After the booming startup market of the last few years, the valuation of many startups has gotten too high. What should you do if you find yourself in that situation? Straight off the bat, if your valuation isn’t right, our main advice is to “take the medicine early” and reset it as soon as possible – in order to bring it down to a more realistic number.
A high valuation can be very tempting, generating positive buzz for your company. However, overly high valuations can lead to problems in attracting investors and pressure to deliver high returns, which doesn’t always lead to the best decisions. High valuations can also affect your 409A valuation, pushing that higher and affecting the strike price of employee stock options.
At Kruze, we have seen this happen hundreds of times over the years and the main thing we recommend is sorting it out as soon as you can.
Why you should fix a valuation that’s too high
If you become too focused on protecting an unrealistically high valuation, it will begin to negatively affect all of your decisions. Internal pressure to hit a target valuation could lead you to push unsustainable growth at all costs. It can keep you from making good choices and may stop you from:
- Hiring the next employee you need
- Investing in the sales team the way you should
- Investing in the product itself
If increasing revenue or growth to meet valuation expectations is your biggest focus, it will impact the way you run the startup, and the company will suffer.
Take your medicine early
So, the reason why we say “take your medicine early” is because, as a startup, you want to be operating from a position of strength to achieve optimal growth. If you reset that valuation and work something out with investors it will probably cause dilution for everybody. However, it’s necessary so that you can then refocus on growth and where you’re going as a company, instead of protecting something that’s way too high and unrealistic.
We understand how tempting it is to be ultra-aggressive with this high valuation, but in the long run it can really slow you down and trigger suboptimal choices. So do whatever it takes to reset the valuation. If your valuation is lower at your next financing round than it was for your previous round, you may need to do a downround – for more information, see our Downround Guide.
By all means, bring in more money, but do it and do it soon. Otherwise, you may end up as a lame duck startup and not really set to go anywhere. It’s extremely tough to recover from not investing in your company and the loss of momentum that goes with that.
If you have any other questions on valuations, startup investing, startup accounting, taxes, or venture capital, please contact us.