Don’t Back Up A Higher Valuation Into A Smaller Vision

If you ask anyone in startups how a founder should value their company for the first round of financing, nearly everyone will say to start with a valuation between $2M-$5M post money on a SAFE. I have an in depth reason for this answer right here, but the main explanation is that founders should select a valuation they can grow into over time, which is probably not the current actual value of the company. Most startups don’t have revenue when they raise their pre seed round of financing, so there is no “multiple” to go off of. And if there is a little revenue traction, the objective valuation could be in the range of $50k-$500k, setting up a founder to be taken advantage of by an investor, capping the fundraising and growth potential of the company.

There is a caveat here. The advice above applies for founders who are aiming to build large technology companies in a modest amount of time (7-10 years). Since the ambitions for the founders and investors are to go big, there is a mutual understanding that the early valuations will be high, because they need room on the cap table to fund the thing to get to an ACTUAL valuation of over $1B in the future. The ideal situation is that, eventually, the real valuation will align with the business metrics years down the line.

What If A Startup Doesn’t Want To Go “Venture Scale”?

With the current trend to raise less, hire fewer people, and have more founder controlled companies, the above valuation strategy can be dangerous. For example, let’s take the one and done fundraising concept, which is where founders raise one round of capital and then plan to operate the business profitably after that. Does it still make sense for a founder to bump up their valuation for the first round so they can back into a higher valuation later? Seems counterproductive, as there is no plan to raise future capital. Actually, It’s not just counterproductive, I think it misaligns incentives between the founder and investors quite a bit.

If an investor wants to invest in a company at the pre-seed stage and the founder is pushing, say a $4M valuation, I think that’s a pretty bad deal for the investor. The investor needs to invest in a company with all the risk in front of it, AND understand that their check will be the only risk capital going into the company. For standard startup investors going for venture scale outcomes, they know that the next round of capital will further equip the company, take some risk off the table, and give them a markup which can be a positive signal to other investors. On the other hand, this solo investor is taking a larger risk for the same reward, so they should be compensated with a more reasonable valuation.

You Can’t Have Your Cake and Eat It Too

A founder that pushes for a higher early valuation but doesn’t plan to raise more capital or aim to build a $100M ARR company in under 10 years is being stubborn at best. For those founders who want more control over their future, they will attract more capital, gain trust from better investors, and even if dilution is 20-40% with that investment, these founders will still have full control of the company and have the capital to do what they want with it, on their terms. They don’t need to plan for future dilution and they don’t need to deal with an unhappy investor five years in. Owning as much of the company as possible is attractive, but just don’t forget why early stage valuations are so high to begin with….to support future fundraises and fuel a rocket ship to get to an IPO. It’s a very specific tactic, not a general blueprint.

Thanks for reading. If you enjoyed, reply and tell me what you liked about it. I love hearing from happy readers.

Some things I’m working on right now:

• I am starting to host retreats for tech folk (founders, investors, job seekers, and tech talent). Join my interest list and we’ll send you retreat opportunities as they come up. Our next one is July 28th in Scottsdale, AZ.

• Sick of managing a group chat/Slack community? Want a community that self regulates and distributes value without relying on your time and effort? We built the perfect tool for this called IntroFlow.

• Founder or investor looking to expand your network with other founders and investors? Try out Seedscout (It runs 100% on IntroFlow).

Until next time…