Don't
Get Lost in the Unicorn Valuation Nonsense
The
quest for PR status is deluding some founders into thinking they have a solidly
functioning company, when mostly they have a solidly functioning fiction.
BY HOWARD TULLMAN, GENERAL MANAGING PARTNER, G2T3V AND CHICAGO HIGH TECH INVESTORS@TULLMAN
These are heady and exciting times for young
tech companies, which are raising remarkably large sums at earlier and earlier stages in their
development, and at pro forma valuations that seem more hysterical than
historical. And make little or no sense.
Instead of Series A, I'd call some of these
deals "Serious A?" rounds. The sole objective isn't to acknowledge
the business's progress, revenue and profitability, or stage of growth, but to
enable the company to claim a putative $1 billion market cap so they can join
the celebrated ranks of the Unicorns.
Of course, the best operators know that
valuations don't build your business. Market caps are nice but transitory,
while figuring out how to consistently make money is what ultimately pays the
bills and builds real value.
The current situation is beginning to look
like the NFT marketplace, where the sums being paid for
digital whatevers are funded with bitcoin or other insanely-inflated cyber
currencies. These NFT deals in turn prop up and accelerate the transaction
flywheel and build up the latest bandwagon or meme stock. And it's
abundantly clear that the people sitting on top of these pyramids are just
praying that they can exit before the music stops and the whole contraption
crashes to a halt.
Everyone seems to be pleased with, and in on,
the unicorn joke for now: Cities are bragging about their tech ecosystems, VCs
are writing up the values of their portfolios as they mark these latest deals
to some make-believe "market" of their own making. The companies are
happy to take the cash, natch, whether they know what to do with it or not.
Funding, after all, is just the start of the journey. The seasoned veterans
will tell you that, especially in the early years, limited funds enforce
and assure levels of restraint, focus, and efficiency that are critical to
building a committed team as well as a real business.
The business press and social media outlets
can't get enough of the latest and greatest breathless tale. Everyone wants to
be part of the smart crowd, particularly because investors at every level don't
actually fear losing their money as much as they fear doing it alone. No one
wants to be the patsy in the poker game or be left holding the empty bag. Money
rarely leads the parade, it's just a fast follower. When people say that money
talks, they're not wrong; it's just that too often it simply says:
"Goodbye."
But is any of this FOMO, froth, and frenzy
really good news for the founders, the business, or the long run? Or are
we seeing just the newest VC-backed bubble about to belatedly burst?
It's important to remember when you're looking
realistically at early-stage "story" businesses just starting to get
their bearings that $1 of customer money (actual sales) is worth about $10 of
investor funding. Too many of these businesses are barely gaining any material
traction, and others are losing their shirts in the faint hope that they'll
either make it up in the volume, or find another sucker to add more cash and
fuel to the pyre. They like to say that they're losing money, but they're doing
it at scale.
Hunter Thompson used to say that there was no
honest way to describe the edge (especially the bleeding edge of technology),
because the only ones who really know where it is are those who've already gone
over it. While this rampant value inflation may feel exciting for the moment to
the entrepreneurs, it's a serious risk to their own longer-term economic
well-being if there's the slightest hiccup or bump in the road ahead, and a
serious cap table reset is required to raise new money.
Down rounds, continued option repricing, and
renegotiating bank covenants are all seriously ugly messages to send to your
team, your investors, your customers, and the market. That's what always
happens when the easy money gets hard. For now, you want to be careful that you
don't mistake the edge of the rut for a bright horizon because a grim reckoning
may be just around the corner.
It doesn't seem that long ago that we were
reminding our startups to take what money was available and that
"flat was the new up," because staying alive and in business was more
critical than being fixated on some theoretical next-round valuation.
And if you look back a few years, you'll already find a number of debunked and defrocked "unicorns" whose
former management discovered--when the truth about their business models
emerged--that they couldn't raise the funds necessary to keep their jobs or to
keep the company's doors open.
The best and simplest advice for founders and
teams riding this crazy valuation wave, and enjoying the rush and adulation
that comes along with it, is to be careful in surfing the crest so as not to
end up being under it or being swept away entirely.
Take all the money you realistically need to
accomplish the objectives in front of you. Don't go out of your way to find new
things to do or fund. Spend the new money carefully and more slowly than you'd
like. And always remember that once you've sold portions of your own equity,
it's gone forever.
JUL 13, 2021
