azeem.azhar

Cooley’s latest private financings report shows some interesting trends:

So it is not surprising to see the Series A valuations come down, with less capital around investors will drive harsher terms from companies.

It helps inject some perspective into various debates around what exactly VC is from Fred Destin and Fred Wilson.

With a median holding period of around 5 years to exit (according to Thomson), these companies will be exiting in 2014 or so. The deals struck in Q1-Q3 look exceptional expensive, more so that ones in 2007 where the bulk of a series A may have been spent.

Of course those doing deals at the $3.75m can expect to do very much better than those roped in during Q4 2008. Why? Simple maths. If you pay £100 for something at sell it a year later for £150, you have a return of 50%. If you were able to negotiate down to £75 in the first instance and sell for £150 a year later your return is 100%. Having purchased at £75, if you achieved a sale at £112.50 you would have the same return as the first scenario.

In other words, initial purchase (or investment price) is a really huge driver of returns.

For an entrepreneur, the question is where are you better off. In 09Q1 you have sold off a third of your company for basically $1m. In 08Q1, you sold off a third for $3m. So looks like you are worse off?

Maybe, maybe not. A few factors come into play:

A. You may have spent your money as if your Series A was small relative to your series B. You’ll find yourself coming back to the table with a down round where the excesses of your Series A will be negotiated away and with possibly with a liquidation pref thrown over the top. According to Cooley, 87% of rounds in 09Q1 were down or flat compared to 28% in the same period last year.

B. The guy who raised money in 09Q1 only needs to get to your initial valuation through his business success to have doubled his investors money. Sure they won’t be lighting cigars yet but it is inescapable maths that if he gets a buyer on the table a $9m, he will have double his investors cash. You on the other hand will be handing them their money back–and taking a chunk of change for yourself, something which may not be acceptable to them.

C. You hired big and you hired fast. Then you all read RIP Goodtimes on VentureBeat. This mean you spent a lot of 2008 firing people and using ‘muscle/bone nor fat’ analogies in manaement meetings. You also found yourself scurrying around trying to sub-let half (or more) of your office which was an urgent task but hardly your vision as an entrepreneur.

As an investor and all too-frequent firer I hate expensive rounds. The downsides for investors appear obvious–the round is expensive.

But the real downside is how it in some ways increases the chance of failure. Investors feel the deal is expensive. Entrepreneurs feel they must be worth a lot. When things go off target, the previous valuation is anchored in everyone’s heads. Current and prospective investors view it as a chance to get even. And people get pissed off.

Worse the cadre of foot soldiers you have hired watch the tension grow and their performance–and so your value creation– diminishes. Just at the time you need be humming.

It would be amazing to get data from VCs or entrepreneurs on their first round valuations and whether this anecdote holds water. Will a monster valuation consign you to failure or at least a very painful humbling?

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