Valuation vs Ownership

Fred Wilson:

We recommend that entrepreneurs keep the funding amounts small in the early rounds when the valuations are lower and then scale up the amounts in the later rounds when it is a lot more clear how money can create value and when the valuations will be higher. This model has worked out pretty well. David Karp raised $600k, then $4mm, then 5mm, then $25mm, then $80mm (or something like that). And at the time of the sale to Yahoo!, he owned a very nice stake in the business even though he had raised well north of $100mm. He did that by keeping his rounds small in the early days and only scaling them when he had to and the valuations offered were much higher.

I made a similar point at Echelon Ignite in Sydney couple of months back. Entrepreneurs should be realistic about valuation in the earlier rounds. The higher the early round valuation, the greater the expectations, and the harder it is to justify the valuation that is going to be even higher the next round (nobody wants a down round). Here’s an example. A startup I invested in was valued at $3m post-money after raising its seed round. Shortly after the initial raise, they did a bridge round at the same valuation ($3m pre bridge money). Realistically, they need a pre-money valuation of at least $5m to do an A round, which requires significant traction in terms of user and revenue growth to justify the increase in valuation. Not easy, bearing in mind this is in South-East Asia where valuations and exits are much smaller than in the Valley. The entrepreneur took what was on the table, and you can’t fault him for it. On hindsight though, perhaps it would have been better for him to have raised a smaller seed round at say half the valuation (so $1.5m post-money), then do a post-seed/Series A at $2-3m pre-money. A $2-3m valuation is a lot easier to justify than a $5m valuation, so chances of closing the post-seed/Series A at the lower valuation are much higher.

The point of all this is, raising a boatload of money too early at an artificially high valuation puts the entrepreneur under a lot of pressure to up the valuation even higher to raise the next round. Doing small rounds at smaller valuations is not a bad thing, especially since raising less money forces entrepreneurs to become more disciplined about how they spend the money.

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