Ep. #581 - Startup Valuations Explained
In this episode of Startup Hustle, join Matt and Matt for Part 14 of “How to Start a Tech Company” while they discuss everything entrepreneurs need to know about startup valuations.
Covered In This Episode
What is a startup valuation? How important is it for founders to know their startup’s valuation? Can a startup even have a positive valuation without revenue?
The Matts are back to share their knowledge with you on all things startup valuations. In Part 14 of the “How to Start a Tech Company” Startup Hustle podcast series, our hosts explain how entrepreneurs, investors, and even banks evaluate the value of startups. They also share the various factors that affect startup valuations, and the steps founders can take to improve them. Don’t miss the useful insider tips Matt and Matt provide when it comes to valuations too!
Sit back and tune in for the 411 on startup valuations in this Startup Hustle episode.
Missed the previous episode in this “How to Start a Tech Company” series? Click here to listen to the 13th episode of the “How or join the Matts in the 15th episode here.
- Introduction to today’s episode (0:01)
- What is a startup valuation? (2:17)
- Pre-revenue vs. Post-revenue valuation (2:58)
- The team is a big deal in company valuation (5:45)
- What kind of competition do you have? (8:08)
- Opportunity to grow and type of business (10:10)
- What is scalability? (12:09)
- The reasons for acquisitions (17:55)
- The Market Multiple Approach (19:25)
- What is a Series A? (25:03)
- What’s a down round? (27:36)
- Venture debt vs. Bank loans (31:49)
- It’s always a competition to get capital (35:36)
- The best advice for founders (40:52)
- Wrapping up (44:52)
You know, my dad used to tell me when I collected baseball cards when I was a kid that something is only worth what someone will pay you for it.Matt DeCoursey
There’s a huge advantage to being a first mover, right? The first mover in a new industry gets all the attention and gets high valuations and then and then the VCs get some FOMO they get fear of missing out. And all of a sudden, you get the big crazy valuations. But for the other 98% of us, none of that ever happens.Matt Watson
A lot of acquisitions have, you know, happened that way. It’s like, we’re not only getting customers, we’re getting revenue, but we’re also getting talent. Talent is a big piece of that cost to duplicate. If you don’t have talent in the field, it’s really difficult.Matt Watson
It’s a numbers game. And you need to get out there need to talk to people, you need to try to align your pitches, your effort, and your energy around investors and wherever entities that are used to making investments and the type of businesses that you as listeners want to start.Matt DeCoursey
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Following is an auto-generated text transcript of this episode. Apologies for any errors!
Matt DeCoursey 0:01
And we’re back. Back for another episode of Startup Hustle, Matt DeCoursey here with Matt Watson. Hi, Matt.
Matt Watson 0:06
What’s going on man?
Matt DeCoursey 0:08
Back for part 14. After we took a break, because you interrupted the tech series by selling a tech company. So congratulations once again. And here we are.
Matt Watson 0:19
Sorry, my startup valuation got so high, I had to cash in.
Matt DeCoursey 0:23
It might; I was thinking that this might be an appropriate appropriate timing here, because that’s what we’re gonna talk about today, startup valuations explained. And man, those things are all over the place these days, so, you know, how do you arrive and come out, come up with a valuation? You know, my dad used to tell me when I collected baseball cards when I was a kid, something is only worth what someone will pay you for it. And I see you nodding your head. So I’m assuming you agree with that.
Matt Watson 0:57
I mean, that’s the thing about the value of anything, right? My mom has Beanie Babies and old Furby she thinks is worth a lot of money. And I’m like, I wouldn’t give you two shirts for this. And when you die, I’m throwing them away. But she thinks they’re worth a lot of money.
Matt DeCoursey 1:11
Well, based on that comment, now I feel like it’s an appropriate time to let you know that today’s episode Startup Hustle is sponsored by Gusto. And Gusto is a simple online payroll and benefits platform built for small businesses. Gusto automatically files your payroll taxes direct deposits, your team’s pay, plus, you can offer all kinds of benefits 401 K health insurance, workman’s comp, and more. And because you’re Startup Hustle listener, you get three months for free once you run your first payroll, go to gusto.com forward slash Startup Hustle once again, gusto.com forward slash Startup Hustle, there’s a link in the show notes and make sure you put the forward slash Startup Hustle on there. So Gusto knows that you came from Startup Hustle, because we need the Startup Hustle valuation to climb higher, because isn’t everything kind of based on the revenue that a company starts? I mean, is that isn’t that kind of the first building blocks? Or maybe not?
Matt Watson 2:08
Well, the podcast is worth like, what? 100 times multiple. But the problem is our income is like $1. So it just doesn’t equate to.
Matt DeCoursey 2:17
Well, it’s not quite that low. But yeah, and I think we’re I think I think I think startup podcasts traded 1000 Multiple. Okay, so if you’re right, right, who’s that? Who’s that we should get them on the show? So yeah, I mean, first off, let’s start. Let’s just define, you know, what is the startup valuation and start a valuation, it can be a process or a number. And when you go through the valuation process that’s calculating the value of a startup and the value of your company, essentially, is an agreement between you and your potential investors or acquirers?
