Are you an indie, angel or venture company?

 
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I don't know what Chris was referring to exactly, but as an angel investor this statement resonates with me right now. I've been seeing some really high valuations floating around.

Don't get me wrong -- there is nothing inherently wrong with high valuations if everyone is aligned in exit expectations. The problem is I don't think the alignment is there in many cases.
The rule of thumb in angel/vc investing (and yes, I realize they differ in a lot of ways but I'm trying to simplify) is to shoot for a 10x return on exit. I'm not going to get into all the math that arrives at that number in this post, but it has to do with the time horizon of investments, the probability that things don't turn out as expected, and alternative investments available for that money.

A simplified way to look at this 10x return on exit from the founder perspective is would I sell my startup for less than 10x this current valuation? Clearly a reserve price is a moving target, but I think a lot of founders would sell their startups in the success case (lots of traction and promise) for way less than this 10x at current market valuations.

Let's take an example. Suppose you do a round at 5M. Say you toil for a year and half, start to blow up, and get offered 5M cash. Would you take it? In that scenario the investors get their money back and you get 1-2M. Or would you turn it down and ride your traction in an attempt to get to 50M (10x), a much less probable but all around awesome outcome?

This brings me to my central question: are you an indie, angel or venture company? I'm not passing judgement, and in fact, I think they often have similar expected values.

One way to categorize yourself is how you react in these exit scenarios. An indie company may take that acqui-hire (at say 1M per head), and as such, I think has no business taking outside money. An angel company would definitely sell for let's say 10-30M unless circumstances were really extenuating. And a venture company is going to hold out for that elusive 100M+ exit.

Remember I'm talking about the success case here. You're blowing up. If you're going sideways or down, sure -- take any exit.

Now back to Chris' comment. If you're really an angel company then I don't think you should ask angels to put in at around anything close to what you'd take for an exit in the success scenario. Last year 5M valuations were common -- now there are plenty of pre-revenue and even pre-launch companies asking for 10M+. FWIW my strategy has generally been to invest in angel companies at valuations where 10x is reasonably possible along the foreseeable path to victory.

VC seed programs and super angel funds are certainly pushing valuations higher. They're (usually, but not always) simply buying an option to invest in your company later and are therefore pretty agnostic to early valuations, and in some cases will do uncapped notes. Some funds did upwards of 90 deals last year, i.e. more than one a week!

As Chris has also pointed out, there are signaling issues with taking this money. All I'm saying is know your reserve price and act accordingly. On the angel investing side, Bryce has a good related post called Does Price Matter; here's an excerpt:

So, does price matter? As with most questions related to the venture business I think the answer is a hearty- it depends. It depends on when you invest, how much money you are able to put to work and whether the investment is more about attaching your firm to a high profile company than driving overall returns.

From my perspective, these valuations completely price me out of the deals. Naval has talked about the eventual un-bundling of money from advice, and perhaps that is what we're seeing now. In that case, I need to keep focusing on adding value and get compensated for that ongoing advice in addition to just money in. 
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