Jeremy Liew, a VC who has backed Flixster and Rockyou, wrote an interesting post on the dangers of startups raising early money at high valuations but sadly used the words ‘assymetric risk’ to describe his argument. Josh Koppelman, of First Round Capital, expanded on Jeremy’s point, wrote it in plain english and also used data to show that valuations are rising and that M&A exits had decreased in value from historical norms which therefore closed a lot of avenues for said early-money-at-high-valuation-cheerleaders. Jason Calacanis, who raised a ton of money at a high valuation before launching Mahalo, ostensibly called Jeremy an idiot and said people should listen to Marc Andreesen, who just closed on $44m at a $180m pre-money valuation for his company Ning.
Even though I am coming at it from the perspective of an entrepreneur, the Venture guys actually have a very valid point. It’s just the inherent conflict of interest when they say it leaves them open to Page-Six arguments by folks like Jason.
I think of the money raising process as like hoping on a train. There are trains that stop at express stops and those that stop at all local stops. If you raise a lot of money, or money at a high valuation, you strap yourself in for the express stops ride that can’t and won’t stop at the good-but-not-great progress station.
Josh Kopelman sums it up well with this:
“While every situation is unique, here’s a simple rule of thumb:
Series A – 10x
Series B – 4-7X
Series C – 2-4X”
What that means is if you raise a series A at a $8m post-money valuation, anything less than someone wanting to buy you for $80m will be rejected by the venture capitalist. And as Josh shows, that’s a shrinking piece of the M&A market. So you effectively shut off a lot of scenarios.
If you raise smaller amounts of capital, at smaller valuations and with smaller required exit multiples, you leave a lot more scenarios open for the future (obviously at the expense of dilution). Like if your company is acquired for $375 million and you end up with $650,000.
Ironically, Jason’s main point: “Listen to successful entrepreneurs not the first-year VC” actually defeats his whole argument. Successful entrepreneurs have been raising smaller and smaller amounts of capital because they can get more done on the back of it. The qualification Jason makes is that raising money isn’t bad but “the risk is if you SPEND to much money”, which is true but a weak cop out. There are real consequences to having a $100m+ valuation before you really even get started, and that is the collapsing of acquisition scenarios in ranges less than that. For Jason and Marc, that’s no big deal, but for a significant number of entrepreneurs, it is.