Matt Watson 2:58
Well, and so to your point, right? It’s one thing to value the startup when you’re like pre revenue, or you’ve got a little bit of traction, right? versus say, where Stackify was where we sold the company, it was seven years, several years old. So you know, later stage, usually the valuations are, you know, multiple of revenue, or whatever. And we’ll, we’ll probably talk a lot more about that today. But early stage is a whole different thing. And it reminds me of one of my favorite episodes of Silicon Valley on HBO where they were laughing about how they didn’t want to have any revenue, because as soon as they had revenue, then then they gotta go by the formula for revenue, right? Like, oh, we’re seven times, you know, our annual revenue. But as long as it’s still zero, we can make up whatever number we want. And
Matt DeCoursey 3:42
That was Ross Hanuman. He’s like, what’s the whole revenue for revenue?
Matt Watson 3:47
We want to be a billion dollar company with no revenue. As soon as we have revenue, we have like multiples and shit, forget that. But there’s some truth to this in the story, when you’re raising, you know, money early on is, once you start having revenue, all of a sudden, what everybody cares about is how fast are you growing revenue, right. And that plays a huge part of your valuation. Versus if you’re pre revenue, you can make up whatever story you want, and be like, we’re gonna be a billion dollar company, just wait. But once you start making revenue, man,
Matt DeCoursey 4:24
you can make up those numbers. But if no one’s gonna, if no one is going to invest at that price, then it’s just it’s it’s well, much like unicorns, they’re fictional. So, you know, there are some things So Matt, we like when we’re in a pre revenue stage. What are some of the things that can boost that can boost valuation of a company by
Matt Watson 4:47
well? Yeah, so it’s definitely the market you’re in, right? The product you sell the addressable market, you know, it’s like, Oh, I gotta think I’m gonna sell for $5 a month. And I’m not sure how To sell it and not very many people need it, it’s like as isn’t gonna be worth a lot of money. But if it’s an enterprise product that can sell for $100,000 a year, and lots of big companies will use it, and you can show that you can sell it, then the valuations can get really crazy. So it’s just all over the board based off of the type of product you have. And there’s a huge advantage to being a first mover, right at first mover in a new industry, gets all the attention and gets the high valuations and then and then the VCs get some FOMO they get fear of missing out. And all of a sudden, you get the big crazy valuations. But for the other 98% of us, none of that ever happens.
Matt DeCoursey 5:45
Right? Right. So you know, I had notes that it’s funny cuz I was trying to consider what book I might want to write next. Because you know, it’s been a couple of years since I’ve written a book, Matt and I thought unicorns don’t exist would be a great title. Because for most startup founders, they that is not that doesn’t exist, like the idea that you have a better chance of, well, you and I are going to the Kansas City, the Kansas City Royals play and you have a better chance of making it to the major leagues, then you do a founding a unicorn company. Just because it’s I mean, for most people, it doesn’t exist, but you do have to start creating some kind of valuation, whether it be now or later. And there are different investment instruments, such as the safe note that might determine that valuation at a later date. Now, for things that I think affect the pre revenue startup, well, I think it starts with who’s starting the company,
Matt Watson 6:36
the team, the team is huge, right? Like if you’ve, if you’re going into a certain industry, and you’ve got experts on the team that know how to sell the product, they’re connected, they’ve got, you know, a network of people to sell the product to like, yeah, that’s a big deal. Really big deal.
Matt DeCoursey 6:51
We talk about, we’ll use our own hometown as a reference. So we have a company here that had a pretty big exit I verify of which one of their founders reddleman dos went and started another company called triple blind. And just using this as an example, because he had already been a successful founder. And I don’t know if I don’t, I don’t have any info or anything on this. But I would imagine that would have made his process of finding investors and attracting other people to be interested in this company. A lot, a lot easier. And you know, because you’ve seen success, you understand you’ve already made you possibly made mistakes. And I think that that success breeds either success. So
Matt Watson 7:32
it’s so you know, yes, yes. And no, yes and no, right. Because I went through this, I sold VinSolutions. And then I was raising money from for stack fi Right. And, and really the first people, the first question I ask you is,
Matt DeCoursey 7:44
why do you need my money?
Matt Watson 7:46
For raising money? So
Matt DeCoursey 7:51
they asked that all the way until the exit, Matt?
Matt Watson 7:53
Yeah, it’s a double edged sword. Right? Like, actually people they’re like, legitimately, like, Why are you raising money you sold I verify $400 million? Like, why are you raising capital? You know, that that’s gonna come up, too. But But you’re absolutely right.
Matt DeCoursey 8:08
There are a number of reasons. I mean, just because you had a successful exit doesn’t, you know, one of the things you mentioned on Startup Hustle, TV. And if you guys want to watch Matt, then we recorded timeline, you know, along the timeline updates on the whole startup acquisition process. It’s episode 10.1, and Startup Hustle TV. And one of the questions that you answered along the way is, would you start another company? You said, yeah, maybe but I don’t know if I want to do it with my own money again. Yeah. Yep. So that I mean, there are legitimate reasons. But here’s the thing is, if you have if you have a great team, and you have proven winners, and people that now Matt, you’ve done, you’ve had two successful exits, it’s not unfair to think that you could help guide a company to a third and you have a pattern forming. Now, if you are in industry x, but you’ve been spent your career working in industry, why and now you’re like, you know, what I think I want to be, I think I want to be a startup founder. That’s not a real compelling argument to get people to invest. So your valuation may be lower. I totally agree with your input on the total addressable market, and then coupled with what kind of competition you have. So like, if there’s already an 800 pound gorilla in the room, meaning someone’s already dominating that space, and people aren’t really going to want to give you a super high valuation pre-revenue, because you’re competing with people that are companies that are well ahead of you, and the timeline of both business and product development, and it gets harder and harder and harder to unseat those kinds of companies. So that can definitely affect your valuation. Now, one of the things that I’ve noticed over the years, is, like you were alluding to earlier is everybody with a pitch deck is like, Yeah, this is a $3 million valuation. I’m like, based on what, like no revenue, no, nothing, no experience, like, get out of here. But on the flip side, od we see people that get huge valuations and big money coming in with zero revenue with zero, anything, they’re just started, you know, they are literally a pure startup.
