How Much to Raise When Times are Good

Talking to entrepreneurs lately, it’s clear we’re seeing some of the best valuations in nearly 20 years (hello, dot com days). This is especially true for startups with limited/no metrics as well as ones that have outstanding growth rates. In the middle — a startup with decent growth and decent metrics — times are pretty normal and valuations are much more reasonable.

Last week, when asking an entrepreneur how much they were targeting for their next valuation, he said he wanted the highest valuation possible along with personality fit with the new investor. On the surface, this makes sense — minimize dilution and enjoy the journey. Only, there’s a piece missing here, and it’s an important one: if you raise at too high a valuation, the business might not be able to grow into it, and the downside can be catastrophic.

Two weeks ago I talked to a different entrepreneur that’s raised almost 5x the equity as they have in annual recurring revenue, and the business isn’t growing fast (< 30%). Unfortunately, the Rule of 40 has been broken for years in this case. Too much money was raised at too large a valuation and the business hasn’t performed. Now, the cap table is broken. Lots of pain is imminent (cram down, down round, common equity getting wiped out, etc.).

When times are good, and exceptional valuations possible, find the upper in end of reasonable where the business can confidently grow into the valuation. The valuation might not be as glamorous as possible, but there’s tremendous value in resting easy knowing that even if the business falters a smidge, the last valuation is readily exceeded with time and the existing cash in the bank.

What else? What are some more thoughts on how much to raise when times are good?