‘To Focus on Valuation So Early Is Crazy’

August 26th, 2014 / No Comments »

There’s so much debate over valuation. In general, the market is frothier than it was when I started the Webb Investment Network four years ago, but it’s not ridiculously frothy. It makes sense: We are in a better climate, the economy is improving, the stock market is doing better and there is more angel money. People are willing to pay big money for a piece of a startup.

But, are they overvalued? That’s an interesting question, but perhaps not the right question. The fact is, in the early fundraising stages of a startup, we’re not talking about liquid assets, just “funny money.” There is no way to trade the asset and get a market validation for price—nor will there be for years—so any price negotiated is somewhat nebulous. The truth is that valuation has little impact one way or another on the public markets. To focus on valuation so early is crazy. It takes years to see returns and the market will go up and down—again and again.

See what other startup mentors have to say about valuations.

Therefore, a more important question becomes: “Who gets the advantage—the founders or the investors?” Investors are exchanging hard cash to get a percentage of ownership in a company. Founders are selling a piece of the company, but it is illiquid for a long time, in most cases. Exits take years and IPOs can take 10 or more years.

Instead of focusing so much on valuation, founders should focus on how to get the investors they want at a fair price. Investors should be kept excited, which means that in the best-case scenario every round should be an up round. In an up round everyone wins—prior investors and shareholders. A down round, or when you raise money at a lower valuation than a previous round, leads to cranky investors and bad dynamics. The ramifications are messy and ugly. The investors feel they were lied to about the plan. Every board meeting is a nightmare. The CEO’s job can be jeopardized. Yet a down round is preferable to losing all of your investors’ money and shutting down the business.

I’ve been a CEO and an investor and I can speak from both sides. As a CEO, I always wanted investors who believed in us and helped us grow and challenged us.

As an investor I look for founders who want to make an impact in the world, but also will deliver a great return. An investor has to know that when things move out of their comfort zone they should walk. They also must know there are always exceptions to the rules. We have a special category for investments like this that we call “rule breakers.” A rule breaker is a good thing: It means that we think so highly of the idea or the team that we will consciously override some of our normal checkpoints, such as valuation or market segment.

A few years ago, I made a large investment in AdMob as an angel investor. The CEO and the company did an amazing job. I luckily made a very large return on that investment and used it to start the Webb Investment Network. That kind of return is very rare—it’s what most people call a unicorn. As all successful investors know, investing smartly is the key—every investment is a risk. You only win when investments pay off. If I worried that it was overvalued, I would have missed knowing something more important—that sometimes the truth is even more spectacular than fiction.