Is Digital Sky Going to Rule Silicon Valley -- or Ruin It?

Yuri Milner Digital Sky CEO
Yuri Milner Digital Sky CEO

The hottest venture investor in Silicon Valley comes from Russia: Yuri Milner, (pictured) the founder and CEO of Digital Sky Technologies. Milner has placed enormous bets on social network giant Facebook, group buying site Groupon, and social game maker Zynga. His willingness to put hundreds of millions of dollars into late-stage venture investments at high valuations has the Valley abuzz -- and somewhat concerned.

The problem? Milner's fat wallet could be ruining it for the rest of the Valley by radically inflating perceived values of hot startups.

"There aren't a lot of people willing to pay that much for those sorts of investments," said one prominent "Bulge Bracket" brokerage money manager who specializes in Internet plays at a conference last week. Indeed, the eye-popping $1 billion valuation of Groupon on a revenue base of well-under $50 million in annual sales has some Valley wags using the b-word. His $135 million investment in Zynga seems more sane, because Zynga has higher revenues -- except for the fact that Zynga is heavily dependent on the good graces of Facebook for its future.

Still, Milner's $300 million investment in Facebook at a valuation of roughly $10 billion looks smart. The company built by Mark Zuckerberg has an imputed valuation of over $20 billion, based on valuations of Facebook shares trading on secondary markets.

When Too Much Cash Is a Bad Thing

So who is this radical Russian? Milner went to Wharton Business School as a young man, then stayed in the U.S., joined the World Bank, and helped oversee development of the financial sector in Russia in the post-Communist era. He returned to his native land in 1996 and went on to serve as CEO of Russian ISP between 2001 and 2003. In Digital Sky Technologies, he has raised well over $1 billion in multiple rounds, and has invested in the biggest, splashiest Internet companies.

An investment from Digital Sky, however, could actually have significant detrimental effects. When Milner drops a check on a company, the valuation of its privately held shares instantaneously balloons. This can make it much harder to hire good employees. Who wants to work at a startup that's issuing stock options with values close to what would be expected in an IPO?

Additionally, liquidity provided by Digital Sky could serve as motivation to top employees to bail out before an IPO. This is particularly true now that secondary markets for privately held shares have become far more liquid.

Granted, in the case of Facebook, Milner seems almost certain to earn a massive return when the company goes public. That could be enough to make his entire portfolio. But whether Milner's touch is truly golden, or whether his big check tactics are good for startups, remain entirely open questions.