Matt Watson 10:10
Yeah, it’s based on the opportunity, right? You look at the opportunity and say, Okay, what is the chance that this team can take this and grow it to do 1050 $100 million a year in revenue, not one or 2 million, because if it’s one or 2 million, nobody’s gonna invest in it anyways. So if you’re listening to this, you think your startups going to a million dollars in business, nobody cares. If you’re gonna raise a bunch of money, you’ve got to be, you gotta have a plan to raise you to sell like 10s of millions of dollars a year in product. So,
Matt DeCoursey 10:39
you know, there’s, there’s another thing here is, you know, I mean, when it comes to raising capital, it really is all relative, when it comes to like, I mean, what, what are you happy with, and I want to give a little disclaimer, because neither Matt Watson nor Matt DeCoursey are, we’re not financial advisors. And you know, we can’t tell you what your what your what your company’s worth, there are people out there that can help with that. So you know, take our input with a grain of salt, but we’ve been around it both from clients we serve at the company we own together at Full Scale, Matt has a lot of experience, we’ve done a lot for a lot of different types of businesses. And that’s, that’s what I think we should talk about next is the type of business you have, and you’re starting, or you’re running, or you’re getting ready to sell has a huge has a huge, huge, huge impact on the the valuation now you and I own Full Scale and FullScale.io together, which is technically a tech services company, which has a lower multiple based on revenue. And the reason for that is it’s harder to scale service based companies as our friend Neil Sharma, who is on episode 150. And a very successful startup founders. Well, he says, well, software shows up to work every day. So you can scale certain things. So like the multiple that you’ll get a revenue based on a service company, or a product company, in some regards, is usually dramatically lower than tech, which has theoretically, an infinite scalability factor.
Matt Watson 12:09
Well, I think service based businesses could be half multiple to one to two, right, depending on the type of business and its profitability, and how much it could grow, and all those kinds of things, right. I mean, it’s, it’s all over the board, if it’s, but but, you know, most thing that’s most the thing that’s usually always true about that is multiples of EBITA. Right? Multiples of EBITA usually always work, but you might not care about EBITA if the company is really growing, and it has a lot of growth capacity or something, right? So it’s not always EBITA. But yeah, it’s, it’s totally different from one another.
Matt DeCoursey 12:47
Let me define EBIT da, that’s EB it da and that stands for earnings before interest, taxes, depreciation, and amortization. And companies like Full Scale, which are service-based or any service based company are usually based on their profitability, their the length of time that they’ve been around the now now a company like Full Scale, which does tech services, which is a wildly hot everything right now are that’s going to drag that that’s going to drag the valuation multiple up, there’s a little more of a, and also like, how unique is is your service or product company, like if you have a product, and you have a patent on that, and you have a you know, X amount of time where no one can compete with that without paying you royalties? That’s a lot more attractive than being like, hey, we here’s a Yo yo, which is in around for a long time. And there’s nothing necessarily proprietary, proprietary to it. Now, when it comes to software match. And you get what what is scalability, and I alluded to this earlier, but what if you if you are if your company is easily or theoretically scalable. What does that mean?
Matt Watson 14:01
Yeah, I mean, part of what you said earlier, right, software shows up to work every day. And if the product and service you’re selling is very scalable, it means mostly that your customers can go to your website and sign up for it and use it. And there’s not a lot of friction in the way to prevent that, right? So you don’t necessarily have to hire a bunch of additional people to support them or or install their product for them. And that kind of stuff. It’s usually more hands off. And it’s very scalable. Now, a software product, it doesn’t mean that you don’t need support people or salespeople or whatever. And it doesn’t mean it’s not scalable. But the more scalable it is, the less people you need, the less labor or other services you need outside of just the software itself, right? So take Giga book as an example, which is an online scheduling platform. Customers go and they sign up for and they use it. They should never talk to a human being they should just use the thing, right? So it’s highly scalable from Apple. perspective, where Netro, the new company I work for, it’s pretty scalable. But you know what people need some professional services, they need some port, getting it installed, once they get it installed, they’re, you know, they’re good to go. And hopefully they’ll pay their bill for many years to come. And they’ll be a happy customer, right. So it’s pretty scalable. It’s, you know, it’s scalable business, but it does have some, you know, component of labor and support for helping them get set up and implementation. So it’s scalable, but not as scalable as, say, the the Giga book example, where there’s zero labor labor involved. Does that make sense?
