The Relevancy of Goldilocks to Valuations
A valuation should be just right—not too high and not too low.
Greetings! We are hope you’re enjoying this week, cooler weather, & maybe even some apple orchard time…?!
💭 Thought Bubble: The Relevancy of Goldilocks to Valuations
As you probably know, valuations are a hotly debated topic between investors and founders. It’s because, as Abby Mercado noted in episode 149, the higher a valuation the less dilution a founder and early employees take. As a founder of a company you want to avoid as much dilution as possible because it means you get a bigger payout when the company is acquired or IPOs.
Of course, this same principle applies to investors: the more ownership an investor has, the bigger the potential return. In an X post, Sam Lessin, a general partner at Slow Ventures, shared a screenshot from The Information Forum on why ownership matters for Seed-stage investors. One sentence in particular rings true: “The absolute worst thing that can happen as an investor isn’t being wrong, it is being right and not getting paid!”
Early-stage venture capital is risky and built on outlier returns. Investors know that most of their portfolio will generate little to no return and rely on a limited number of companies to drive the majority of their fund’s returns. This is why initial ownership of a company is so important to investors, despite them having a portfolio of many different companies.
In the go-go times of 2021 and early 2022, as valuations peaked, it seemed like high valuations for companies with little to no traction was the norm. The greater fool theory was pervasive. Venture capital funding started to become like a “factory line” (this episode of More or Less explains the concept in more detail), where there was always going to be a downstream investor that would pay a higher price than the last investor.
For a time, this was the case. 2021 saw 1,033 IPOs, a record number. The path from Seed investment to a large exit appeared clear. Then came interest rate hikes and inflation, knocking market caps of publicly-traded tech companies back down to earth and halting IPOs.
The stark reality is that there isn’t, and never was, a guarantee of future financing, let alone one at an elevated valuation from the last round. This is borne out by data that Peter Walker, Head of Insights at Carta, references in episode 154: 20% of rounds on Carta in Q1 2023 were down rounds. Even though down rounds are happening to more companies and Peter hopes they continue to be destigmatized, it can still be an incredibly demotivating experience for founders and early employees.
This is where Goldilocks becomes relevant. Aiming for the highest valuation at the earliest stages is problematic because you have to grow into it. In ’21, companies might have been able to kick that further into the future, but the market is less forgiving now. At the same time, founders have to avoid taking investment on a valuation that’s too small and significantly dilutes them. Future investors will worry that the founder doesn’t have enough “skin in the game” to see the company through to an exit.
Raising money at too high or too low of a valuation presents future financing risks. Similar to Goldilocks, as a founder, you have to align with potential investors on a valuation that is just right for you, your early employees, current and future investors, and the market.
Unlike Goldilocks, though, you don’t have to blindly test to find the right fit. Venture capital is becoming (we still have a ways to go) less opaque and there are resources out there to help you understand what is standard. Start by checking out Carta’s blog section that discusses trends across a variety of topics—valuations, deal terms, and startup compensation—to help you triangulate the just-right price and terms for your round.
🚀 The Path to Finding Product-Market Fit
Part five of Lenny Rachitsky’s series on scaling a B2B business provides a guide for founders on finding product-market fit. This article is chock full of useful metrics; e.g., of 24 leading B2B companies, the median time it took to go from idea to “feeling product-market fit" was roughly two years. It also includes a number of quotes from founders of later-stage companies about how, when, & why they felt (or never fully felt, in many cases) product-market fit.
📝 FAQs for Investors
Jason Shuman had a great LinkedIn post that outlined the importance of having a FAQ document for investors and what to include in it. As Jason mentions, VCs almost always write some version of an investment memo and having a detailed FAQ helps you control the narrative while making the investor’s job of writing the memo easier. As unique as investors’ processes can seem, most are usually trying to answer the same set of questions. Creating a FAQ list as extensive as what Jason outlines might seem like a lot of work, but trust me, it’s worth it. It’ll strengthen your pitch and save you a ton of time once you start actually meeting with investors. You’ll have responses ready to go to many of the questions you’ll receive.
📉 Thriving in a Downturn
Crunchbase’s CEO, Jager McConnell, pinned a post that provides advice to startups on how to thrive in a downturn. He talks through the following three critical actions and provides examples of how Crunchbase has addressed these:
Rethink every aspect of your business model
Operate as if you’ll never raise again
Share more, not less
😴 Decompression Zone
Synthetic biology feels like one of the next big frontiers. This Wall Street Journal article highlights four companies that are leveraging advances in this space to develop new products, such as LanzaTech, which is “using recycled carbon emissions to help create materials that can be turned into clothing, plastics, jet fuel, and even perfume”. We’re still in the early innings of commercial applications for this emerging science, but it’s exciting to “dream the dream” and think about the vast potential!
👋 Have a great end to your week!