Higher Valuations Are Not Always Better
Transcript
Valuations. Higher is not always better. I know that sounds radical, but let me explain. You see, there have been a rash of really high valuations, especially for very early stage companies. And as an entrepreneur myself, it feels great when the entrepreneurs are winning. I'm seeing valuations that are 2x, 4x, even more than what they would have been just a couple of years ago. And on the surface, this feels amazing. The problem is that some entrepreneurs don't see that they're going to be a good one.
that there could be some unintended consequences.
And I want to make sure that you don't fall into that trap.
One thing I want to agree on is that investors love to invest in things that are going up
and to the right, a rocket ship.
That's easy.
But we also should agree that investors don't like to invest in companies that are going
down.
That's what we call a down round.
When your subsequent round is at a valuation less than the prior round, it's very hard,
almost impossible to raise money like that.
All right, now that we established that, let's take a fictitious company.
I'll call it Acme Company.
And let's say that they raised $3 million on a $15 pre.
That's an $18 post.
Well, it's really important that if they do that, that they have enough money, the $3 million, to grow into their valuation.
Let me be specific.
Let's say all they had when they raised was an idea and a deck.
They were like, woo-hoo, we raised $3 on $15 with an idea and a deck.
That's amazing.
What a great time to be alive.
But with that $3 million, they have to hire a team, build a product, go to market,
and have some metrics and KPIs that are going to justify an up round.
Now, the first round was an 18 post.
The next round, it's got to be north of 20 because they're going to have an option pool expansion, etc.
We'll call it 20 plus just to be safe.
So can they build a company with that $3 million that based on metrics and KPIs is going to get a valuation north of 20?
If they can, it's amazing.
Because in their first round, they gave up.
You include option pool.
It's probably a little over 20%.
But they kept almost 80% of the company.
They had $3 million to work with.
But if they can't, they're done.
The game's over.
You see, there's something I've said here many times, which is that raising money for an entrepreneur is sort of like playing a game of chess.
While it may be tempting to optimize each move, the real thing that matters, the only move that matters in chess is the last one, the one where you say checkmate.
The only move that matters when you're raising money is when you sell the business and when you get to take money off the table.
And so while it's tempting to optimize and get as much as you can at each subsequent, each round, you have to make sure you put yourself in a position where you will have the subsequent round.
So more is not always better.
Make sure you put yourself in a position where you raise as much as you need
and make sure you know that you are going to be able to use that capital
to get to something that is an up round from the valuation you were just at.
And if you can do that, you're on the road to building an amazing company.
Now just to wrap this up, that Acme company,
it's actually, while the name has been changed to protect the innocent,
an actual company a friend of mine recently raised three million on 15 with just an idea
and a deck and i hope i hope that they build an amazing product and i hope that they have the
KPIs and metrics so that their next round is north of 20 because if it isn't they're not
going to have one they're going to have to start all over i hope this was helpful
Thank you.
A high valuation feels like winning, and sometimes it is. But every round sets the bar the next one has to clear, and a down round is close to unraisable.
Troy runs the arithmetic on a fictional company that raises $3M on a $15M pre — an $18M post — with nothing but an idea and a deck. That money now has to hire a team, build the product, get to market, and produce metrics strong enough to justify north of $20M next time, once the option pool expansion is accounted for. If it can, the founders kept almost 80% of the company and it was a great trade. If it can't, the game is over.
The framing he keeps coming back to: raising money is a game of chess. It is tempting to optimize every move, but the only move that matters is the last one.