Matt DeCoursey 15:31
Yep. So that in that scalability, and the reason that’s important is one, it can lead to profitability. And also, if the company does take off, and you’re headed to the moon, because we like we like trips to the moon right now. Absolutely. So if you’re headed that way, you know, you have some time to backfill some of those things like support and stuff like that. But the exponential growth and ability to really get moving is remarkably higher. And that’s why that’s why companies trade, it’s such a huge multiple now. You know, one of the things and we’re gonna get into, you know how some more of these, there are some formulas and actual definition for that. But, you know, as you grow, it’s important to know that taking care of employees has never been more important. And for years, gussto has been helping more than 100,000 small business owners run payroll, offer benefits onboard new employees, and more, they call it the people platform, and it doesn’t just look nice, it actually works. So your payroll taxes are filed, deductions are calculated and your team gets paid. You can even offer health insurance 401 Ks, and you get three free months after your first payroll when you go to gusto.com forward slash Startup Hustle once again, gussto.com forward slash Startup Hustle, link in the show notes. All right. So there are some that back to the topic of how startups are valued. There’s some, you know, general guidelines that do some formulas that people look to, you know, one of which is like the cost to duplicate, and that involves calculating how much it would cost to build another company, just like the one that you have from scratch?
Matt Watson 17:06
Well, honestly, net trail, I think, looked at that, right? So one of the analysts told them like, hey, instead of buying SEC fi, why don’t you guys, you know, take this open source project that you can learn from, and just like, you know, incorporate that technology in your platform, or whatever, and just kind of duplicate it, right? I mean, that was an option. But they might look at that and be like, hey, it might take us a year to two or do it, we don’t have any expertise, we don’t really know how we’re too damn busy doing other shit anyways. So let’s acquire some people that are experts in the field. And we also get their revenue with it and their customer base with it. So it’s a win win. Right. And so that’s why a lot of acquisitions have, you know, happen that way. It’s like, we’re not only we’re getting customers, we’re getting revenue, but we’re getting talent, talent, a big a big piece of that cost to duplicate, you’ve duplicating yourself, if you don’t have the talent in the field, it’s really difficult.
Matt DeCoursey 17:55
One, and also, the cost to duplicate is also time time. So so like you mentioned, like nitro and stacked bar, like sure they could have taken something like that on a it’s one more thing to do. And be I mean, dude, it didn’t, it took years and usually does to get it right, when it comes to tech. So, you know, we have quoted Warren Buffett, like 10,000 times in his famous saying of nine women don’t make a baby in one month. And, you know, just because you have you can throw a bunch of people at it, it doesn’t mean you’re going to it doesn’t mean you’re gonna build it faster. In some cases, you may even build it slower. So a lot of companies and Dude, this is a huge, this is a big, big, big factor as to why companies get acquired. It’s because big bank takes little bank, and it wants to do it right now, it doesn’t want a three year roadmap that you don’t even know if you’re gonna get down and plus what is what is life look like in three years. So you know, it’s like,
Matt Watson 18:56
yeah, and I talk to analysts, I talk to analysts a lot for Netro, right. And a lot of our competitors and other people in the space are always acquiring things because of consolidation, or their customers want to buy more than one thing from them, or, you know, the markets changing that the products are changing, and they’re trying to keep up and offer different services and, you know, address different market needs and whatever. And so they do a lot of different acquisitions. But the hardest thing is always integrating and all together. So there’s that side of it, too.
Matt DeCoursey 19:25
So next on the list, the market multiple and this is basically the market multiple approach values companies, against recent acquisitions of similar companies. I mean, it’s just the market price. And this comes up a lot, regardless of whether you’re being acquired or if your people are going to invest in you. So if you and where you rank in the pecking order, and that industry is going to ratchet that up or down a little bit. So if if the if you’re the market leader, and whoever’s in second place, gets a great valuation and gets acquired We’re gonna, that’s gonna, that’s gonna prop you up a little bit, and can also bring you down. If people in or around your grouping or market share, get a shitty valuation? Well, that’s because you’re gonna, you’re like, well, that’s not even my company, might as well be in some regards, because that is going to be the measuring stick that you that they stand next to you. Did you run into any of that recently?
Matt Watson 20:25
I mean, not a lot. I mean, our deal wasn’t really competitive. So we weren’t running a big process or anything. But that, you know, for software,
Matt DeCoursey 20:33
it wasn’t competitive, meaning like, there weren’t four companies
Matt Watson 20:37
by now. So the most SAS based companies like stack phi, right are based on a multiple of annual recurring revenue, which probably starts at three to 4x on the low side, and goes up to seven, maybe 10, on the really high side, right, and then some publicly traded companies or whatever, or unicorns may go over 10. But kind of like four to seven is probably kind of the normal range. And it all depends on how fast you’re growing. customer churn customer expansion, you know, how big you are, in general, right, if you’re doing $100,000 a year in revenue, you’re obviously not going to take up five times multiples of that, as we talked about earlier, but, you know, once a company has been around for a while, and you’re doing a few million dollars a year in revenue, usually the multiples work out, and that’s what people go off of. But the big factors are going to be things like churn and expansion growth rate. And if you are killer at all three of those things, your multiples is going to be higher. If you know, businesses slow and you’re not growing very fast, and you got a lot of churn, multiples gonna be a lot lower, so it’s just going to be somewhere in that kind of spectrum.
