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Is Valuation a Key Issue in Funding Startups?

George Lipper, Editor, National Association of Seed and Venture Funds (NASVF)

Ron Conway, an iconic angel investor from Silicon Valley, was recently quoted as saying, "I will not talk to an entrepreneur about valuations for more than five minutes. If they want to talk more than five minutes, I probably do not want to invest."

Conway's logic is so simple and straightforward and built on so much commonsense it is difficult to dispute. Valuations for pre-seed startups, regardless of the ups and downs of the venture marketplace are as level and consistent as a Tiger Woods round of golf. Oh, sure, there's the exception, but if you're a rational entrepreneur or investor, you wouldn't want to bet on identifying it before investing.

Much more important, as Conway's logic seems to run, is the capability of the management to grow the company to, say, $50 million. An entrepreneur who spends time focusing on pre-seed valuation probably doesn't understand valuation, which probably means the entrepreneur does not have the vision and ability to put a company on the path to high growth.

The predictability of seed valuations is underscored by trend lines plotted by those who keep score, Dow Jones VentureOne, among them. Since the bubble burst, seed-stage investing by institutional venture capitalists has hovered around $2 million, regardless of variations in other stages of investment.

The consistency becomes even more apparent when plotted:

There you go: as straight and long as Tiger's drives. You're expected to hit the green from there, followed by an initial putt out (IPO).

It matters little, if at all, whether the investment is made by an institutional investor, an angel group, or an individual. "The task (for the entrepreneur) is to build a company that is worth $50 million," Conway observed. "At that rate of growth, no one is likely to care much about a million or two."

For this article, we used the description of seed capital that Dow Jones VentureOne uses in its quarterly reports of venture financing: An initial round of venture capital financing used to start a company. Other criteria are that the company has fewer than ten employees and that the investment round, with some exceptions, is less than $2 million. The definition itself is a significant element in the valuation data described above.

Nonetheless, when an alternative criterion is used—funding by stage of development instead of round of investment—the numbers line up as shown in the accompanying table.

Yet the trend line for startups differs very little from that of the seed round:

All this data appear to reinforce Conway's philosophy about valuations placed on seed or startup entrepreneurial businesses. The exact amount matters very little to the entrepreneur or the investor as long as the valuation is in the $2 million range and the entrepreneur has the management capability to grow the company.

For follow-on and later stage investing, the range of valuations is much wider and the number and complexity of valuation equations much greater, especially when considering the precipitous fall pictured from the end of the bubble in 2001.

In summary, then, based on available data, evaluations of small, high-growth opportunities ought to focus more on the quality of the management and less on the amount of the valuations.

© 2007 George Lipper. All rights reserved.

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