Entrepreneurs fared better taking less venture capital.
It seems that raising as much venture capital as humanly possible is Silicon Valley’s mantra, there are reasons to be cautious when signing termsheets. Startups raising a couple of million dollars had a median exit price of more than $10 million, while the outcome for those raising double that was actually worse, a recent study shows.
The report, by San Francisco-based Exitround, a marketplace for M&A deals for small tech companies, found companies raising $2 million to $3 million were more likely to exit at a valuation over $10 million, while for startups raising $3 million to $10 million the median exit price was less.
“While raising large amounts of funding at high valuations is generally exciting for entrepreneurs, it is often forgotten that it limits exit opportunities down the road and also raises pressure for the next round of financing,” says Boris Wertz, Board Partner at Andreessen Horowitz and Co-Founder of AbeBooks. “I’ve seen many companies that have announced valuations ahead of their development stage and were subsequently forced to grow into that valuation very quickly before the next funding round – leaving little margin of error.”
Exitround analyzed deals using proprietary data from more than 200 deals worth less than $100 million, provided by startup incubators like Y Combinator and Tech Stars.
Enterprise companies also had better exits from a return-on-capital perspective than consumer companies by a factor of close to 3x. Overall, some sectors such as mobile (13.1x avg ROI) and cloud (9.8x ROI), had higher average returns on investment than others like social (6.4x ROI).
Gil Penchina, an angel investor in over 60 startups with $25 billion in exits, says the study leaves room for a nuanced answer. “Entrepreneurs should raise as little as they can until it works for their business, then raise as much as they can to scale,” he says. “If you raise too much before the correct formula is achieved, it can mean bad news for the valuation outcomes.”
The more money you raise, the higher the stakes, says Satya Patel, Partner at Homebrew Venture Fund. “As a company raises ever more capital, the bar for the next financing gets higher, the pressure to “invest” the capital in the business gets greater, and the options for liquidity get fewer. If a founder raises lots of capital, he or she better be prepared to go big or go home.”
While chasing an IPO is the dream for many entrepreneurs they will likely be better off concentrating on the M&A market, thinks Nathan Beckord CEO and startup advisor at Foundersuite.
“Entrepreneurs have to think about it like this: the larger the VC rounds you take, the more ‘unnatural acts’ you need to perform to deliver an acceptable ROI to your investors,” he says. “When you do the math, you’ll find entrepreneurs can actually make more money by selling early, with a large chunk of equity and a reasonable valuation, than by swinging for the IPO fences. Plus, big exits usually take seven to eight years or more— which means more opportunities for things to go wrong or for the market to shift.”