Matt DeCoursey 21:50
Okay, next one’s a little a little more complex DCF, the discounted cash flow method, which involves forecasting how much cash flow the company will produce in the future, and then using an expected rate of investment return, calculating how much that cash flow is worth. We have talked about this through and through when I hear the word projection, I think wrong. Like that is the word, the first word that I now associate with the word projection, because nobody knows what’s going to happen in the future. And I think this is where a lot of people get sideways in their deck and their and their pitches and talk in their investor relations. Because, you know, they’re like, Yeah, but look, in three years at the top of the hockey stick, we own the entire planet. And it’s like, yeah, but are you really going to? So I think if you’re going to rely on the discounted cash flow method, you have to have had cash flow for quite a while. That’s not, I mean, if you want it to be credible. Now, I’m wrong in some regards, because this, this is also a method of future projection where you can get some, you know, say, hey, look, there’s no revenue now. But we’re gonna have a fair amount and a few years, but it’s still Yes.
Matt Watson 23:10
Well, I mean, so this would be akin for me as an investor and say, Full Scale to say, okay, Full Scale today, let’s say it’s making $100,000 a year in profit, but we’re on track, you know, it’s gonna keep growing 20%, year over year, whatever. So we’ll give you a little higher valuation, because over the next five years, we agree with you, it’s going to continue to grow. And so we’ll give you a little a little higher valuation, right? I mean, that’s basically what we’re talking about.
Matt DeCoursey 23:34
And in some cases, if your business has been around for a while, and you’ve shown an average growth rate of X over Y number of years, this is going to feel a little more fair, where in the beginning, it’s a gas. And yeah, I mean, honestly, man, I This isn’t one I’ve run into a whole lot. It’s when you kind of think about that. I know it’s used, I mean, any other comments on that? No? No? Yeah. All right. So next in line valuation by stage I mean, the earlier the stage, the bigger the risk, which if you’re gonna get investors in and that data or that day one kind of place, they want a bigger return so I mean, if someone shows up someone that’s an unproven entity with a whole lot of you know, fancy shit in their pitch deck, but nothing to back it up. I’m not super interested in owning 2% of a company that’s gotta guess of evaluation. So you know, like when you’re pre-revenue when you’re a true like pre-seed round like You’re like a true Angel, Angel angel like hell, but this is a guest that you don’t fail before next Wednesday. I mean, but then also you see some companies making headlines in their in their Series M. You’re pretty far down the road there. Yeah.
Matt Watson 24:57
Is that series what
Matt DeCoursey 24:59
Yes, yeah, so that’s why it’s like, you know, from
Matt Watson 25:03
my experience with talking to VCs, and I think this varies a lot from, say, Kansas City to the coast, you know, bigger cities like Silicon Valley and Boston and stuff that do a lot more have a lot more VC activity, it does seem like these days that now a Series A, it’s kind of a bigger round than it used to be, where people are getting, you know, three to $5 million checks and Series A, so the companies are probably worth 15 to 25 million or something. And for a lot of those VCs, it’s probably that’s a common thing, we write a three to $5 million check, and the valuation is 15 to 25, or something like that for their Series A, and if they’re not talking to you, like you don’t even make it into those talks into their Series A, it’s because you don’t have a big enough opportunity to even make it to that level, right. Some other smaller VC might be interested, but your lower caliber level, right, so those VCs are talking to the highest caliber opportunities. And that’s why their valuations are that high. Were a lot of smaller things are gonna be way less than that. But I imagine for some VCs, they see a lot of deals that are kind of in those similar kind of tracks, because they’re, they’re looking at big opera, you know, high quality opportunities.
Matt DeCoursey 26:12
Well, in different investors, you know, like you said, have a different risk profile, they have different things that they’re bound to, they have different things that they will invest in, and certain things that they won’t, and, you know, they have minimum and maximum check amounts that they’ll typically write and, you know, anytime in the past when I’ve talked to whether it’s been on the show, or some are just in person, and it’s just kind of a casual conversation point. You know, what size checks? Do you like writing? You know, and that’s,
Matt Watson 26:38
I mean, some companies billion dollars.
Matt DeCoursey 26:42
I mean, that’s you, Matt. You know, for me, it’s more like 1 billion doll hairs, which is probably still worth about 60. Grand us. So I mean, doll hairs can get expensive if you get enough of them. So I mean, do you? I think a common question I’ve run into, I’m sure you have as well as from other people as well. Is this valuation? I’m getting fair? I don’t know. How do you feel about it?
Matt Watson 27:09
Yeah, I mean, from a SaaS company, like stuck by right. Like, like I said that for that, you know, you think, oh, it’s four to seven times and you talk to some different people, and you get kind of a consensus on like, okay, four to five or six or seven, or whatever feels right. It’s, it’s tough, but then it all depends on the terms right. pends on the the terms, the investors are giving in all the details, because they can pull some other shenanigans that make it a better or worse deal. So
Matt DeCoursey 27:36
yeah, you know, I think the question is, is do you need a high valuation to start or do a lot of stuff, I mean, once again, it’s all relative, every, every company companies are like snowflakes, man, they’re all different, they all have different needs, they all have different stuff. And you know, like, now one of the things is, if you do get a high valuation, especially early, that’s gonna come with some some added expectations. Now, what’s a down round?
