Monday, August 4, 2014

Do startups give more than due attention to valuation?

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Q: Do startups give more than due attention to valuation?
A: Some of the young startup founders want to get rich very fast. While that is not a bad goal in itself, if this is the primary motive to start up, the startup is doomed. Building a startup is incredibly hard and if founders want to take the first available opportunity to exit, the business will never scale up.
We believe building a successful startup takes 8-10 years. Even though great exits are not common in India, if you don’t even survive that long, you are unlikely to generate any meaningful value for your investors or yourself.
When you are setting out for a journey so long, checking the milestones every now and then is only going to distract. Plus the ‘wealth’ you are creating in process of building a startup is only notional and you will rarely be able to withdraw any piece of it in first few years. Hence, we believe that startups give more than required attention to valuation.
Q: What is the relevance of valuation during funding- early stage v/s growth stage startups?
A: Valuation, in very simple terms, is the amount an incoming investor is willing to pay for buying a piece of the company. The value of a company is not just a function of the fundamentals of its business. It also depends strongly on the view of the investor about the firm and her assessment of the founders’ ability to create a successful venture. Hence, the valuation of private companies, even growth stage startups, is a very inexact science.
At the same time, however, the valuation ranges become more defined as the startup becomes mature. For example, the valuation bracket of Flipkart is unlikely to change drastically till its IPO. While a couple of good quarters in a growth stage company like Helpshift can make a big difference in the amount VCs are willing to spend for the same pie in the company. For a still early stage company like TouchTalent, even a couple of months of good momentum can land them in a sweeter deal.

Q: How relevant is the concept of valuation during the funding process?
A: Although terms of a funding are usually quite complex, valuation remains a very important part of the funding process. In most cases, it is a make-or-break scenario for the two sides. It is common for founders to walk out of a deal in case the valuation offered is not as per their expectations. Though not the best practice, some founders even use term-sheet offered by a VC to negotiate a better deal with another.
We believe the process of funding should be approached from a ‘fit’ perspective. While an entrepreneur may find more value in a big-name VC, some others may have more passion, insight or connections in the industry leading to faster growth. Since the relationship with a VC is going to be a long-term one, we always advice our portfolio to look for the VC who they feel most comfortable working with.
Arpit Agarwal is a Principal at Blume Ventures, one of the world’s most active micro-VC firms. He tweets at @arpiit

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This is a repost of an article that appeared on on July 28, 2014

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