Some thoughts on when to raise money, and the current financing environment

A key question for founders is when they should try to raise money. More specifically, they often wonder whether to raise money now or wait, say, 6 months when their startup has made more progress. Here are some thoughts on this question generally along with some thoughts on today’s venture financing market.

- In the private markets, macro tends to dominate micro. Venture valuations have swung by roughly a factor of 4 over the last decade. In finance speak, venture tends to be high beta, moving as a multiple of the public markets, which themselves tend to move more dramatically than economic fundamentals. Hence, it is easy to imagine scenarios where the same private company will command 1/2 the valuation in 6 months due to macro events, but it’s rare for a company to increase their valuation 2x through operations alone in 6 months.

- Therefore, when it seems to be the top of a venture cycle, it’s almost always better to raise money sooner rather than later, unless you have a plausible story about how waiting will dramatically improve your company’s fundamentals.

- Prior to the Facebook IPO, the consensus seemed to be that private valuations were near the top of the cycle. Today, FB is valued at up to 50% below what private investors expected. Moreover, the financial crisis in Europe seems to have worsened, and unemployment numbers in the US suggest the possibility of a double dip recession.

- It takes many months to understand how macroeconomic and public market shifts affect private company valuations since (with the exception of secondary markets) private transactions happen slowly. So we don’t know yet what these recent events mean for private markets. According to a basic rule of finance, however, it is safe to assume that companies “comparable” to Facebook are worth up to 50% less than private investors thought they were worth a few weeks ago.

- The question then is what companies are comparable to Facebook. Clearly, other social media companies with business models that rely on display or feed based advertising are comparables. Internet companies that have other business models (freemium, marketplaces, commerce, hardware, enterprise software, direct response advertising, etc) are probably not comparables. The public markets seems to agree with this. Defensible companies with non-display-ad business models have maintained healthy public market valuations.

- One counterargument to the “all social media companies are now worth less” argument is the discrepency between how the smart Wall Street money and smart internet money views Facebook and social media companies generally. The smart Wall Street money thinks like Mary Meeker’s charts. They draw lines through dots and extrapoloate. This method would have worked very poorly in the past for trying to value tech companies at key inflection points (and tech investors know that what matters are exactly those inflection points). In Facebook’s case, Wall Street types look at revenue and margin growth and the trend toward mobile where monetization is considerably worse (for now). Smart internet investors, by contrast, look at Facebook in terms of its power and capabilities. They see a company that is rivaled only by Google and Apple in terms of their control of where users go and what they do on the internet. Smart internet investors are far more bullish than smart Wall Street investors on Facebook. Thus if you believe the internet perspective over the Wall Street perspective, you’d likely believe that Facebook and social media in general is undervalued by the public markets.

 

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