Do not overestimate your valuation

Early stage valuation is a difficult concept to tackle. While experience certainly helps, you can’t always apply a specific methodology, so ultimately the market dictates the rule.

The basic rule and tacit understanding when raising successive amounts of capital from different investors is that you’re supposed to create value for yourself and your investors. Meaning your valuation should go up, not down nor stay flat. Among entrepreneurs, closing a seed round with a high valuation is considered a great achievement but in the long term it could be completely counterproductive.

After their first or second round, founders are sometimes facing external or internal issues that results in down rounds: i.e. a new financing round resulting in a lower valuation than the preceding financing round. It’s not a deadly event but it can definitely make things much harder for founders by sending negative signals to the market, the investors, and internally.

If an investor thinks your last round valuation was too high then he is more likely to pass rather than try and negociate your valuation.

Over the last couple of years, we have witnessed some over-valuation at seed/Series A stage mainly resulting from:

• Abundance of liquidity
• Competition between investors
• Bad practices from new comers / ill advised investors

We are now beginning to notice more and more startups having difficulties legitimating such valuations when trying to raise their next rounds. This is usually because they failed to hit their planned milestones and executed poorly their strategy.

Most of the time startups end up wanting to raise Series A money using Seed Metrics or Series B money using Series A metrics.

At this point, it is crucial to have some good investors to bridge you up while you work on redefining your metrics because VCs hate down or flat rounds.

Why is that ?

• It implies that something went wrong (either in your planning or in your business)
• Investors don’t want to piss off your previous-round investors because they’ll likely have to work with them in other deals
• They don’t want to become a shareholder in a company where every other shareholder starts by being annoyed with them
• Such a round will very likely represent too much dilution for the founding team. At this stage investors know that a skilled founders team will be more motivated if they own enough of the company. Indeed you don’t want to invest in a company where founders are slowly drifting, thinking about their next company.
• A big part of the problem is that for potential investors, a startup’s valuation is the easiest thing to measure and thus it dictates the perception. So for founders, the perception of taking a down round can be difficult because you constantly have to preserve the narrative.

In a market where there are hundreds of great deals, why sign up to one where you know there are going to be bruised egos from the beginning?

If you are an exemplary entrepreneur and you maintain a very good relationship with your shareholders, you might have a solution. Even if you are in need, if they still trust you, you may be able to convince them to give you some money to keep going while you hit your targets. The founders who have survived down rounds emphasize that it is critical in such tough moments to focus on the things you can control : your mission and the fundamentals of the business.

Raising money is tough and so is determining a valuation. There is no such thing as a magic formula but reason is key. Also, keep in mind that your financial needs must be consistent with your progress, future developments and being capital efficient will certainly increase your chances during your next round.

Be flexible, but don’t let off the leash because on the contrary a low valuation is a negative signal: it suggests a lack of understanding of fundraising, the market, and the value of what you’ve built.

Sharpn is a fundraising advisor supporting ambitious entrepreneurs. We aim to support startups from late-Seed to Series A round.

So if you’re interested in our killer program please contact us at contact@sharpn.eu or visit our website https://www.sharpn.eu/