As we begin a new year, leaving behind the year that will forever be remembered (2020) as the pandemic that changed the way we all work/learn/communicate, many investors are experiencing mixed feelings towards the market. On one hand, we experienced a big blow in the retail world with stores are closing (some would argue it was bound occur), restaurants are struggling and many business owners are closing shop. On the other hand, companies are skyrocketing (see Tesla’s 2020 stock graph) in market share and valuation, construction is booming and the real estate market outside many cities is reaching an all-time high. With that we are experiencing some of the biggest unemployment rates we’ve had in a while and everybody is wondering, are we inside the next bubble that is about to explode? Is this 2008 all over again, maybe 2001?
Many years ago when I started doing business my mentor explained that uncertain times are inevitable; every 5 to 10 years our economy goes through times that are more cloudy than usual. It can be a month reflecting 2018 patterns or 3 years of 2008-like slump. It is not in our power to predict the future, but it is definitely in our power to make sure that the actions we take are calculated and are promoted with knowledge and strategy. It is in our power to structure any financial move we initiate in a way that will bring the best results throughout the entire process.
One of the key factors that influence all levels of fundraising is the valuation. When meeting with founders both senior and new, I often find that their approach to valuation is very protective. This is understandable due to the fear that they might lose their part of the company they’re building. The dominating thought in their head is, “My startup is a once in a lifetime idea. It’s going to be a unicorn, and I want top dollar for it.” In some cases they might be right and in ALL cases it ought to be their core mindset (“shoot for the stars” and all that). However, the thought process in deciding something as crucial as valuation, the line of thinking must be deeper.
There are 8 to 10 different methods in evaluating companies’ worth. Each financial analyst will choose the method that suits them the best, but in many cases when discussing the stage of pre-revenue or low-revenue companies, the valuation methods don’t fit. Then the founders conclude that they will “decide” on the valuation based on what they think their company is worth. This decision is extremely risky for two main reasons:
1) It will keep “smart” money away. Investors that are doing more than simply writing a check and maybe sitting on the board, are by nature more active in the business. They advise and guide, they help with product design and how to direct it to the right market, and eventually how and where to collect more funding once the company is ready. It is crucial for the founder to decide which type of investor they are looking for because that will determine the starting point of the valuation.
2) High valuation leaves very little room for future rounds of fundraising, and for strong VCs to join the board. The higher the valuation, the less flexibility the company has to raise the valuation at VC rounds and the less shares the company has to offer.
In summary, my suggestion is to keep valuation within reason(based on actual achievements and short term projections) for the initial fundraising stage, and to ensure that the funds coming in will optimize its contribution to the overall value of the company.
Comments