Praying to the God of Valuation

Sep 26, 2023

Something happened in the past 7 years in the startup and venture capital world that I hadn’t experienced since the late 90’s — we all began praying to the God of Valuation. It wasn’t always like this and frankly it took a lot of joy out of the industry for me personally.

What happened? How might our next phase of the journey seem brighter, even with more uncertain days for startups and capital markets?

A LOOK BACK

I started my career as a programmer. In those days we did it for the joy of problem-solving and seeing something we created in our brains be realized in the real world (or at least the real, digital world). I have often thought that creative endeavors where one has a quick turn-around between idea and realization of one’s work as one of the more fulfilling experiences in life.

There was no money train. It was 1991. There were startups and a software industry but barely. We still loved every moment.

The browser and thus the WWW and the first Internet businesses were born circa 1994–95 and there was a golden period where anything seemed possible. People were building. We wanted new things to exist and to solve new problems and to see our creations come to life.

And then in the late 90’s money crept in, swept in to town by public markets, instant wealth and an absurd sky-rocketing of valuations based on no reasonable metrics. People proclaimed that there was a “new economy” and “the old rules didn’t apply” and if you questioned it you “just didn’t get it.”

I started my first company in 1999 and was admittedly swept up in all of this: Magazine covers, fancy conferences, artificial valuations and easy money. Sure, we built SaaS products before the term even existed but at 31 it was hard to delineate reality from what all of the monied people around us were telling us what we were worth. Until we weren’t.

2001–2007: THE BUILDING YEARS

The dot com bubble had burst. Nobody cared about our valuations any more. We had nascent revenues, ridiculous cost structures and unrealistic valuations. So we all stopped focusing on this and just started building. I loved those salad days when nobody cared and everything was hard and nobody had any money.

I remember once seeing Marc Andreessen sitting in a booth at The Creamery in Palo Alto and nobody seemed to take any notice. If they didn’t care about him they certainly didn’t care about me or Jason Lemkin or Jason Calacanis or any of us. I would see Marc Benioff in the line for Starbucks at One Market in San Francisco and probably few could pick him out of a line up then. Steve Jobs still walked from his house on Waverly to the Apple Store on University Ave.

In those years I learned to properly build product, price products, sell products and serve customers. I learned to avoid unnecessary conferences, avoid non-essential costs and strive for at least a neutral EBITDA if for no other reason than nobody was interested in giving us any more money.

Between 2006–2008 I sold both companies that I had started and became a VC. I didn’t make enough to buy a tiny island but I made enough to change my life and do some things that I loved out of a love for the game vs. the necessity of playing.

SEEING THINGS FROM THE VC SIDE OF THE TABLE

While I was a VC in 2007 & 2008 those were dead years because the market again evaporated due the the Global Financial Crisis (GFC). Almost no financings, many VCs and tech startups cratered for the second time in less than a decade following the dot com bursting. In retrospect it was a blessing for anybody becoming a VC back then because there were no expectations, no pressure, no FOMO and you could figure out where you wanted to make your mark in the world.

Starting in 2009 I began writing checks consistently, year-in and year-out. I was in it for the love of working with entrepreneurs on business problems and marveling at technology they had built. I had realized that I didn’t have it within me to be as good of a player as many of them did but I had the skills to help as mentor, coach, friend, sparing partner and patient capital provider. Within 5 years I was on the board of real businesses with meaningful revenue, strong balance sheets, no debt and on the path to a few interesting exits.

During this era, from 2009–2015, most founders I knew were in it for building great & sustainable companies. They wanted to build new products, solve problems that were unfilled by the last generation of software companies and grow revenue year-over-year while holding costs in check. Raising capital remained difficult but possible and valuations were tied to underlying performance metrics and everybody accepted the the ultimate exit — whether through M&A or IPO — would also be based on some level of rational pricing.

WHEN OUR INDUSTRY CHANGED — THE ERA OF THE UNICORN

Aileen Lee of Cowboy Ventures first coined the term Unicorn in 2013, ironically to signal that very few companies ever achieved a $1 billion valuation. By 2015 it had come to signify by the market a new era where business fundamentals had changed, companies could easily and quickly be worth $10 billion or MORE so why worry about the “entry price!”

