Valuation

What the greatest technology investors say about Valuation

There's No Science to Early Stage Valuation

Fred Wilson venture capitalist and Co-Founder Union Square Ventures

“There is no science to early stage valuation.  It’s simply a matter of supply and demand.  So generate a lot of demand and you'll get a good price.” Fred Wilson, Valuation and Option Pool comments, Nov 6, 2009;  http://www.avc.com/a_vc/2009/11/valuation-and-option-pool.html#comment-22043449

Dilution Benchmarks & Fundraising

Mark Suster Partner Upfront Ventures and former entrepreneur

Negotiations between entrepreneurs and investors include dilution and other fundraising terms.  “[] the “fairway” of [investor’s equity] is 25-33% per round [i.e., entrepreneurs’ dilution]. [] If [the entrepreneur is] “super hot” or “super experienced”, [he] can end up with much less dilution –in some cases 12-15%.  But this is the exception, not the rule.”

“[] [These] dilution numbers don't take an option pool into account [].  Options are additional dilution.”

“[] [Valuation can be driven up] ONLY if there’s [] competition [for] a deal.  [Investors stay honest when entrepreneurs] talk with multiple parties.”

Fundraising also requires considering how many future rounds are needed and expected total future dilution.  It’s not an arbitrary spreadsheet-driven exercise reflecting attaining profitability.  It requires “understanding [industry norms necessary] to build a successful Internet business and where [the company falls] on that spectrum given [its business type].”   Mark Suster,  8 Questions to Help Decide if You Should be Raising Money Now, February 17, 2011 and comments;  http://www.bothsidesofthetable.com/2011/02/17/8-questions-to-help-decide-if-you-should-be-raising-money-now/

Be Leary of Too High a Price

Mark Suster Partner Upfront Ventures and former entrepreneur

 “[] [Suster has] seen a destructive cycle where otherwise interesting companies have been screwed by raising too much money at too high of prices and gotten [] [trapped] when [] markets correct and they got ahead of themselves [on inherent market valuation]. []

[It’s] OK to [] shoot for the “top end of normal” for the market conditions. [] [He] caution[s] entrepreneurs from [] raising money at significantly ABOVE market valuations. []

If [entrepreneurs] haven’t figured out product / market fit and therefore still have a highly risky business [they] run great risks for getting too far ahead [] on valuation. [] [Most] investors won’t want to [][do] a “down round,” which creates tension between them and early investors.

[] [Sophisticated] investors know [a major down round] is fool’s gold.  They get a cheaper price, [] wipe out much founder stock value and [] reissue [founders] new options. [Founders] take the money []” except their incentives get eliminated.

[] He advises “[] us[ing] competition to [][ensure] a fair price [and] rais[ing] a slightly higher round than [] [otherwise for some strategic reserve]. [] [One wants] to show an uptick in valuation [] for new investor confidence and to maintain [early investor relations].”  Mark Suster  Why Startups Should Raise Money at the Top End of Normal,  June 5, 2011;  http://www.bothsidesofthetable.com/2011/06/05/why-startups-should-raise-money-at-the-top-end-of-normal/

No Great Science to Determining Valuations

Mark Suster Partner Upfront Ventures and former entrepreneur

 “There is no great science to [how prices (valuations) are determined].  The earlier [one] invest[s] the higher the chances the company won’t work out and thus [one] pay[s] a lower price than later-stage investors. [An investor tries] to pay the appropriate price for [his] perceived risks of the company succeeding and protect [himself  if] it isn’t quite as valuable as [he] had hoped.  As the risks [] get eliminated the higher the valuation investors are prepared to pay.”  These risks over time are “[first] product [], [then] market [], [then] growth/scale [] and [finally] monetization/competition [].”    Mark Suster, Why Startups Should Raise Money at the Top End of Normal  June  5, 2011;  http://www.bothsidesofthetable.com/2011/06/05/why-startups-should-raise-money-at-the-top-end-of-normal/

Strategic Value Increases Valuation

Basil Peters angel investor and Principal Strategic Exits Corporation

Illuminating strategic value of an acquisition target can increase valuation.  “The only reason any company buys another company is because [it believes it] can increase the value of the company being acquired, and/or the acquired company will increase [its own value]. [] The most successful company sales [result in] the combination of the two businesses increas[ing] the total business valuation faster than either company could achieve alone. []

[Strategic value increases business valuation by] reducing competition [] [and/or cross selling or promotion of] complementary products or services. [] [Also an acquirer] that would like to develop a similar product or service [] will [often] pay to reduce []‘time to market’, [] [so] being fast is often better than being good.”  Incremental strategic value can show why “the business is worth more to [the prospective buyer] than to another bidder”, which drives why he’ll often pay more.  Basil Peters,  Illuminating Strategic Value When You Sell a Business,  August 1, 2009; http://www.exits.com/blog/illuminating-strategic-value-when-you-sell-a-business/

The Biggest Mistake Entrepreneurs make when Raising Money

Babak Nivi Co-Founder AngelList and Venture Hacks and angel investor

Nivi says “the biggest mistake entrepreneurs make when [] raising money” is that “[they] focus on valuation when they should be focusing on controlling the company through board control and limited protective provisions.   (Protective provisions let preferred shareholders veto certain actions, such as selling the company or raising capital.)

Valuation is temporary, control is forever.  For example, the valuation of [a] company is irrelevant if the board terminates [the founder] and [he] [loses his] unvested stock.

The easiest way to maintain control of a startup is to create good alternatives while [] raising money. If [the founder is] not willing to walk away from a deal, [he] won’t get a good deal.  Great alternatives make it easy to walk away.

Create alternatives by focusing on fund-raising: pitch and negotiate with all [] prospective investors at once. This may seem obvious but entrepreneurs often meet investors one-after-another, instead of all-at-once.

Focusing on fund-raising creates the scarcity and social proof that close deals.  Focus also yields a quick yes or no from investors so entrepreneurs can avoid perpetually raising capital.”  Babak Nivi, What’s the biggest mistake entrepreneurs make? , October 14th, 2007  http://venturehacks.com/articles/biggest-mistake; Why do investors want protective provisions? August 2nd, 2007;  http://venturehacks.com/articles/understand-protective-provisions

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/