Today’s guest post features an interview between Colin Kinner, founder and CEO of Startup Onramp in Brisbane, Australia, and Andrea Gardiner, Founder and CEO of early-stage VC fund Jelix Ventures. Andrea has been a successful entrepreneur, a lawyer and investment banker, and has also had an extraordinary career in professional climbing, having scaled many of the world’s best known big rock walls.
You can read the first part of Colin’s interview with Jelix Ventures here.
Colin: Let’s start out on the topic of valuation. It’s one of the most contentious issues when founders are fundraising.
Obviously, nobody wants to raise money at a low valuation, since they’ll be giving up more equity than they need to. But accepting funding at too high of a valuation can also be problematic and affect future funding rounds.
I’d love to hear your observations and how you assess companies when it comes to valuation.
Andrea: Early-stage valuation is much more art than science. Often with little or no revenue, valuation is about what an investor is prepared to pay, based on their perceived potential value of a company.
Startup valuations take into consideration several factors:
- First, and most important, is the caliber of the founders. Do the founders work well together? How big is their appetite to learn? How deep is their customer understanding? What is their capacity to build and retain relationships with team members, customers, strategic partners and investors? Are they people of integrity? Will we enjoy working with them?
- Second, we look at the product. Do early customers love the product? At Jelix, we look for innovative technology that provides a strong competitive advantage. Is there a clear differentiation from competitors?
- Third, we look at the market. Is it large, global, and growing? Can we see an opportunity to build a large and profitable business?
And then we price in the risks in execution and of not finding product market fit. Is there growing early revenue, or at least rapid customer acquisition? Do the founders have a strong track record?
Then there are always broader economic trends. Currently, changes in the macroeconomic environment have exerted strong downward pressure on tech company valuations which have filtered down to early-stage startups. This means that there is now a lower risk of investments being completed at big overvaluations.
Colin: What sort of dynamics or problems do poorly crafted startup valuations create for founders?
Andrea: Overly inflated valuations can become what I call a valuation coffin. Very early investors—like friends and family or other inexperienced angel investors—are often driven by emotions and may not understand what valuation is fair. If the valuation is too high then that becomes a high risk for the founders and investors. This risk is particularly acute where the startup is pre- or very early revenue and the valuation is not based on actual revenue metrics.
This is because following funding valuations will generally be based on revenue metrics. The risk is that the startup will be unable to demonstrate sufficient growth in the following 12-18 months to justify a significant valuation uplift in the next round. In these circumstances, the following round could be flat—or worse, a “down round”—which is too often the start of the slow death of the business.
A flat funding round happens at a valuation that is at little or no uplift on the last round. A down round is at a lower valuation than the previous round. This can signal that the company is not growing well. That can spook investors and employees—and even demotivate founders. Depending on the funding terms, a down round can also trigger anti-dilution protections, giving existing investors extra shares to compensate them for the dilution.
My advice to founders is to take capital only on terms that set them up to succeed, at realistic valuations that set up achievable growth expectations.
This minimizes the risk that founders will struggle to raise further capital or lose leverage with potential investors and raise on increasingly sub-optimal terms. Too often, this causes the slow death of the startup.
Colin: You mentioned “macroeconomic” effects that impact valuation and funding. We’re in the third year of the COVID pandemic. How do you think the pandemic has affected funding terms?
Andrea: Until the recent changes in the macroeconomic environment, VCs awash with capital put significant upward pressure on valuations. Investors were seeing lower returns from other assets classes like listed stocks and bonds and there was a big shift of capital to venture.
Increasingly, VC funds had large amounts of capital to deploy and competition for investments escalated. So, valuations went up and other deal terms loosened. It was a startup’s market to raise capital.
Now, the market has changed. Downward pressure on big technology company valuations has filtered down to early-stage startups and many investors are sitting on their capital to “wait and see” what happens in the markets, making it harder for startups to raise funds.
For Jelix, this is an opportunity. We are as excited as ever to invest in extraordinary founders and their startups. Rather than focusing on dilution, I believe that smart founders recognize the importance of a long-term mutually beneficial relationship with their investor.
Statistically, early founder/investor relationships last longer than most marriages. Wise founders ask themselves the same question that wise investors ask: Am I confident that I can build a mutually trusting long-term relationship with these people? As an investor I want to be confident that when times are tough our portfolio founders will pick up the phone to us first, trusting that we will do our best to help.
Colin: I always recommend to founders that they talk to their prospective next round investors informally a long time before they’re ready to raise their round. Do you have any advice for founders on when to make contact with investors?
Andrea: I like to meet founders early, even 6 to 12 months before their capital raise. This provides the opportunity for us to get to know each other and for me to track their progress and for both parties to decide whether the fit is right.
Colin: We all know startups are risky, but in your experience what approach do successful founders take to manage risk?
Andrea: Early in my career, I was a professional climber, so I am particularly sensitive to risk.
I think doing a startup is a bit like approaching a climb. You need to be prepared to accept that there’s risk involved, but good climbers will do everything they can to research the route and understand the risks in advance, create a plan that attempts to mitigate the most serious risks, execute the climb as flawlessly as possible, and be prepared to deviate from the plan when required.
It is not dissimilar for a startup founder.
Founders need to identify the biggest risks and plan, execute and regularly evaluate risk management. Then, founders need to be able to identify changes in the risk landscape and adjust their plan accordingly.
If a founder is unable to identify the major risks to their business, then they are flying blind. Startups must move fast, but that doesn’t mean throwing caution to the wind. The best founders I’ve backed are incredibly diligent and have always done a ton of research before they make strategic decisions.
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