Matt Watson 28:02
You know, when you, you raise that $5 million, Series A, and you blow through it a year and a half, and there’s a pandemic, and now you need to raise another 5 million and your valuation hasn’t changed, you know, or is lower,
Matt DeCoursey 28:16
and that, and that’s going to be a product of you not living up to your expectations to your prior life. So look, the stuff you put out on the street people, the things that you’re out there looking for and asking for, there’s a strong likelihood that you’re going to be talking to those same people again, downstream, and they probably still have that original pitch deck those original projections, and they then they’ll look at him and say, oh, okay, so this didn’t come through the way that you needed it to now, I know it’s funny on the you mentioned the show startup or Silicon Valley, and they’re terrified of a down round. And that you know, like that’s the worst thing that could happen that’s like that’s like being in the plane in the major leagues and getting sent to the minors it’s, but it happens and I would imagine that the pandemic especially being the if that were the fulcrum and the middle of several valuations, there’s probably a lot of companies that went up and a lot of them that went down so I think that here in 2021, there was probably a lot of down rounds and then there was also a lot of companies that were probably not the belle of the ball that are suddenly really high.
Matt Watson 29:34
Yeah, I mean, like it’s dogfight we saw that right we have over 1000 customers all over the world and we had some online education and their business is just booming out of control. Right. And then you got others that are in tourism that are just toast. So it’s just been all over the board. Well, Full
Matt DeCoursey 29:50
Scale was like out a little bit and you know, we had we were out and if you want to see me turn down a million dollar investment offer. Check out Startup Hustle TV cuz, yeah, that happened and we filmed it, which is okay. But, you know, prior to the pandemic, you know, we were a we were really young company. And also we were saying, Yeah, well, and we’re recession-proof. Well, we proved it because we grew 25% during a pandemic, which makes that now provable. And then on top of it, I, you know, the end of that tunnel, which we’re just now exiting from it, at least here in the US, for those of you listening across the world, hoping that that happens for you soon. But now, all of a sudden, there’s growth that’s that we didn’t even see prior to the pandemic. So being able to execute, you know, a plan and show that you’re survivable, and make it through tough times and, and continue to grow can be really good, where, you know, like I mentioned, there’s probably a lot of companies that it had some problems along the way. So I don’t have the exact examples of that. But, you know, overall, I mean, there’s, there’s a lot to be said, we’re going to have kind of a free form discussion about the rest of this. Before we get into that, once again, today’s episode, Startup Hustle is brought to buy gusto. If you’re on a startup, you’ve got to try gusto, payroll, deposit, paychecks, file payroll taxes automatically. Plus, get employee health insurance, onboarding, expert HR and more, you get three free months when you go to gusto.com. Forward slash Startup Hustle once again, gussto.com forward slash Startup Hustle, there’s a link in the show notes. Now, Matt, when it comes to valuations, I mean, look, I think if you’re in an early stage, I see people get so hung up on this, like, I think it’s more important to be hung up on who you’re taking money for how they might be able to help you and just getting started.
Matt Watson 31:49
Well, at some point in time, right, you just need the money to get going. And there are other solutions out there, too. So like at stack phi, we raised some venture debt from a company called Cypress in Dallas. And that’s one of the things they pitch, right, it’s like, well, you can take some debt from us and wait for your valuation to get higher, and then do a round later at a at a better valuation. Right. That’s, that’s another alternative. And the venture debt is becoming more and more popular. Cypress I know is is booming, they just raised another $50 million round themselves to invest in other companies. And their works great. I mean, you you take the money, and you pay them back a little bit every month, to good alternative to equity, and they don’t care about the valuation. Doesn’t matter to them. It’s debt.
Matt DeCoursey 32:36
Yep. Well, and I don’t mind talking about that. Because there’s a lot of different ways you can raise money where your valuation doesn’t matter. Once again, you know, Matt, and I own Full Scale and FullScale.io together, and we help build tech teams, companies grown super fast, but we actually created our own round, we did it with venture debt. So what’s venture debt? And look it up. And once again, you know, we’re not the financial experts, you need to talk to you to get through that. But basically, so what Matt was talking about as often known as RBF, which is revenue based financing, or funding, depending on how you want to use the app. But that is non dilutive capital, meaning you can bring capital in, but it doesn’t, it’s not equity isn’t involved. So in those cases, they take a percentage of your revenue until that money is paid back. And the faster they get their money back. The last the total repayment is, in our case, at Full Scale, we actually created some we not investors, but lenders of sorts, because we didn’t want to sell equity. But we did want to raise some capital. And because our business was so young, we had a hard time getting a loan. And you know, they’re talking about two people that have been successful. So don’t get frustrated, and I’m throwing us under the bus like Matt and I weren’t able, well, we could have gotten traditional lending, but the things that they wanted, like, yeah, we beat that million dollars, but we’re gonna do want $10 million of liquidity signed over, I literally told a guy at a bank, if I, if I had $10 million liquid today, I wouldn’t be on the fucking phone asking for a loan to help grow our business. Like it was just absurd. And you know, and some of that, as you mentioned, like, Well, why don’t you write the check? Why don’t you do this? Well, we did some of that. But at the same time, you know, like a business and your business is set up to be a different entity for a reason it doesn’t not everything that you have to do is tied up and wrapped in and around that. So at some point, all businesses that grow and become mature, they get they used, the investor roster usually grows, but a whole lot of different things do but you know, one thing I do know is you’re not going to walk into a bank and be like, Look, this startups worth $4 million. They don’t give A shit bank, they don’t care at all,
Matt Watson 35:03
banks didn’t do anything really to help early stage startups because you don’t have any lend against.
