The Danger of High-Valuation Series A Rounds

Tech startup valuations are exploding around the world.  As a result, we are seeing higher expectations from entrepreneurs here in Turkey and CEE rising, as well, with higher "asks" in seed and Series A rounds than ever before.  We find ourselves passing on opportunities we find interesting for valuation reasons, which is quite new for us.

This is not so much of a problem for seed rounds.  There are investors, mostly angels, who can live with more modest returns than a VC, so these startups do get to find funding and go to market.  However, I think it's a dangerous game to play in Series A, even if you are able to secure funding at lofty valuation.

Let's start with the reminder that, by our count, there have been only 7 Turkish internet startups that have reached the $100m valuation mark, and it took some of them more than a decade to get there.  You can do the math with the super high discount rate you should apply to a Series A stage venture, to come up with the range at which we would consider as Series A round.

How you value a Series A round is usually not based on financial metrics, but is an exercise around how much capital the company needs to get to its next set of major milestones, how big the founder team is, and what level of dilution is appropriate to make sure the team stays motivated.  As a result, almost all Series A rounds already overvalue a company, with the hope that rapid growth in a large market will allow the company to fill beneath this high valuation in time for Series B.  

What happens when this is not accomplished is the prospect of a down round.  Talking with founders, I find that most underestimate the difficulty of down rounds, which rarely happen, and when they do, are usually damaging to so many aspects of a company, that very few companies go on to become successful.

If you are a tech founder, please keep in mind that an overprices Series A round can create an existential risk for your startup.

 

 

 

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