With the sharp decline in seed, venture and growth capital in Q4 2015, most entrepreneurs now recognize the increased difficulty of raising capital. Unfortunately, indicators also suggest a re-pricing of the startup market. In the last two years we have seen startup valuations climb to all time highs. In fact, during Q1 2015 venture capitalists invested the most money in any quarter since 2000, and venture-backed companies also commanded the highest median valuations on record. Now just one year later in Q1 2016, the volatility of public markets and the erosion of seed and venture investments, means we will likely see a more conservative approach to valuations.
So what should a startup do in this type of environment? Most importantly, founders need to learn what factors take priority in valuations. Today, many founders will unknowingly factor in ownership pride in their valuations. It’s no surprise. It’s much like taking pride in the ownership of a home. Many owners feel that the value of their home is higher than a new buyer believes. Why? Because the current owner has an emotional connection to the property, whereas a new buyer does not. Instead, the new buyer is looking for a solid structure, a good price with value and upward growth potential. The same exact thing goes for the A seed investment market. In 2016 founders will need to overlook their ownership pride and instead focus on what investors are ultimately looking for:
# A well-priced deal
# Solid fundamentals and business model
# A company with high growth potential
# A company with a strong management team who can make it happen.
What’s interesting is that the basics of valuations and growth potential of startups is now back on the table. Some investors may chuckle at this recent trend. Tiring of zealous fund managers, with pressure to deploy war chests of capital, who drive up average valuations. Investors may be relieved to see a return of sanity, however mild, to the seed market while entrepreneurs may cringe at the correction. Whatever the case, entrepreneurs can expect a return to basics when raising capital this year.