It’s a no brainer that we’re living in an era of extravagant startup valuations, and a plethora of high tech startups for virtually any service you’d think of, even if it’s inviting people for your funeral!
Nevertheless, entrepreneurs and wanna-be tech billionaires come up with garbage ideas every 12 seconds, and go to any bicycle repair shop – sorry, I mean venture capital firm – to raise money for their “Next Facebook” startup.
The Presentation and Term Sheet
Guess what? The bicycle repair guy – sorry I forgot, he’s now a VC – gets excited about the founders’ idea, which is converting Coke cans into keychains, and promises a lot of value-added services and keeps saying: buddy, the sky is your limit, how much investments do you want?
20 minutes later, after watching a Powerpoint presentation that was prepared two days ago, over pepperoni pizza using one of Microsoft Office’s templates, the VC offers a term sheet, which was also downloaded from Scribd.
The Startup Valuation
The offer is $2m of seed funding, for 5% of the company. Did the founders show any financials to support such valuation? Of course! The founders expect to gain 1% marketshare of the aluminum recycling business in 3 years, that is 1% of the $200 Billion market* which is $2 Billion. Very interesting! The deal is done the next day, and a Crunchbase page is made. The founders are now waiting for their feature in TechCrunch.
A year later, they have burnt through the money by having a weekend in Vegas to brainstorm their customer acquisition plan (assuming they know what customer acquisition is?!), and now request more funding. They call the value-adding VC who presumably knows Warren Buffet, requesting more money but he doesn’t even pick up the phone (very value adding!). Fortunately, one of the founders knows an investor two blocks away, and they set a meeting with him. They get slapped with the reality, their valuation is extravagant, and their business is worth nothing.
The Brutal Truth
The investor goes on and on questioning everything from their team, their idea, their execution, their sales strategy, etc… Basically, they were doing ‘nothing’ the past year. Assuming the business had any potential, maybe their team knew something about Python, and they could be building something else with value, it’s impossible to do it now. They have no money, and no ‘sane’ person will ever invest in a Coke to keychain conversion business at a valuation higher than $40,000,000 !
Who’s to blame?
- Founders: they are fame-craving people wanting to ride the Silicon Valley trend in any way they can, even with the stupidest ideas. But were they aware of the principles of business and investing before to know that such valuation was simply crazy? No.
- The first VC: He was approached by a couple of high net worth individuals that do not want to be late to the startup trend, and want to ‘save money’ with the traditional venture capital fund expenses, so they hired him instead. He’s been in the bicycle business for 15 years so he should know how to run a business, right? So, is the VC to blame? Hmm.. Maybe but no.
- The sane investor: He crushed the founders and pushed them to shut the company down. Is he to blame? No. But he caused the company to die an agonizing death! I think he should earn a Medal of Business Honor for what he did.
So, who’s to blame?