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Don’t get hung up on valuation.

I can’t tell you how many times I’ve walked away from deals where the entrepreneur insists on a start-up premoney valuation that is so high, no angel could expect to make a return upon the investment, even with a reasonable sales price for the company down the road.

Raising_moneyThere is always another attractive deal at the ready, and most have reasonable expectations of valuation. Why fight about valuation, or disappoint the founder at the outset? The real focus should be on smart planning, finding ways to launch and build the business with smart but frugal use of money.

Let me tell you two stories that are linked. The first is of a 2004 startup that I cofounded and led the investment group for several early rounds, then VC rounds. The company has grown to forty employees and a healthy eight figure gross revenue run rate, but has absorbed over $36 million of angel and VC money to do so, and without yet reaching breakeven.

[Email readers, continue here…] The second story involves a founder who is using outsourced development, support, outsourced customer relations and more. The total capital raise will have been under $600,000 if all goes as planned, and the founder retains majority control of his baby through this and even one optional future round.

For the first, company, the founder’s remaining portion is under 4% after all the subsequent rounds, and not yet at breakeven. The second company finds the founder with majority control even if the original raise is not enough. For the founder to see any return at all in the first company, the ultimate selling price must be above $40 million. In the second company, better planned, the founder would be made pleasantly wealthy at a selling price of $10 million. The chances of the latter occurring are much greater than the former. This founder was not hung up on valuation for the second company, just upon efficient use of capital.

  • Judy Connolly

    Dave you keep us all grounded.

    Thank you.

    Judith Connolly

  • EXCELLENT STORY AND EXAMPLE. You are so accurate it is amazing.

    We started Apnea Sciences Corporation four years ago with $500,000 we are now approaching $18 million in revenues are very profitable and the best is yet to come. By being good stewards of funds we are debt free, all molds, R&D have been paid for. We expect to increase sales 50% annually of the next three years.. Because these type medical device companies sell for 3X – 6X we believe we can return 40X plus to investors who own 20%. They are already receiving annual dividends that are quite healthy.

    We prepared the PPM and no one investor challenged our modest valuation that has turned out to be within your specs. Our IP portfolio is amazing and will continue to grow dynamically.

    It was great the day I met you. You speak with wisdom and truth.

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