In the last newsletter, I put forth the “Venture Investing Expression” below:

✅ Depth of market problem ∝ solution fit ∝ non-obvious insight ∝ traction ∝ business model ∝ market size ∝ go-to-market strategy ∝ team execution potential ∝ status of fundraise ∝ valuation ∝ stage of business ✅

A startup’s valuation is one of the most critical pieces for VCs. But it's also critical for YOU.  

Here is how I think about it - your startup has a beginning, middle, and end of the story. The startup story. Your story. 

Investors seek to understand the beginning, middle, and the end of the story. They are interacting with you at the beginning, or close enough to the beginning. It’s when you are building product, hiring people, bringing in revenue, etc. 

The middle of the story is one to two years down the road. You ideally have product/market fit. The Go-To-Market strategy is in full swing. You have likely raised a Series A round. You are adding talent to the team at a quick clip.

Then, there is the end of the story. That’s when the company gets acquired which is the reason why any venture investor would choose to invest in the first place. 

👇 Here is my thesis:👇

✅ Founders and Investors must understand how the story might END before you can truly understand the BEGINNING. ✅

When I had my FinTech startup, I was under due diligence from a VC fund. The Manager tasked me with giving them clarity around the type of exits in the space. 

Funny enough, I hadn’t thought a ton about that before that point and I was three years in. Yet, I had a really hard time finding that information. Perhaps it was due to the capital markets technology space and it was seemingly less covered or publicized. I couldn’t find it. 

I told the VC fund manager that I couldn’t find much information and data to answer the request. To my surprise, they were not satisfied with me not being able to find it. I didn't get it. I struggled to know WHY in the world it was so important. 

As an investor, now I know. 

👇 Here is why the end of the story matters: 👇

✅ The investor needs to know the potential end of the story, the exit valuation, to be able to calculate what equity (after dilution) they need to own to hit the return that they promised to their LPs of their fund. ✅

For example, if this company could be sold for $150MM based on other comparables, then what equity percentage do we need in the early stages, factoring in dilution, to make this a 20x-40x opportunity? 

You’re not building a tech startup company for the thrill of it. Among other awesome achievements - making a change in the world, influencing your industry, changing lives for the better - you’re building a tech startup company to eventually create wealth for yourself and other people. 

✅ Thus, the question of “How big can this company be?” is not a trite question. You as the founder should know the answer to this question. 

You’re not providing capital to the startup as an investor is, in most cases. You’re providing years of time, stress, mountaintop and rock-bottom moments, and hustle. You better sure as heck know what those five to seven years of your life may be worth someday. ✅

✅ You as the founder need to know the potential end of the story, the exit valuation, to be able to calculate what equity you will need to own (after dilution) to make the startup journey and overwhelming and ecstatic financial success. ✅

✅ Knowing the number that you are heading for from an exit valuation perspective helps you and the investor manage equity for yourself, the investors, and employees in an astute way at the beginning of the story. ✅

This helps you think about your equity now, after your pre-seed raise, then the seed stage raise, and beyond. This acts as guardrails because it helps you be astute and not be easily taken advantage of, but also not be too cheap with your equity.

In practice, this is the furthest concept from “Pick a number that sounds good.” 

Confession: I brought on a key role to my team and did exactly this. We jointly picked a number that sounded good. We settled on 14% equity with a 3 year cliff. NOTE: Without any sense of time dedication or milestones associated with it!!! We never had a liquidity event so it didn’t matter. But a mega learning lesson. 

For all the rub that tension between investors and founders get, solid investors and great founders harmonize this tension.

✅ The investor should make sure the founder is incentivized several funding rounds down the line, and the founder should make sure the investor is still exiting the investment with ecstatic LPs. ✅

For all startup founders, but especially those who are first time founders, you do not know what is a good or bad deal on valuation. I cannot overstate this enough.

For one, you need an expert who lives in this space who can call out what valuation is appropriate relative to what traction and stage of the company, and what’s BS. 

The sophistication of our changed by an order of magnitude once we started working with legal counsel who lives in startups and venture capital deals all day long. If you don’t know where to find them, I’m happy to put you in touch with the one we use or others who do startups and VC deals on the regular. 

When a startup pitches me, every so often I they tell me that they are raising $X at a valuation that seems way too low based on their stage of the business. But more commonly, the founder is soliciting a valuation that is too much in the stratosphere compared to the traction profile and stage of business. I know that no investor in their right mind will do that deal. 

I often feel compelled to tell the founder this. Often the advice is unsolicited so it lands in a variable way. But astute founders ask for my honest perspective on valuation. I appreciate that. It shows a degree of thoughtfulness about the process and reflects well on the founder. 

Often venture investors are too caught up in optimizing a number rather than looking at overall opportunity and potential. Valuation too easily can become an easy way for investors to say “no.” For example, I had an email this week from an investor who I was communicating with about a mutual deal. This investor said that the valuation should be X and the valuation solicited was about 20% above X. All the investor heard was the pitch, when I had a much more in depth conversations from many angles I knew the opportunity at play and what it could mean in the market and who the acquirers could be. Still, the somewhat random valuation expectation to be at X seemingly overcame the decision. 

In closing, I heard a story once from Mike Maples from Floodgate VC on his Starting Greatness podcast. On one of the episodes (I looked and cannot recall which episode it is), Mike casually makes a fascinating comment to the person that he is interviewing. In the late 2000s, one of his investor friends from Canada reached out to him. The investor said, “Mike, I know that you and Floodgate do seed stage deals. I have a startup that is raising their Series A. I know it’s a bit later than you typically invest but I wanted to at least mention it. The startup’s name is Shopify.” 

Mike shared that and started bemoaning to his interviewee, “I should have had the presence of mind to take that pitch. But I passed because it was a later stage than we typically do. So I passed on the intro.” 

Valuation is an art. Even for investors. 

In closing,

1. Know the end of the story and what it will mean for you.

2. Act astutely at the beginning of the story to steward equity well to that outcome.

3. Surround yourself with experts who can give insightful and unbiased perspectives on valuation 

4. Some investors will window-shop and pass based on price. Find the middle ground with the believers that care about you and what you're doing.