154. Valuations are Down; Down Rounds Are Up feat. Peter Walker, Head of Insights @ Carta

If we look back, unfortunately to late 2021, early 2022, a lot of those founders took term sheets that look pretty silly at the moment right now. And you're seeing a lot of companies having to do down rounds or bridge rounds or getting really creative to keep money coming in the door because the valuation is just too high. I think founders should, while they're shooting for big valuations, just keep in mind that you wanna make sure you are right sizing the valuation to the growth of the business and the potential that you see. And you're really just trying to do that math in your head and say, what do we need in order to get to the next big milestone that's probably two years away? And then how much does that back into what my company is worth? we could spend an hour and a half on valuations in general. As a topic, let's just talk about it and disambiguate the idea of valuation at the Pre-seed level, and then valuations within Seed and Series A. At the Pre-seed, if you are raising on a convertible note or a SAFE, the reason that you're doing that is to explicitly avoid valuing your company And that's for the sort of obvious reason that it's incredibly difficult to value an idea or a very early company. Just kind of slapping a 10 million valuation on a business that was started three months ago, it's not very precise. A lot of times the investor and the founder in this case agree to explicitly not set a valuation and let that valuation get set by somebody down the road. And that's why the equity converts when that valuation is set during the price round. Of course you may hear from investors, yes, that's true, but if you have a valuation cap on your safe, you're effectively setting a valuation on your business. I can understand that argument, but it really isn't the same thing. What we're seeing right now is that with all the turmoil that's going on, startups have kind of suffered this valuation decline over the last 18 months after flying really high in 2020 and 2021. For pre-seed companies, the median valuation cap on a safe that we're seeing is just about 10 million. Just below, about 9.5 million for a standard pre-seed safe. And companies are raising, I think on average something like$600,000 on that safe. Not from one investor. That's, that's quite a few investors usually in those rounds. When you jump up to seed, the median seed valuation on Carta at the moment is 13.1 million. And the amount of cash that's raised in a given seed round is anywhere from. Three to three and a half million dollars is a pretty good median there. If you jump up to Series A you're talking about a 40 to 42 million valuation and you're raising about 10 million bucks. So that gives you a little bit of insight into how it jumps up through these stages. one big topic that comes up here that founders should be aware of is down round So down rounds are just like what they sound, it's taking on new fundraising at a lower valuation than what you had previously been valued at. And for a while they were kind of, to be candid, a black mark on a company's prospects. And that's for two reasons. One when you take a down round, obviously you are implicitly stating, Hey, we were overvalued and we need to rethink things. But the hidden side of that is oftentimes you issued equity to employees and others at an inflated valuation. And so you have to go back to your employees oftentimes and explain to them that their equity is not worth what they thought it was worth. In fact, it might be that their exercise price is now higher than the fair market value of their equity. So they're unlikely to even exercise those stock options. And that's a really tough place to be as a founder. A good data point for you all to know is that close to 20% of all of the rounds on Carta in Q1 of 2023 were down rounds. This is not just happening to a few companies, it's happening to a lot of companies because of the way the macro environment has changed. It's my hope that down rounds become a little bit less of a stigma. There's certainly nothing to shoot for, but there have been great businesses that have been built after they take a down round. So it is by no means the end of a company. But it does entail some difficult trade-offs.