Don’t Get Greedy with Your Valuation, or Investors Like Me Will Put You in Hell for It
Mr. Wonderful here –
I can’t tell you how many times a founder has stood in front of me and asked for $100k, $200k, or even $300k in exchange for just 1% of their company. That’s an eight-figure post-money valuation. So unless you have at least $1 million in revenue and solid justification for a 10x multiple or better, you’d better believe I’ll put you in hell for it – and smart investors will too.
Need a refresh? Checkout our guide to startup valuations.
Overvaluing your company can hurt you in the long run.
Let’s just say for argument’s sake that you’re in the Seed Round and you’ve boondoggled your way into a $90 million valuation – i.e. the average valuation for a Series B. Now you collect a huge bag of cash and ride off into the sunset, right? Wrong.
If – and it’s a BIG if – you do manage to raise at such an overvalued price, you seriously risk your company’s sustainability in the future. Say other businesses in your vertical are selling at 4x annual revenue. At a $90 million valuation, that means you need to reach $22.5 million in sales or you’re looking at a down round at best. Odds are, in the seed stage, you’re not even close.
So what do you do? If you’re following the playbook of former unicorns like Uber and Airbnb, you’ll spend heavily on sales growth, then close your eyes and pray for profitability later. And maybe that could’ve worked two years ago, but now cash is king and companies that grow too big too fast are getting slaughtered.
But Mr. Wonderful – what about dilution, you ask?
My response: What about it? Most companies will undergo about 20% dilution in the Seed Round. But in my view, focusing on dilution is the wrong way of looking at things in the first place.
Let’s use easy numbers and say you raise $200,000 at a $1 million pre-money valuation. Your effective dilution is just over 16%, except now your company is worth $1.2 million – so your roughly 84% stake is still worth $1 million. In other words, yes you’re diluted but the value of what you own hasn’t changed.
More importantly, though, is what that extra capital unlocks for your business. And, if you set your valuation appropriately, you can deploy that capital toward sustainable growth. As my friend Howard Marks likes to say, “I would prefer a relatively smaller slice of a giant pie all day long.”
Investors from the crowd are in it for the long haul, so don’t treat them like a VC.
Look, investors from the crowd aren’t VCs. In fact, they tend to be the early adopters of your product or service, which makes them very sticky as shareholders. Unlike VCs, they don’t have a strict time horizon to liquidate either.
That stickiness can be very interesting for founders but it also means you don’t want to piss them off with an unrealistic valuation or unfair terms. So if your cap table already shows millions in preferred shares, don’t go short-shrifting your crowdfunding investors with common stock. As far as I’m concerned, do that and you don’t deserve another cent.
It’s not hard folks – do yourself and your business a favor, be smart about your valuation, and treat your investors right. In the long run, you’ll be glad you did.
Kevin O’Leary is a paid spokesperson for StartEngine. View the details here.
