes in market trends, and customer tastes, and entry of
new competitors. While Yahoo! will face the same risks, they are more likely to be able to monetize the
service early on, making these risks less significant.
Benefit of Attracting Additional Bidders
Dennis Crowley is a savvy entrepreneur who realized that driving up the valuation of his Company serves
several purposes:
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
The price of the Series B shares increases with the valuation. At a higher price per share, there is
less dilution of ownership percentages, particularly for the executives. (see below)
Impact of valuation on share price and ownership %
Valuation
40,000,000
50,000,000
60,000,000
70,000,000
80,000,000
90,000,000
100,000,000

Series B Price
$
5.33
$
6.67
$
8.00
$
9.33
$
10.67
$
12.00
$
13.33
Ownership Percentage
Executives
Series B
64%
20%
67%
17%
69%
14%
70%
13%
71%
11%
72%
10%
73%
9%
The return on investment is less favorable for the venture investors but more favorable for the
executive team (since they have a higher ownership percentage) at a higher valuation.
However, the venture investors also prefer to secure a higher valuation for promising
companies in order to attract an acquirer or eventually take the company IPO. (see below)
Impact of valuation and deal size on Series B ROI
Valuation
40,000,000
50,000,000
60,000,000
70,000,000
80,000,000
90,000,000
100,000,000
Deal Size
125,000,000
3.3
2.9
2.6
2.4
2.3
2.1
2.0
150,000,000 175,000,000 200,000,000 225,000,000
3.8
4.3
4.8
5.3
3.3
3.7
4.1
4.6
3.0
3.3
3.7
4.1
2.7
3.0
3.4
3.7
2.5
2.8
3.1
3.4
2.4
2.6
2.9
3.1
2.3
2.5
2.7
2.9
As demonstrated by the analysis below, Foursquare’s strategy of creating a competitive auction
environment to increase the valuation of the Company results in a positive outcome for the owners of
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the Company. The Company effectively used Yahoo!’s acquisition proposal to “remind” the venture
funds that Foursquare’s LBS services are immediately relevant to companies seeking to solidify their
position in the mobile web space.
Outside option – double edged sword
Having Yahoo! as an outside option, while increasing the valuation of the other players, can be a double
edged sword. Following Yahoo’s offer, Khosla Venture’s valuation of the Company increased to $80-100
million, which played to the benefit of Foursquare. However, soon after that announcement, the other
three VC funds in the game dropped out. The outside option drove players away from the game.
As the single player in the game, we expect Khosla Ventures to lower its valuation if the current term
sheet expires. An important assumption in this case is that Khosla Ventures is able to call Foursquare’s
bluff. If Foursquare doesn’t take Yahoo’s offer at $125 million, it is clear that they are not interested in
being bought out. Khosla Ventures can support that conclusion also given the history of Foursquare’s cofounder, Dennis Crowley, who sold his previous startup to Google, got burnt and left to start a new
company. It is very reasonable to conclude that Crowley will always prefer to keep the Company given
the option.
That in mind, given a range of $40 to $100 million, the average player’s valuation should be $70 million.
As the single player, Khosla Ventures can choose to change its strategy. Since this is an auction, we can
assume Khosla’s bidding strategy will be:
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E[Profit] = (V-B)*Pr(B is the highest bid / higher than reservation)
Pr(B is the highest bid) = Pr(B > b(v)) = Pr(v<=B/a) = B/100a
a is a fraction
E[Profit] = (V-B)*B/100a
E’[Profit] = (1/100a)(V-2B) = 0
B = V/2
While this is the correct strategy in a pure game theoretic manner, mental models will shape Khosla
Venture’s strategy. We actually do not expect Khosla Ventures to bid half the value, since they will
attempt to be fair to Foursquare, but we do expect the bid to be lower than their valuation, at $65-70
million.
When Does Foursquare’s Gaming Become Too Much?
With only Khosla Ventures remaining and the Company valued at $80 - $100 million dollars, Foursquare
was in a significantly better position than before it initiated the auction for investors. Having secured a
term sheet from Khosla Ventures, Foursquare has effectively locked in a high valuation and does not
face the reduction in valuation that may occur if Khosla Ventures realizes the extent to which
Foursquare manipulated the valuation.
If Foursquare mistakenly allows the term sheet to expire, the valuation of the Company effectively
resets. This is a dangerous position for Foursquare to be in because though a valuation ceiling of $125
million has been set, Foursquare should be aware that the tactic of using Yahoo! to bid up the valuation
can only be used once. As mentioned previously, given a second opportunity, the venture capitalists
may call Foursquare’s bluff and keep the valuation from rising from the initial $40 million to the final $80
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- $100 million. If the Khosla Ventures term sheet expires, the Company may find that subsequent term
sheets have a lower valuation for a variety of reasons:

The LBS landscape is rapidly changing and the introduction of a new service may render
Foursquare obsolete and less valuable of a company. For example, Google Latitude may become
a “Foursquare killer” if it continues outpace Foursquare in terms of user base.7

