Although the thirst for venture capital at startups appears hard to quench, a study shows that bellying up to the investment bar can lead to a long-term valuation hangover.
Recent data analyzed by Exitround indicates that those entrepreneurs who raised $3 to $10 million in venture capital were actually worse off at exit than startups that took $2 to $3 million in seed money.
Forbes.com’s Hollie Slade explained in a June 10 post that the study found entrepreneurs with less than $3 million in venture investment for their startups exited with valuations of more than $10 million. Startups nearing the $10 million level in venture capital exited at a lower median price.
Boris Wertz, co-founder of AbeBooks and a board of directors partner at Andreessen Horowitz, told Slade that in the excitement of the initial capitalization, entrepreneurs often lose sight of the valuation limits and future financing pressures large amounts of capital can bring.
“I’ve seen many companies that have announced valuations ahead of their development stage and were subsequently forced to grow into that valuation very quickly before the next funding round – leaving little margin of error,” Wertz said.
In its study, Exitround analyzed data on 200 mergers or acquisitions of less than $100 million. Exitround, an online marketplace for the acquisition of start-ups based in San Francisco, obtained the data from several startup incubators.
Like Wertz, Satya Patel, a partner with Homebrew Venture Fund, said the study confirms the pressures that come with a deep well of initial venture capital.
“As a company raises ever more capital, the bar for the next financing gets higher, the pressure to ‘invest’ the capital in the business gets greater, and the options for liquidity get fewer,” said Patel.
According to Slade, the Exitround data also revealed that enterprise companies enjoyed three times the return-on-capital in exits than did consumer startups. Among the former group, mobile and cloud enterprises outperformed social media startups upon exit. Those better performing startups have provided an exit-strategy roadmap for future entrepreneurs, one that ends with an M&A, rather than starting with an IPO, according to Foundersuite CEO Nathan Beckord.
“When you do the math, you’ll find entrepreneurs can actually make more money by selling early, with a large chunk of equity and a reasonable valuation, than by swinging for the IPO fences,” Beckord said. “Plus, big exits usually take seven to eight years or more— which means more opportunities for things to go wrong or for the market to shift.”
Slade, Holly. “Entrepreneurs Better Off Taking Less Venture Capital, Study Shows”; Forbes. June 10, 2014.