Entrepreneurs

Don’t Get Lost in the Unicorn Valuation Nonsense

These are heady and exciting times for young tech companies, which are raising remarkably large sums at earlier and earlier stages in their development, and at pro forma valuations that seem more hysterical than historical. And make little or no sense.

Instead of Series A, I’d call some of these deals “Serious A?” rounds. The sole objective isn’t to acknowledge the business’s progress, revenue and profitability, or stage of growth, but to enable the company to claim a putative $1 billion market cap so they can join the celebrated ranks of the unicorns.

Of course, the best operators know that valuations don’t build your business. Market caps are nice but transitory, while figuring out how to consistently make money is what ultimately pays the bills and builds real value.

The current situation is beginning to look like the NFT marketplace, where the sums being paid for digital whatevers are funded with bitcoin or other insanely inflated cybercurrencies. These NFT deals in turn prop up and accelerate the transaction flywheel and build up the latest bandwagon or meme stock. And it’s abundantly clear that the people sitting on top of these pyramids are just praying that they can exit before the music stops and the whole contraption crashes to a halt.

Everyone seems to be pleased with, and in on, the unicorn joke for now: Cities are bragging about their tech ecosystems, VCs are writing up the values of their portfolios as they mark these latest deals to some make-believe “market” of their own making. The companies are happy to take the cash, natch, whether they know what to do with it or not. Funding, after all, is just the start of the journey. The seasoned veterans will tell you that, especially in the early years, limited funds enforce and assure levels of restraint, focus, and efficiency that are critical to building a committed team as well as a real business.

The business press and social media outlets can’t get enough of the latest and greatest breathless tale. Everyone wants to be part of the smart crowd, particularly because investors at every level don’t actually fear losing their money as much as they fear doing it alone. No one wants to be the patsy in the poker game or be left holding the empty bag. Money rarely leads the parade–it’s just a fast follower. When people say that money talks, they’re not wrong; it’s just that too often it simply says, “Goodbye.”

But is any of this FOMO, froth, and frenzy really good news for the founders, the business, or the long run? Or are we seeing just the newest VC-backed bubble about to belatedly burst?

It’s important to remember when you’re looking realistically at early-stage “story” businesses just starting to get their bearings that $1 of customer money (actual sales) is worth about $10 of investor funding. Too many of these businesses are barely gaining any material traction, and others are losing their shirts in the faint hope that they’ll either make it up in the volume, or find another sucker to add more cash and fuel to the pyre. They like to say that they’re losing money, but they’re doing it at scale.

Hunter Thompson used to say that there was no honest way to describe the edge (especially the bleeding edge of technology), because the only ones who really know where it is are those who’ve already gone over it. While this rampant value inflation may feel exciting for the moment to the entrepreneurs, it’s a serious risk to their own longer-term economic well-being if there’s the slightest hiccup or bump in the road ahead, and a serious cap table reset is required to raise new money.

Down rounds, continued option repricing, and renegotiating bank covenants are all seriously ugly messages to send to your team, your investors, your customers, and the market. That’s what always happens when the easy money gets hard. For now, you want to be careful that you don’t mistake the edge of the rut for a bright horizon because a grim reckoning may be just around the corner.

It doesn’t seem that long ago that we were reminding our startups to take what money was available and that “flat was the new up,” because staying alive and in business was more critical than being fixated on some theoretical next-round valuation. And if you look back a few years, you’ll already find a number of debunked and defrocked “unicorns” whose former management discovered–when the truth about their business models emerged–that they couldn’t raise the funds necessary to keep their jobs or to keep the company’s doors open.

The best and simplest advice for founders and teams riding this crazy valuation wave, and enjoying the rush and adulation that comes along with it, is to be careful in surfing the crest so as not to end up being under it or being swept away entirely.

Take all the money you realistically need to accomplish the objectives in front of you. Don’t go out of your way to find new things to do or fund. Spend the new money carefully and more slowly than you’d like. And always remember that once you’ve sold portions of your own equity, it’s gone forever.

The opinions expressed here by Inc.com columnists are their own, not those of Inc.com.

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