bank-valuation

Is all seed funding good for you?

The obvious answer would be “No”, though it’s hard to see the forest for the trees when someone *with* money is discussing investment where no others have been interested.

I had this phone call yesterday with, what I thought, was a really good graphic designer. In layman terms he was an artsy-fartsy guy with a really solid understanding of the user experience and how to bring that out from websites. He was a very pleasant guy and basically helpful and open-minded. He was a referral from a friend and judging from his portfolio, it’s clear this guy knew what he was doing. Little did I know how *much* he knew.

As the conversation progressed I learn that he’s much more than simply an artist. He has a profitable dot com of his own and, with partners in tow, was in the process of being acquired. He was funded to the tune of $500k and from that built the product that is now being sold. He also talked about another “venture” that he and his partners had started that could best be described as a less intrusive, less capitalized Y-combinator. He called it a “venture catalyst” (a play on “venture capitalist” which all dot com’rs know well).

Eventually we started talking about equity stake when I casually inquired, on average, how much equity stake do you take in the companies you take under your wing (so to speak). The answer was an astounding 9%. So they have a fraction of the reach and contacts of investors like Paul Graham, offer less money, less training, less exposure (from what I could gather on the call), but take even more of a percentage than YC demands of it’s fledgling companies. The value seems a bit arrogant to me.

We talked about other things as well. I mentioned that in my own mind I really need to have a click-able-prototype, as well as a complete requirements outline that includes not only hierarchically-defined application requirements, but fully fleshed out UML “use cases”, and business process modeling. He mentioned something I’ve read a number of times in my 10 years following the world of start ups, which is the notion that people with money invest in founders who have half-way decent ideas, not ideas that have half-way decent founders. You don’t need to have a fully complete site or even close so long as the idea is sound and the founders are real go-getters. There’s nothing new about this concept, but the whole phone call sparked an interesting mental exercise for me and something that’s been bubbling under the surface for about a year in my head.

When is it appropriate to place a value on your idea, your invention? What is the right time to sit down and say “Yes. This idea is worth between $X and $XXX,XXX,XXX dollars”. The idiotic, though possibly unavoidable, trap that so many young founders fall into (emphasis: YOUNG) is putting a price tag on their idea way, way, way too early. If Zuckerburg had placed a value on Facebook much earlier than he did, it’s highly likely he would have negotiated all of his financial leverage away before the site was even gaining traction or at least before the potential of the traction was realized. On the flip side, businesses like Groupon have placed such a high value on their product that they’ve essentially priced themselves out of the market for scores of investors and set really high marketing expectations.

However. It seems you can’t even get in the door to see or speak with investors without being at least somewhat willing to give up a share of the business in return for start up capital. Now, I’m not suggesting in any way that the risk investors take isn’t substantial. I’m not suggesting that the risk they take shouldn’t be rewarded if the venture turns out to be a barn-burner. It doesn’t make sense however to cut the pie into any pieces until you know how big it is. The chance that you’ll know how big the pie is before a year or more has passed is highly unlikely. Not only that, but the size of the pie is based on a rather large number of unknowns such as the founders’ ability to execute the plan, the market your product first targets, how easy the idea is to replicate for the unforeseen clones that will come after you’ve told the world you’ve been given capital. Christ, the virility of the world economy even plays a role.

I guess the bigger point I’m making is that valuation of a company shouldn’t be done before you even know how big your market is. To quote the movie version of Zuckerburg (admittedly a Hollywood-ized version from the Land of Make-Believe), don’t put a price tag on your venture too early because “We don’t even know what it is yet.”

Just my $0.04

-Brian

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