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The Risk Of Accepting A High Valuation
And how to correctly value your startup
Michael Houck
October 28, 2023
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If your dream investor offered to invest in your startup at a higher valuation than you planned to ask for, would you take the money?
Of course, right?
High valuation = low dilution = more equity for the founders and/or more to offer in future rounds. Done deal. Send over the term sheet please.
Turns out it’s not quite that simple. Paul Graham agrees:
If you're a hot startup, investors will offer you money on terms so good it would seem crazy to refuse. And yet it will often be the right thing to. Not because of the dilution, but because raising too much will make your company slack and bloated.
— Paul Graham (@paulg)
Sep 27, 2023
Most founders don’t think about the downsides. My last startup made this mistake twice. We raised:
A seed round at a $20 million cap with $0 recurring revenue (~$250,000 total revenue)
A Series A at a $85 million cap soon after launching our subscription offering
At the time we were thrilled. In fact we negotiated hard to get those terms.
We were a hot startup, but the terms put us in a tough spot for any future rounds.
We put ourselves on a treadmill where we needed to generate a ton of revenue fast to grow into our valuation before we burned through the investment. Otherwise, eventually, we’d be dead in the water.
Today I’m sharing:
How to know what valuation to raise at
When are terms too high?
Why do investors make high offers?
Why do founders accept high offers?
What actually happens when you accept a high offer?
The Risk of High Valuations
How to Know What Valuation to Raise At
First things first. Set an (internal) benchmark for the valuation you want to raise at before you even engage investors based on how much capital you’ll need to raise the next round, and current market conditions.
Last year I shared my framework for how to determine the right valuation for your startup:
Map out the milestones you need to hit for your next round
Understand how much you expect to burn to hit those milestones
Calculate how much you need to raise, given that burn + 12 months of runway
Determine your target valuation based on how much you need to raise and expected dilution
Check the markets — does that target match the current reality for the stage you’re at? Adjust if needed.
The full piece goes into more detail and shares formulas to help you make calculations along the way.
When Are Terms Too High?
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