Monday, March 24, 2008

Startups high pre-money valuation is a killer

Startups like to raise fund at a high pre-money valuation. It's understandable; founders want to give up little % of their company for a lot of money. But that could be very dangerous, even fatal for startups/founders. When the company is new and unproven, it's better to raise capital at a low pre-money valuation. Founders know when the company is a few thousand line of code, or barely bringing revenue, it shouldn't be valued as high, but they raise the valuation bar anyway. Let's say the founder's wish come true, and the company gets acquired, which is the new business model for most startups now these days. Investors will get the money they invested and more, before founders get anything. Sometimes founders get nothing. It's never about founders get 45%, investors get 65% of the company's stocks. Investors always want to get their investment back, and possibly more... If taking 65% is higher than taking 10X their investment, they'll take 65%; if taking 10X their investment is higher than taking 65%, they'll take 10X their investment. Investors get paid before founders. In an acquisition, the higher the pre-money valuation is, the more likely investors will take all, if founders don't sell as high as their company pre-money valuation. Now days, before a startup gets out of beta phase, it's already valued at millions. Facebook barely bringing $200 million in revenue is valued at $15 billion. Even Mark Zuckerberg doesn't think his company worth that much. barely has a business model, is valued at $200-$300 million. What happen to the good old fashion of buying low to sell high? Startups need to buy investor's money at a low pre-money valuation to exit the company high to make a profit.

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