The reason a high valuation too early can cause more harm than good
Updated: Jul 30, 2020
Who hasn’t read a headline lately of a little-known startup landing a large pile of cash from investors creating a huge valuation? This creates a pile-on effect from increasingly larger venture funds seeking the next Unicorn – the billion-dollar valuation. Who doesn’t take notice? The problem is that many people do take notice and it can create a cascade of problems for young companies.
Of course there are always exceptions in life and when a young entrepreneur has a great idea, they feel like they are the exception to the rule. Rules don’t apply when you are going to change the world. Right?
Rarely. Often deep behind the headlines are good reasons for the exceptions – the founder is a bankable entrepreneur that delivered great companies before or the Angel investors are well-connected into the rarified world of multi-billion dollar venture capital funds.
The essence of the problem is that exceptions tend to cause false expectations. False expectations can turn investors off. If you have something truly great – 49 times out of 50 – you’ll need to prove it. That means MVPs, that means revenue, that means a well thought out channel strategy. That means quite simply you need proof points that validate what you are projecting. Without those hard-won proof points it is nearly impossible to convince investors that your company is worth the full value of the potential you project will come one day.
There are many approaches used to determine the valuation of an early stage company. That is not the purpose of this article. The purpose is to deliver the message that as an early stage company without substantive proof points, you should avoid establishing your target/potential valuation. The risk of doing so is you may send a subtle message to the investor, “I have unrealistic expectations and am not sufficiently focused on proof points and achieving them today.”
It is a classic pitfall for the young entrepreneur. Investors hear the word “valuation” too early and a big red flag goes up for them. Of course you have a dream – a vision for what all this could mean for you and your family. Keep that dream! But stay away from this trap. Wait until there is genuine interest in what you have, how you’ll get there, and until you are having discussions about investment. Your objective then is to cross that chasm at an early stage of raising enough money to fund the next phase and have sufficient runway all while avoiding raising too much at a low valuation. Leave that worry at home until you are at the negotiating table.
So what’s the advice? Leave the word valuation out of your pitch altogether! Good investors know their numbers. If 5 years out you are projecting turnover of $X and EBIT of $Y they can estimate the future valuation quite nicely in their heads. So let them. Don’t start negotiating something on paper before you know the people on the other side of the table. Leave it at home on your proverbial vision wall. Focus on clarifying your story and aligning that to the proof points you have and those you will attain. Get aggressive on the proof points – not the valuation.
Sage Partner Marc Fox contributed this Sage Advice