Valuation Tipping Points

As a somewhat active angel investor, I’ve come to the conclusion that too many startups are looking for money too early in their development these days.  Perhaps this has always been the case, but it’s become more obvious to me in the last 6-12 months.  In the last month, alone, I have seen three deals that each involved teams that wanted to sit back in there current big-company jobs while producing no more than a PowerPoint presentation.  No skin in the game, no special effort, nothing proven.  They have taken little-to-no risk and applied relatively minimal effort, so why should an investor? 

I’m a great believer that time is almost always the biggest competitor to any enterprise, but I also believe that there are certain milestones that need to be achieved to show that a startup is investment worthy (meaning that the company has a reasonable shot at success).  Generally speaking, the market does a good job regulating this.  For the most part, startups that have not made enough progress get crappy valuations (where crappy includes not getting noticed by investors) and startups that have made the appropriate progress get reasonable or even good valuations.  I refer to the difference between these two states as the valuation tipping point.

The interesting thing about the valuation tipping point is that there is no fixed criteria or plan of attack for reaching it.  Often, the tipping point is defined by the industry you’re in or by how you reach your customers.  Good friend and VC Brad Feld posted a while back on the fact that in a Web 2.0 company, the first 25,000 users are irrelevant.  If that’s true, then the tipping point for a Web 2.0 startup is going to be achieving more than 25,000 users.  Other companies, markets and industries will have different measures for the achievement of the tipping point – usually involving one or more of the following:

  • Achieving some level of revenue
  • Selling to a certain number of customers
  • Signing up one or more partners
  • Reaching positive cash flow
  • Demonstration of the underlying technology
  • Establishing a sales channel
  • You get the idea . . .

Sometimes a valuation tipping point will be as simple as getting an OK from the gorilla in your market that it’s cool to play in their playground.  If, for example, you’re using eBay’s API to build a business that doesn’t help eBay, investors will be interested in a getting some confirmation from eBay that they won’t 1) change the API to screw you or, 2) won’t drop a cease and desist letter in your inbox.  Before you get such a confirmation – bad valuation, after you get it – good valuation.

Recently, I looked at a deal that had three difficult hurdles to clear in order to even be on a path to success.  They were the development of the underlying technology; a relationship with a data provider required for their service; and a relationship with the distribution network.  They had nailed two of the three, but the third remained a huge potential barrier to success.  The company has yet to get any investors to make a move and until they deal with their remaining barrier, the company will probably not get funding.  After they take care of the issue, though, I believe that this startup will get a great valuation.

Do you know what your valuation tipping point is?  It’s probably going to fall in one of two general categories:

  • It’s going to be a big hurdle which you can’t control by simply managing your day-to-day business.  Most often, this involves a business decision that has to be made by another party and is not in your direct control. 
  • Or, it will require that you attain a level of business (measured by users, revenue, profit, etc) to prove market acceptance or competitive viability.  Often, that requires you to successfully deliver in multiple areas of your business.

Before you look for any investment you should make sure that you understand where your tipping point is and how you will overcome the barriers that make it up.  Even better, to maximize your valuation, get to the tipping point before you even look for an investment. 

Note: the most important valuation tipping point happens at your first round of investment, but it is not the only valuation tipping point.  Each subsequent financial round requires an analysis of the tipping points in your business and how getting to those points will impact the valuation you get.


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