Thursday, July 12, 2007

Short-term "optimal" valuation may spell future disasters

A very interesting post published on Always On's Insider Network shows a number of worrying trends in the venture investment landscape and highlights one of the common mistakes entrepreneurs make when negotiating with investors, that is seeking the best possible valuation / least possible dilution. The AlwaysOn article links to another very interesting perspective provided by a VC on his blog, where he discussed the concept of asymmetric risk and the issue of getting too high a valuation for a business.

Valuation and investment terms may be the single most difficult discussion I am having with some of my customers, the second being to help them consciously decide on the kind of investor they wish for their business. I agree with the author, Josh Kopelman, that entrepreneurs should focus on long term value creation, that getting too much funding can be as bad as lacking resources and that the full scope of consequences from a given negotiation strategy is seldom considered by founding teams prior to making decisions to have a deal with investors. As a result a great valuation can actually be the worst thing that happens to a business... In fact, I tend to believe that:

  1. the terms of investment other than valuation are more important that valuation itself

  2. lacking consistency in dealing with prospective investors of different rounds is a recipe for a lot of problems, potentially well before exit time. For example, having consistent valuation methods is a very sound practice

  3. crafting agreements that help align the interests of all stakeholders is critical to superior performance and valuation is but one aspect of an agreement with investors

While writing this post I can think of past and present cases in which a perspective larger than the valuation / dilution focus would have helped a lot...

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