By: Mark Wallace at: http://capitalistexploits.at/ [3]
Mark, have you LOST your mind? 500 Startups rocks! They help a ton of young companies get over the hurdle and launch to greatness. Dave McClure is a renaissance man, a hero, an advocate for all things startup... a giant among men!
Well, he certainly is all those things in his mind, if you take his public persona at face value. Look, this isn't going to be a rant against Dave, I've never even met the guy. He seems like he'd be "interesting" to have a beer with. But, do I want to invest my money with him? I'm not so sure.
Here's a great quote from Sam Biddle over at Valley Wag [4]:
McClure has long prided himself on being a bad boy, in-your-face venture capitalist, which only works when you're really a bad boy, and anyone wants you to be in their face. If the only x-treme truth you have to offer is the persona of an insecure 9th-grade boy at a Rage Against The Machine show, we all ought to start to question why this man is in charge of investing large sums of money on a regular basis.
500 Startups is all about investing small sums into a ton of startups. The name says it all. What does that guarantee? Industry average returns. In effect, Dave is running a startup index fund.
That's not the problem, and it's not necessarily a flawed model. I agree that less is more when it comes to high-risk investing, but there's a bigger issue.
The issue is valuations. The message that McClure and his team (and to be fair, a LOT of other VCs) are sending to these young startups is, in my opinion, dangerous to their future success. That message is that valuations don't matter.
We know a few of the companies that have made their way through the program. They say it's great, and I'm sure it is. Being mentored by those who have "been there and done that" is very valuable.
However, I'm sorry, valuations DO matter. The next startup with zero revenue, a product in alpha, no customers, no real business plan and a team that has had no past successes, that approaches me with a $5mm pre-money valuation... I'm going to go spider monkey on your ass! Just sayin'.
Look, valuing a startup properly is hard. Because they are inherently high risk and often have little or no revenues, traditional quantitative valuation methods won't work. Startup valuations are largely qualitative.
We've screwed up plenty in this area, which is why I'm writing this missive. Learn from your mistakes!
The valuations we're seeing right now are, in general, just too high! Companies have little, if any, margin for error. When you raise a pre-seed round at $5mm, or God forbid, $10mm (yep, we've seen it!) where do you go from there?
Setting too high a valuation early on sets expectations for later rounds of funding which may be difficult to achieve. Come the next round you might not have "grown into" the valuation set in earlier rounds and may find it difficult to exceed your initial valuation, which could result in the next round being a flat or a down round. That's not desirable. Chris wrote about one way to solve the valuation conundrum HERE [5] and further explained a real life situation of a poor financing involving convertible debt HERE. [6]
When I invest early I want a good return. You have to manage my, and other investor's expectations. Investors that come along after an inflated seed or early round may think the company’s value is unreasonable, especially if important milestones are not being hit on plan.
Right now we're talking to a company that has developed a massively promising SaaS big data platform. The guys running it are 40+ years old, veterans of the tech industry. They said, "We need $3-$5mm to scale quickly." It's the first outside capital they are taking, so in effect it's a seed round, as they've "pre-seeded" with their own capital to date.
We told them to consider reducing the capital they take in this seed round, place a reasonable valuation on the company, and then use those funds to hit some key milestones quickly. After that they can go out for a larger round, at an increased valuation. This can happen quickly if they execute properly.
Coming full-circle... I hear Dave McClure is actually a decent guy, and his outrageous antics are just for show. A friend of mine just had lunch with him a few weeks back and enjoyed the discourse. Hey, any PR is good PR, right? He has his method and we have ours. I'm just not sure I want invest my capital with him.
We're in a raging bull market for startups. Bull markets make heroes out of everyone... until they don't. Usually I advise companies to take the money when it's available, but that doesn't mean you shoot yourself in the foot. PLAN AHEAD.
- Mark
"I figured maybe I had some talent as an investor… since it seemed like I was only a half-assed entrepreneur." - Dave McClure