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Which Mold is Broken: Entrepreneurs’ or Investors’?

How much is too much money?  If you’re running a business in SF, NY, London, you need a lot of money.  It’s not just fixed costs that are killer, naturally labor costs are also much higher than they would in a smaller market.

Yesterday Marc Andreessen announced that his latest company Ning raised a massive $44M for a post money valuation of over $200M.  That’s a lot of money for a company in a space that has yet to prove it can generate substantial revenues.  In other words, the only successful companies yield exits that come in the shape of an M&A, and these are scarce despite the big headlines.

MSFT’s Don Dodge - who’s worked with some of the most notable startups, well, ever - pointed out the lunacy in the numbers.  Of course, he was quick to add that Andreessen is one of the few entrepreneurs whom you can trust with such a valuation.  Jason Calacanis who recently raised a rumored $16M on a $100M valuation is, like Andreessen, in the “seize as much as you can” camp.

I don’t mean to knock neither Andreessen or Calacanis, but their advice is somewhat irrelevant to an entrepreneur who did not, well, create Netscape or sell his startup to the company that bought Netscape!

Anyway, I’ve long stated that massive valuation don’t help, neither do low ones.  Everything taken to the extreme will come back and bite you.

My first Web experience ended up doing a valuation at $40M in 1999.  Little, if any, cash exchanged hands, but what that deal did was put the founder (my boss) in a corner because by 2000 no deal made that round look smart.

My second Web experience ended up doing a very low valuation.  In many ways, it put the founders in a corner because they were shell-shocked into diluting in a further round.  Ultimately, despite having a stellar business on paper, the company only fetched $13.5M in a sale for 12 times EBITDA (the mean was 15.9 times EBITDA, don’t ask).

Neither one of those cases were ideal, and both cases, the founders got squeezed in one way or another.  My gut says the right strategy lies somewhere in between: if your valuation is low, you’ll regret it pretty quickly and won’t be comfortable raising more money even if you need it; if your valuation is high, your financiers might block deals that might seem rich to you.  A Series A investor likes a 10x return, a Series B or C wants to see 5x return (according to Dodge’s post above).

For the record, the second company returned 27 times on a convertible deal.  I generated $8M of approx. 10M in the company’s sales… because my background in sales, business development, marketing and finance, I’m not too keen on doing a financing round that does not make sense for the financier and the founders.   Of course, running a company that is 75% content and 25% technology (just because our media business is that strong, of course ;) - means that VCs are not really even the best fit… but I do advise some entrepreneurs formally and informally and I don’t think that you should ever accept terms that you are not comfortable with…

Frankly, I advise people to look at the financing challenge differently, the good thing about media, for example, is you can hit ad revenue sooner than securing licensing revenue if you’re a tech company.  Bottom line, you should also look at costs in a different light.  In my experience, apart from the gaga Web 2.0 crowd, most companies don’t really have much traction in sales or business development until they have a meaningful business to show off, so in the initial months, why even bother setting up shop in SF or NY?

I think moderation is key. 

But when you see some successful VCs come out and urge lower valuations, it makes you wonder, what is broken: the entrepreneur’s mold or the VC’s?

Related:

- Not sure about the crazy valuations

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Posted By: Ashkan Karbasfrooshan | Jul 10th

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