Why startups should take lower, rational valuations
JULY 12TH, 2018
It’s not uncommon for startups to receive irrationally inflated valuations in today’s fundraising environment. Investment dollars are seemingly streaming in from all around the world, eager to find the next unicorn. First-time entrepreneurs, in-particular, are at risk of falling into the trappings associated with accepting investment capital from the wrong investor at the wrong valuation.
There has always been an aspect of herd mentality when it comes to investing in technology and biotechnology startups. New technology trends and sectors arise, and investors, drawn to the promise of a new sector, come pouring in. This is to be expected because these sectors are where the highest investment returns are generated, but it also leads to irrational valuation inflation. Fear of missing out on a sector, or individual company within a hot sector, can lead to a bidding war in which investors use valuation and ever increasing dollar amounts to entice startups of accepting their investment.
Situations in which valuations (and raise amounts) snowball for reasons other than the underlying value of the company rarely work out for either investors or entrepreneurs. With great valuations come great expectations. Runaway valuations oftentimes set companies upon trajectories that are wholly unrealistic. This inevitably leads to disappointment and discontentment for investors and entrepreneurs. Entrepreneurs are already under a tremendous amount of stress, and heaping unrealistic expectations on founders and teams can have disastrous consequences. Situations such as these leave no room for error and every stumble becomes exaggerated- this results in down rounds, dilution and significant disillusionment amongst founders and employees. Oftentimes dilution associated with a down round results in a cap table that looks very similar to what the cap table would have looked like if the company and investors had agreed upon a rational valuation on the front end, and founders/employees would suffer significantly less disillusionment.
Use external valuation comparable and industry reveneue/profit multiples to estimate a reasonable valuation for your company. Know this valuation benchmark going into your raise, and avoid thinking in the short-term relative to valuation and taking fast cash. Think through the mid-term and long-term implications that inflated valuations have for your company. This is hard to do, but it will result in a happier founders, employees and investors in the long-run.
