Red Flags

What the greatest technology investors say about Red Flags

High Valuations Can Limit Exit Opportunities

Josh Kopelman Partner First Round Capital and former entrepreneur

Kopelman advises that entrepreneurs who “[] try to maximize valuation [] in many cases [] might be shortsighted” because high valuations can limit exit opportunities.  “[] too many founders are not aware that they are shutting off the majority of exits -- and therefore increasing risks -- when they accept a high valuation.”  “[] the “unwritten term in the term sheet” [means] few VC’s will willingly part with a “winning company” (i.e., a company that is executing/performing well) for less than a 10x return.”  Thus, a VC could block an exit that could have been a fabulous payout for entrepreneurs and angels.  Josh Kopelman The Unintentional Moonshot, July 10, 2007, http://redeye.firstround.com/2007/07/the-unintention.html;  When the music stops... March 10, 2006;  http://redeye.firstround.com/2006/03/as_a_little_kid.html

Problems Taking Seed Money from Big VCs

Chris Dixon General Partner Andreessen Horowitz, angel investor and former entrepreneur

When entrepreneurs raise seed money (under $1 million) from big VC firms’ seed programs, potential investors typically ask ““is the big venture firm following on [with financing]?”” If not, entrepreneurs will likely have difficulty raising more money because potential investors will question why they should invest if the big VC firm doesn’t.  “[When entrepreneurs take big VC’s seed money], [] effectively [they’re] giving [the VC a non-contractual] option on the next round, [acting as a VC lead generator.]  And, somewhat counterintuitively, the more well respected the VC is, the stronger the negative signal will be when they don’t follow on.

[When] the VC does [] follow on, [the company will likely] get a lower valuation than [had it] taken money from other sources” because new investors often offer to co-invest at a lower valuation, keeping an artificially low valuation or “hesitate to [bid] for fear of being used as [leverage to get a higher priced deal]. [] [Having] a big VC [] as a seed investor [] prevent[s] [the entrepreneur] from getting a competitive dynamic going that [generates] a true market valuation.  

[][Dixon] sometimes compete[s] with big VC’s for investments so [he’s] not disinterested here.”  Chris Dixon, The problem with taking seed money from big VCs, August 14, 2009; http://cdixon.org/2009/08/14/the-problem-with-taking-seed-money-from-big-vcs/