Understandably, when evaluating a startup investment, one of the most – if not the most – important questions is, “What is the valuation?”
After all, this figure determines your eventual payout.
Well, it’s no secret that valuations have been a hot topic in 2022 for a different, less exciting reason. They were as inflated as practically everything else in the economy.
We’ve wrote ad nauseum about the FOMO conflict that permeated the early-stage investment ranks in 2020 and 2021.
If Sequoia Capital is investing in this startup, who am I to say they’re wrong? I’d better join them.
Unfortunately, those unchecked equations have come home to roost.
While the free-for-all atmosphere sent the valuations ballooning, the macroeconomic landscape and catapulting inflation have the spotlight burning particularly hot.
It’s the same reason we’ve seen so many startups attempt to avoid the infamous “down round,” where the company raises capital at a lower valuation than previous rounds.
For these businesses, it’s understandable. Those sort of headlines – company X’s valuation decreases 44% — send ripples through public perception.
However, these are not the only types of valuations. Companies generate internal valuations, too, — known as 409A valuations. And while these are made public less often, they can tell as valuable a story as their counterpart.
A 409A valuation is defined as a fair-market valuation of a private company’s common stock. But this discounted valuation isn’t actionable for outside investors, instead informing the value of employees’ stock options.
That said, the process for determining these valuations from third-party assessors is certainly relevant to investors. Determined by a startup’s ability to hit its own revenue projections and the valuations of comparable public companies, they provide a useful glimpse at a company’s present standing.
It was notable when Instacart lowered its internal valuation three separate times in 2022, from $39 billion at its peak down to its current mark of $13 billion. Similarly, Stripe, the payment platform, saw its internal valuation decrease 28%.
In this current landscape, more weight is understandably being placed on a startup’s ability to hit its own financial targets. An inability to do so is a surefire way see a reduced internal valuation.
However, experts in the space feel the pressure on startups varies between sectors.
Businesses that hinge on consumers are more greatly impacted by the macroeconomic conditions, while software infrastructure- and cybersecurity-based startups focusing on business-to-business sales will be less impacted.
So, while the lack of down rounds might attempt to paint a picture of business-as-usual for startups, other signs tell a different story. Although this information isn’t made available to the public, it is a reminder of the constant appraisal taking place throughout the early-stage ranks.
And when it does reach the public, as it did in the case of Instacart and Stripe, it helps inform and flesh out the state of the overall landscape.
After all, as angel investors, we must absorb all of the information available to make the best decisions possible.
You’ll never hear us complaining about knowledge of this ilk adding to that reservoir.