Valuation Discussion From Two Pros: Are High Seed Valuations Here to Stay?

This is one of the reasons I like Twitter.  Sam Altman is one of the most respected people in seed/early stage investing.  He runs YCombinator, arguably one of the best company incubator/accelerators out there, if not the best one.  Chris Sacca is a great seed stage investor.  He previously worked for Google ($GOOG) and was a seed investor in Twitter ($TWTR), the first check into Uber, Kickstarter, Instagram, and Twilio.

Startup valuations at all stages are creeping higher.  Is it sustainable or is it a bubble?  No one knows, but most people feel like it’s a bubble.  Here is the exchange that happened yesterday.

Sam Altman @sama

1) this is the time of year when my inbox fills up with investors complaining about valuations of YC companies.

2) believe it or not, we really try to tell founders not to optimize for valuation.  most actually listen and don’t take the higher offer.

3) but there’s not much we can do about market pricing—there are a lot of investors willing to pay high prices.

4) founders make their own decisions about how much value they’ll actually get from investors, and whether to give a discount for it

5) investors: if you don’t like the price for a company, don’t invest.  don’t berate the founder.

6) and generally speaking, “value investing” is not the way to win in early-stage startup investing.  investing in the best companies is.

7) founder to me: “every investor says they provide more value than other investors and i should give them advisor shares. what do i do?”

And a Response from Chris Sacca @sacca

1) Access to the deal is the new advisor shares

2) Those “other” investors who have been bidding prices are starting to lose their asses.

3) This will accelerate as the later round money isn’t there to prop them up

4) Further, public market deterioration will dampen angel enthusiasm and evaporate dry powder.

5) I’m long startups. Have been forever. But the seed space is overfunded. Reckoning will come soon.

6) My hope is that the bubble bursting will act as a quality filter. The poseurs will leave town. The killers will stick it out.

7) The same discipline that @bgurley would say is missing from late stage is absolutely missing from seed stage.

8) Demo days have led to no chance to play with live code, jam on product and get a sense for collaboration, or reference founders.

9) So, do I blame the guys and gals who take the eager money? No. It must feel awesome to see that kind of interest and validation.

10) There is also something awesome to be said about being done fundraising so quickly and getting back to work.

11) But these conditions will not last. Seed money will tighten. A’s will be harder. Down rounds will happen. Ugliness ahead.

I agree with a lot of this, but disagree with some points.  For example, Sam points to “value investing”.  He is correct.  It’s impossible to buy a startup like a stock.  But, it’s possible to ascertain risk versus reward across multiple startups and decide if you are in or out depending on the valuation.  No one knows at the beginning if the startup is a billion dollar company or not.  All seed investors do is bet on teams, and what seem like good ideas.

Chris Sacca thinks that seed investing has become crowded.  In Silicon Valley, he is totally correct.  It’s a crowded space and that has pushed up valuations.  But, here in the Midwest, the seed space isn’t over crowded.  In fact, there is an argument to be made that it’s underfunded.  Going back to Sam’s point, a value investor might start nosing around other areas of the country.   Companies in the Midwest have the same chance of becoming billion dollar companies as any other company being started anywhere else.

Here is some data that I would love to see in aggregate.  Of the companies that are raising seed rounds at a $6M+ valuation, what’s the percentage gain on their next rounds?  How big of an up is that up round, or are they flat?  What’s the valuation of the next round?

Do higher valued companies fail at the same rate as lower valued companies?

If the company was valued lower at seed, $2M-$4M pre-money; what’s the next round look like and the round after that?  What’s the failure rate of those companies?

One thing higher seed valuations do, they allow you to raise more early capital.  That is a double edged sword.  Having a lot of money early can kill off a company because they aren’t disciplined with it.  Having double the capital doesn’t automatically double the runway.

We have data on how many companies get funded each year, and what the median and mean valuation/raise is.  It would be cool to have data on the rest of the financing rounds aggregated too.  More information might help founders and investors structure deals more efficiently for success.