The truth behind high valuations

Recently a founder asked me to invest in his seed round (pre-revenue) at a $35M valuation.

I said “No” as it makes no sense to me and I’ll explain why.

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After investing in 10+ startups in the last 2 years, I’ve learned that aiming for a really high valuation for your seed round does not always make sense.

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To give you some more context on the startup valued at $35M with $0 in revenue, it’s a SaaS company, the product isn’t a technological breakthrough but the team is great and the founder has a strong track record.

These were enough to convince VCs and drive the valuation up a lot.

So what is the problem?

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The trap of a high valuation

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As the valuation of your company increases, so does the pressure that you’re gonna put on yourself and your team

Because you will need to grow quickly to justify the money you raised from the investors.

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In an ideal world, startups find optimal valuations (not the highest ones) at which they are comfortable and which will allow them to raise only the amount of money they need.

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But in reality, since many founders associate the valuation they get with success they tend to overestimate it.

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And it may be a trap.

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Let’s go back to my friend.

When you raise at such a valuation ($35M), your investors want you to raise a series A in the next 18 to 24 months.

Now let’s say that everything goes well and that you manage to reach $3M in ARR in 24 months to raise a series A at a $100M valuation (which is very unlikely.)

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Your early investors are gonna be pretty happy because they can now report a ~3x growth on their initial investment (not including dilution)

And guess what? Now, the series A investors are gonna ask you to raise a series B in 18-24 months so they can also show their investors that their portfolio is growing well…

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If your valuation is $100M when your ARR is $3M, your startup is valued at 33x its ARR.

But when you look at public SaaS companies, they’re trading anywhere from 5x to 12x…

NOT 33x…

And that will most often lead to bad long-term decisions.

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Why?

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Because from now on you will try to optimize your business decisions and the product roadmap for funding rounds which is exactly the same as optimizing for fancy offices, press releases, or speaking events. It hypes people up, but essentially it does nothing for the real growth.

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Sam Altman calls it “fake work”. It’s very distracting.

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As a startup, after a seed round, your only goal should be focusing on listening to your users, writing code, collecting feedback as fast as you can, and iterating. Especially when your product isn’t a technological breakthrough and its success is determined by whether you’ll be able to solve your customers’ problems better than the existing competitors.

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Instead, founders obsess over the next round without considering whether the foundation of the whole business is solid. The number of companies going bankrupt because their business model can’t work is huge.

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The three possible ways out

And because VC-backed startups are not profitable, it means that when you can’t raise another round, you have 3 options as a founder:

1. Fire a big chunk of your team to reach profitability. (Another mistake that many founders make after fundraising, is doubling the size of their sales team because they need to sell, sell, sell. But then they fail because there was product/market fit in the first place)
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2. Shut down the company and file for bankruptcy
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3. Sell your company for $1, call yourself an “exit SaaS founder”, and start saying that “you can’t disclose the amount of the sale”

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When it comes to investing, VCs play a “portfolio” game. They lose seven times out of ten, so it’s their job to make you take the maximum risks.

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Meanwhile, for you, as a founder, it’s gonna be an “all-in game” where you will give up on the decision-making freedom, put stress on yourself, and your team, and may lose your entire business in the end.

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The moral of the story: don’t get fooled by all the overnight success stories and super high valuation.

It’s better to go slow but steady and be in the driving seat of your business.

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Build to last 💪

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Every week I’ll publish new articles on how to build and grow a B2B business that generates millions of dollars.

Without any BS and giving you practical templates that you can steal.

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Peace, love, and profit 💰

G. ✌️