Venture capitalists realize that Foursquare employed the Yahoo! acquisition threat as a means
to inflate the valuation of the Company. They will likely be more realistic about their valuations
the second time around.
Changing the Lens
Looking at the current situation we have asked ourselves what could VC funds have done to prevent the
Foursquare valuation skyrocketing.
In the first place, VCs knew Crowley preferred to take venture capital financing but they did not
anticipate the anchoring effect the valuation from third parties such as Yahoo! or Facebook was going to
have. If they had done so, one action they could have undertaken was to shorten the timeframe of the
term sheet to accept the deal. That would have pressured Foursquare to take a rapid decision and, if
played correctly, Foursquare would not have engaged in conversations with Yahoo! or Facebook.
The VCs have also failed in emphasizing the enormous advantages venture capital money has for
Foursquare. Given Crowley’s profile, they can expect that this extremely ambitious CEO will not allow his
7
Siegler, MG. "Google Latitude has 3.0 million active users, check-ins likely on the way". Techcrunc.com. May 6,
2010 http://techcrunch.com/2010/05/06/google-latitude-users-check-in/
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second startup to be shuttered by a large company again. By selling to Yahoo!, not only does Foursquare
lose managerial control over the operations but Foursquare also caps the boundaries of its own
potential.
Shopping the different VC offers takes approximately 6 to 8 weeks in Silicon Valley. During this shopping
process, especially if the company is a hot startup, sensitive information gets spread out by the press
and will very likely reach competitors. It is not clear what stage the conversations between Facebook
and Foursquare are in, but in the venture financing process Foursquare may have released important
information to their biggest competitor. VC funds could have preempted this scenario and taken
advantage of this fact for their own benefit.
Finally, when closing a VC deal, the percentage of equity and valuation of the company are not the only
two terms being negotiated. VC terms sheets have many more terms that may persuade Foursquare to
go with one firm or another. Some examples of these levers that are likely to be hotly contested are
terms and conditions of the voting rights, dividend rates and preferences, mandatory redemption
provisions, conversion features, liquidation preferences and the anti-dilution provisions. VCs can utilize
these levers to compel Foursquare to accept a term sheet and prevent them from going to Yahoo! to
secure an acquisition value.
Conclusion
Based on the mental models constructed, we believe that Foursquare is not interested in being
purchased, and is only using the Yahoo! offer as a mean to inflate VC valuation and therefore reduce the
equity stake given to the VC.
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This, however, may play against Foursquare as it can eventually lead to VCs losing interest, driving
valuation back down. As it currently stands, three VCs have already backed out from the race, with only
Khosla Ventures remaining.
The threat that Khosla Ventures will back out and driving the valuation back down is plausible. As such,
we expect Foursquare to accept the Khosla Ventures term sheet at a valuation of $80-$100M.
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Appendix A
Foursquare - Venture Capital Return on Investment Calculation
Purpose: The capitalization table and exit scenarios modeled below serve the purpose of illustrating the potential return on
investment to venture capital investors.
Assumptions:
- All executives of Foursquare are issued common stock and do not participate in Series A financing. There are 6.0 million shares
issued prior to the Series A financing
- Series A shares are issued at $1.00 per share . O'Reilly Technology Ventures (OTV) and Union Square Ventures (USV) are the
sole participants in the financing.
- Series B financing is provided solely by Khosla Ventures. For simplicity , OTV and USV do not participate in the B financing.
- All shares are convertible to common stock at a 1:1 ratio
Venture Financing Details
Series A - March 2009
Pre-money valuation
Series A funding
Post-money valuation
Total shares (pre-financing)
Price per share
Conversion to common
Series B - May 2010 (pending)
Pre-money valuation
Series B funding
Post-money valuation
Total shares (pre-financing)
Price per share
New share issue
Total shares post Series B
Conversion to common
Capitalization Table
Investors
Common Stock - Executives
Series A - OTV & USV
Series B - Khosla Ventures
Total shares
Common share equivalents
$
$
$
6,000,000
1,500,000
7,500,000
$
6,000,000
1.00
1.00
$
$
$
80,000,000
10,000,000
90,000,000
$
7,500,000
10.67
937,500
8,437,500
1.00
Common
6,000,000
Shares
Series A
Ownership
Series B
Ownership
71%
18%
937,500
11%
937,500
100%
Total
Shares
6,000,000
1,500,000
937,500
8,437,500
937,500
8,437,500
Shares
1,500,000
80%
20%
6,000,000
1,500,000
100%
6,000,000
1,500,000
$ 125,000,000
10,000,000
12,611,111
1,500,000
20,177,778
80,711,111
$ 125,000,000
$ 150,000,000
10,000,000
15,388,889
1,500,000
24,622,222
98,488,889
$ 150,000,000
$ 175,000,000
10,000,000
18,166,667
1,500,000
29,066,667
116,266,667
$ 175,000,000
$ 200,000,000
10,000,000
20,944,444
1,500,000
33,511,111
134,044,444
$ 200,000,000
2.3
14.5
2.5
17.4
2.8
20.4
3.1
23.3
Foursquare Exit Scenarios
Acquisition price
Series B (1:1 liquidation)
Series B (participation)
Series A (1:1 liquidation)
Series A (participation)
Common
Check total
Return on Investment
Series B
Series A
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