Matt DeCoursey 35:09
And then in our case where we’ve invested in, in multiple cases, venture backed companies that do have a street value, they didn’t care that we that we owned points in those companies, because you can’t put them on Robin Hood and sell them by the end of the day. And you know, that had a lot to do with it. Now. Yeah, there’s, it’s not that it’s not that some banks don’t want to do that. They just can’t, there are certain types of securities. And so
Matt Watson 35:36
today, how you started this, right? Startup valuation is all based on what people are willing to invest at. It’s a market, right? There’s, there’s buyers and sellers, the the thing you also have to remember is when you’re going to other VCs, they might be like, Hey, I get 100 things across my desk every month, and I could invest at a five times multiple and all these opportunities, your guys’s opportunity is worse than these other 99 that I’ve looked at, why would I give you the same valuation? Right? And at the end of the day, you’re competing, you’re competing for dollars from investors, if investors can invest in some other thing and make more money, why would they invest in you? Right? And so that’s why the valuations and multiples and all that come in, and at the end of the day, the investors want the best investment they can get at the lowest price. And so you’ve got to be the best to reach the top of the stack. And it’s always a competition for capital.
Matt DeCoursey 36:33
And then some well, and but on the flip side, sometimes it’s a competition the other way around. Sure. And and some companies that well, some companies get really hot, and they will either oversubscribed around or they just choose who the money that comes in who the money comes from. And, you know, it was really interesting, because I did an episode with a guy named Brian Shikata, who has been involved in he’s made about 100 different investments in startups. And he was talking about how he remember, he’s out out in California. And he was like, I remember when there were 50 Different venture firms. And now there’s 5500. And so there is some competition on the other side. Now, one thing I do know is you don’t you can never have an auction with one better. Yep. So you know, really, in the end, when it comes to valuations, when it comes to raising money, and I just said this a zillion times, like I read a couple months ago, I talked to someone who said, Well, I’ve had I wasn’t I didn’t raise capital successfully. I said, How many people did you talk to who’s like 10? And I was like, Dude, you’re like 90 Short of the average? I mean, most people that I’ve talked to on the show, and you’ve been on on some of those, and some have not, you know, how many investors did you have to patch before you got money? Usually, it’s like, anywhere between 60 and infinity, that it’s rarely, it’s rarely 10 or less.
Matt Watson 37:55
That’s like saying, I use Tinder, I only swipe left on 10 people and I was expecting to find a date. You’re gonna have to go through a lot more than that, to find one
Matt DeCoursey 38:05
that and it may it may depend on who you are. Before that, because there are some people that might get it on one. And then there’s,
Matt Watson 38:13
yeah, so I’m up to 1000 Still no look.
Matt DeCoursey 38:17
But but that’s the thing is, is you gotta it’s a numbers game. And you need to get out there need to talk to people, you need to try to align your pitches, your effort and your energy around investors, and wherever entities that are used to making investments and the type of businesses that you that you as listeners are wanting to start and you know that for, you know, like, for example, at Full Scale, like tech services, there’s just like eight out of 10 investors that are in the tech space aren’t gonna write a check, right? It just doesn’t matter. They just don’t do it. It’s just not what they do. So barking up the wrong tree is sometimes difficult. Now, we’re coming up on probably the 600 after this episode of the show, and man, I’m not even on the shows where I’m talking to others. Without you, I’ve continued to ask how many deals do you look at to maybe write one check? And it’s still 100 Plus, and the math and then and then, and then the companies then they support it? They’ll say, you know, we’ve had 1500 companies apply? And we’ve written 150 Check so
Matt Watson 39:21
and if it’s 100 to one that way, that means 15 Excuse
Matt DeCoursey 39:25
me, 15 checks, but yeah, go ahead.
Matt Watson 39:27
Yeah, if it’s 100 to one ratio from the VC that means as a founder, I’ve got to talk to 100 people before I get a VC to invest, too. So keep dialing, people keep
Matt DeCoursey 39:37
calling. And you know, that’s the thing is like, honestly, and I wish that I had been tracking this all along because both from the founder side to the investor side, those numbers have held up like I mean, it’s it’s I don’t really see outliers in the cases where there is an outlier. It was it was founders that had already been already been successful. And they and they went back to the well you Usually with investors and people that they had made money with, and for the first time, which made it a lot easier, like I mean, Matt, here’s the thing is like, if you decided to start a third company, dude, that’d be a lot easier for you than the first one. And the second one is that I mean, would that be your basic expectation other than answering the question of why aren’t you writing this? Check yourself?
Matt Watson 40:21
I mean, it’s going to be easier for sure. But depending on the industry and stuff like that you’re going into there, it could still be very hard if you don’t know the industry, you know, if you’re, if you’re doing the same thing you did before, then yeah, it’s it’s like, you know, rinse and repeat. But if you’re going into something new, even though you’ve been a successful entrepreneur, it’s still a hard journey.