I wrote a post in 2015 that memorialized at the time how I felt about all of this, titled, “Why I Fucking Hate Unicorns and the Culture They Breed.” I admit that my writing style back then was a bit more carefree, provocative and opinionated. The last seven years has softened me and I yearn for more inner peace, less angst, less outrage. But if I were to rewrite that piece again I would only change the tone and not the message. In the past 7 years we built cultures of quick money, instant wealth and valuations for valuations sake.

This era was dominated by a ZIRP (zero interest rate policy) of the federal reserve and easy money in search of high yields and encouraging growth at all costs. You had the entry into our ecosystem of hedge funds, cross-over funds, sovereign wealth funds, mutual funds, family offices and all other sources of capital that drove up valuations.

And it changed the culture. We all began to pray to the altar of the almighty valuation. It was nobody’s fault. It’s just a market. I find it funny when people try to blame VCs or LPs or CEOs as though anybody could choose to control a market. Ask Xi or Putin how that’s going for them.

Valuations were a measure of success. They were a way to gather cheap capital. It was a way to make it hard for your competition to compete. It was a way to attract the best talent, buy the best startups, capture headlines and keep growing your … valuation.

In stead of growing revenue and holding down costs and building great company cultures the market chased valuation validation. In a market doing this it becomes very hard to do otherwise.

And the valuation party lasted until November 9th, 2021. We had lamp shades on our heads, tequila in our glasses, loud music and perhaps too much sand, and burning men, and art exhibits and tres commas. The hang over was bound to be searing and last longer and drive some people to stop playing the game altogether.

We’re still trying to find our sober equilibrium. We are not there yet but I seem signs of sobriety and a new generation of startups who never had access to the Kool Aid.

THE VC VALUATION GOD

Valuation obsession wasn’t restricted to startups. In a world when LPs benchmark VC performance on a 3-year time horizon from deploying one’s fund (is your 2019 fund in the top quartile!!??) you are bound to pray to the valuation Gods. Up and to the right or perish. I see your $500 million fund and I raise you with a $1.5 billion fund. Top that! Oh, $10 billion? Whoa. Hey, we got to raise again next year. Let’s deploy faster!

We were told that Tiger was going to eat the VC industry because they deployed capital every year and didn’t take board seats. How’s that advice holding up?

So now our collective companies are worth less. If we took them public we are naked now. The tide has gone out. If they are private we still have fig leaves that cover us because some rounds might raise debt vs. equity or might fund with terms like multiple liquidation preferences or full-ratchets or convertible notes with caps. But this is still all about valuations and none of it is any fun anymore.

A REVERSION TO THE MEAN

I don’t have a crystal ball for 2023–2027 but I have some guesses as to where the new sober markets may go and just like in our personal lives a little less alcohol may make us fundamentally happier, healthier, in it for the right reasons and able to wake up every morning and continue our journeys in peace and for the right reasons.

I am enjoying more discussions with startups about the ROI benefits for customers who use our products rather than the coolness of our products. I am enjoying more focus on how to build sustainable businesses that don’t rely on ever more capital and logarithmically increasing valuations. I find comfort in founders in love with their markets and products and visions — whatever the economic consequences. I am confident money will be made be people who frugally and doggedly follow their passions and build things of real substance.

There will always be outliers like Figma or Stripe or perhaps OpenAI or the like who create some fundamental and persistent and massive change in a market and who gather outsized returns and valuations and rightly so.

But the majority of the industry has always been made by amazing entrepreneurs who build out of the extreme spotlight of the industry and build 12-year “overnight successes” where they wake up and have $100m+ in revenue, positive EBITDA and a chance to control their own destiny.

I am having fun again. Truly it’s the first time I’ve felt this way in 5 years or so.

I told my colleagues at our annual holiday party this past week that 2022 has been my most fulfilling as a VC and I’ve been doing this for > 15 years and nearly 10 more as an entrepreneur. I feel this way because no matter how much founders are kicked in the shins by the financial markets or by customer markets I always find some who dust themselves off, cut their coats according to their cloth, and carry on determined to succeed.

Deep down I love working with founders and products, strategy, go-to-market, financial management, pricing and all aspects of building a startup. I suppose if I loved spreadsheets and valuations and benchmarking I would work in the even more lucrative world of late-stage private equity. It’s just not me.

So we’re back to building real businesses. And that personally brings me way more joy than the obsession with valuations. I feel confident if we focus on the former the latter will take care of itself.

Photo by Ismael Paramo on Unsplash


Praying to the God of Valuation was originally published in Both Sides of the Table on Medium, where people are continuing the conversation by highlighting and responding to this story.

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