The previous article “Have Venture Capital valuations peaked? How do valuation movements affect me as an investor and entrepreneur?” covered how the valuations of different assets behaved and analyzed their impact on investors and the vintage effect.
This time, we will analyze the impact that startup valuation movements have on entrepreneurs and what aspects to consider in order to manage the different funding needs, mainly financed through successive capital increases.
One of the most distinctive characteristics of startups is the need for significant funding to develop their MVP, consolidate their business model, and, subsequently, scale up. Although these funding needs are usually financed with capital increases, they can also be financed through credit and loans under favorable conditions for such companies.
Focusing on capital increases, investors contribute their money to the company’s development. This investment must be structured in successive rounds of capital increases throughout its development and scaling, depending on the fulfillment of milestones or objectives. Each stage has specific resource needs that require capital for its execution. Therefore, it is advisable to avoid a single round at the beginning of the project since it would imply a higher risk for the investor and an excessive dilution for entrepreneurs.
These successive stages, linked to the accomplishment of predefined objectives, vary depending on the company, the current and the target stage, such as the creation of a Minimum Viable Product (MVP), Product Market Fit, growth in the number of customers, optimization of expenses, achieving or improving profitability, expansion into new markets, among others. The time elapsed between the different stages varies according to each company, usually taking several years to complete.
As a first conclusion, the planning of funding rounds is therefore completely linked to our company’s stages and the fulfillment of the objectives outlined in each stage.
However, why is it crucial for entrepreneurs, and how can market movements affect them?
Just as we discussed in the previous article, a company with the same execution and capabilities can have a very different valuation depending on the market cycle at any given time. In a company’s ideal scenario, capital increases are likely to be made when its valuation is at a high point, and the dilution to existing shareholders will be lower. However, no one is certain when and to what extent valuations will vary to plan successive capital increases to cover our company’s stages. Moreover, a startup is usually limited to tight deadlines to raise financing, preventing it from assuming deferrals while waiting for more favorable conditions.
During the financing search process, investors positively appreciate that, as a general rule, the company’s value grows in each of the successive financing rounds and following the different stages or states of the company. There may be understandable adjustments at times of abrupt market movements.
This gradual increase in the company’s value generates an adequate resource management narrative and the achievement of objectives. In other words, the company’s value creation process is quantitatively demonstrated. However, the valuation of our company will not depend exclusively on its performance. Consequently, it is essential to plan and execute valuation rounds at levels that allow us to continue to grow and maximize the future value achieved.
So, what can we do to achieve a good value creation narrative and maximize the value of our company?
The key to adequate management of capital needs and their financing is to consider the essential planning of our business, keeping one eye on the present and the other on the future. For this purpose, in our opinion, it is necessary to consider two major points:
- Identify and quantify the different stages and objectives. Although it is not necessary to know how many rounds you will do when starting an activity or during its development, it is convenient to establish the different milestones and quantify the objectives in each one. In this way, we will be able to know more precisely the project needs and maximize the present and future value of our company.
- Consider the future value as much as the present value. As mentioned above, there are extrinsic and intrinsic risks that affect the valuation of the company. We recommend having an adjusted valuation in the present with the clear objective of offering a path to investors, both implicitly and explicitly. In this way, we are generating a narrative of value creation that allows us to obtain financing in the future and that our shareholders feel satisfied and accompany us.
In our opinion, it is damaging for any company, especially for startups, to develop a round at an excessive valuation and discount only optimistic scenarios. In such a case, we may be allowing lower valuations than the previous ones, in the event of small unforeseen events, in the following rounds of capital increase. This situation would lead potential investors to consider it as a destruction of value by the company, resulting in greater difficulty and even the impossibility of attracting new funds.
Juan Sánchez Margareto