Matt DeCoursey 40:41
So I shouldn’t pitch you on the action figure startup that I’ve been working on.
Matt Watson 40:47
Actually, that sounds great. I have four little boys, I would probably buy all of them.
Matt DeCoursey 40:52
And then we would have revenue, and why would we want revenue valuation wouldn’t make any any, any event. So as we usually do, let’s, let’s end this episode with the best advice that we can give to founders. And then we did a little freeform conversation there. But I mean, overall, What’s the best advice when it comes to this subject?
Matt Watson 41:12
Well, so I think when you’re early stage, and you’re raising money, I don’t think you should get too hung up over your startup valuation, try and get something that’s fair, and raise some money and go kick ass and you get to, you know, a later round Series A, Series B, whatever, if you’re really kicking ass, then you, you know, control the game a little bit, and you can get a better valuation. But when you’re first first going, just take the money and and, you know, be successful and try and get it going. On the flip side, you know, another company I invested in recently almost sold their business, and they didn’t sell it because the valuation wasn’t good enough. And sometimes you get in that situation to where like, you really need to sell or, or whatever, and you’re desperate to get a reasonable valuation. So you can exit, which can be tough, too. And sometimes you just gotta keep hanging out there until you finally get to a place where you can exit and it makes sense. It’s really hard. And as I mentioned earlier, if you really need to raise capital, and you’re worried about valuation, all that stuff, that’s always a good option, too.
Matt DeCoursey 42:11
Yeah, and there’s, I mean, there’s every I’m gonna go with everything Matt said, and, you know, kind of parlay on and tack on to like, like, have realistic expectations. And, you know, how much money do you really need in the beginning, if you’re concerned that your valuations too low, but you need money, then just take a smaller amount of it and show some progress and move things along. One thing I do know is that the further you get down the timeline, and the more and one thing you’re gonna hear the frickin word traction get used to that one. So when you have traction and things are moving forward, now, that doesn’t always mean revenue, sometimes it’s a working product, and that represents traction, and that can edge the price up. In the end, though, focus on creating revenue, you know, and data is usually the biggest lever when it comes to pushing valuations, higher sales, cures sales, and can also mean that you don’t give a shit about your valuation unless you’re trying to sell so you know, do things that that build at least users signups and revenue, and you’ll find that the conversations related to your startup valuation are a lot easier. And then the final thing that I want to remind everyone of is, you know, if you’re using if you’re looking at your startup valuation, because you’re looking for an exit, or you’re looking for investment, you need to remember until that other person writes you a check and science papers and stuff. They’re, they’re not on your team, it’s their job to get the best deal possible for themselves, their firm their fund, or whatever. So you just need to keep that in mind. And, you know, like, it’s, I mean, just expect some of that, and you know, that that’s, I see, some people get a little, you know, maybe a little they don’t understand that. And there’s a zillion things that go can go wrong until the money’s in your account, you didn’t get funded. So remember that all the way through and just be ready for an excruciatingly painful process, or one that takes a while. If you want an inside look at that. Once again, go check out the episode of Startup Hustle TV, on our YouTube channel, and watch Matt Watson age. Watch him. Ah, yeah, a couple of comments about that. Actually, someone texted me over the weekend, Matt and said, Man, I really enjoyed that episode about Watson’s exit and made a comment that you could kind of see it now you look right now you look like you rested, but it’s all those shifts stressful man.
Matt Watson 44:52
It was really stressful. And I think that’s maybe one of the last parting thoughts here too. I forgot is we talked about valuation. Trying to get a deal done and raising capital. It’s an enormous amount of work right? To some degree. Just take the money because you’re just tired of chasing a better valuation or whatever, right? I mean, it’s exhausting. And it’s it’s crazy. My My thanks again for doing that episode on Startup Hustle TV. It was incredible. And the funniest thing to me was to watch my hair get longer and shorter.
Matt DeCoursey 45:23
Yeah, we did. We bounced around in the timeline. Yeah, on some of the I mean,
Matt Watson 45:29
I cut my hair like every three weeks. So it goes from super short to a little longer. And you could really tell like, it was kind of funny.
Matt DeCoursey 45:34
And you know, some of that, I mean, I thought, you know, it’s really funny about that and going back. And I’m glad we did it too. Because I was there’s a couple of times when Matt was a little stressed out, I’m like, dude, just record it, whatever. Just be honest. Because you’ll look back at it and see the process. But I mean, it was so it takes a lot longer. And we have talked about that so many I love the the history of Startup Hustle podcast, because we’ve talked about like, if you’re seeking funding, it often takes six to nine months to finalize it and close it and you are just under six months from day one till the till the exit because there’s a lot to be considered when companies and businesses and funds and yeah, they’re when they’re spending a ton of money. They’ve got to check a lot of boxes, and in some cases, they got to do that to get the money from somewhere else. And yeah, yep, it’s all cya and do that and do that amidst running their their current business waiting for you to reply and just keep an eye on all of it. So, you know, speaking of keeping an eye on on all of it. Join us again next week as we will be back for yet another installment of what we may rename as how to start and sell a tech company.
Matt Watson 46:47
There we go.
Matt DeCoursey 46:48
See you next week, Matt.