Mind the Valuation Gap

Recently I was talking to an entrepreneur that’s raising a round and the topic of valuation came up. Valuation is always a sensitive issue. Entrepreneurs, rightly so, figure they should get the highest valuation possible. Investors, on the other side, want the lowest valuation possible that still wins the deal. Only, we’re in unusual times with valuations at or near their all-time highs (excluding the dot com days, of course).

Entrepreneurs need to mind the valuation gap.

The valuation gap is the delta between what the public market multiples currently support and the valuation private investors are willing to invest. For example, if super high growth SaaS companies trade at 8x run-rate on the public markets, and an entrepreneur raises money from an investor at 12x run-rate, there’s a 50% valuation gap.

Assuming superb execution, the startup will grow into the valuation and skip over the gap. For entrepreneurs, the risk is raising at too high a valuation and not growing into it. One of the worst possible outcomes for a venture-backed startup on the fundraising treadmill is to have a down round. Startups are essentially broken when they raise a new round of funding at a valuation lower than their last round.

The strategy for entrepreneurs: find a balance between the best valuation possible and the best valuation that ensures a strong likelihood of a higher valuation in the next round. There’s no right or wrong answer, but there’s often an answer that makes it easier to sleep well at night — find that one.

2 thoughts on “Mind the Valuation Gap

  1. And consider the quality of the people who will become your financial partners – their ability to make you and your company better, their integrity, and whether or not you have a shared vision for what you want your business to become.

  2. Yes, I’ve recently met a couple of startup’s who were considering a down round. A difficult situation considering that you’ll have to manage relations with investors who had paid
    More in the previous round vs new incumbents who’d get more shares for less money. Ends up in more challenging issues internally for the management team to resolve

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