In recent months, I’ve talked a lot about how expensive some startup rounds are becoming.
That doesn’t mean you should avoid every round that looks expensive at first glance. Sometimes startup investments seem expensive when they are actually more than fair.
AngelList co-founder Naval Ravikant explains this concept succinctly.
There’s also the Peter Thiel rule: When a company’s valuation climbs rapidly between rounds, that should attract you, rather than scare you off, because humans are bad at calculating nonlinearities. That’s true as long as a credible or top-tier investor leads the round.
When you see a company’s valuation go up 5x in nine months, you might automatically think it’s overpriced. But that’s because your brain can’t handle the fact that a company might actually grow 10x in nine months.
When a startup is growing at a pace of 10x a year, it’s naturally going to have a higher valuation. Sometimes you see companies that raised at $10 million a year ago and are now raising at a $150 million valuation. But that doesn’t necessarily mean it’s a deal you should automatically pass on.
However, interpreting this “Peter Thiel” rule gets tricky during bubbly times like we are experiencing now. It can be hard to tell the outrageously expensive deals from the reasonably priced ones right now.
In these situations, I like to look at the company’s revenue trend. Does it have a clear path to $100 million or more in sales? Is the model scalable? Also, who else is investing in the round? If it’s a bunch of brand new VC firms, that might be a signal to steer clear. If it’s an experienced group of investors and the valuation can be justified, then it may be worth investing in.
As I said, it’s a tricky balancing act. Ultimately, I go with my gut. For me, that means I won’t be investing in companies with $1 million revenue at a $150 million valuation. I can’t make that math work in my head. But if the company is growing rapidly with $1 million sales in the last year and showing 40%-to-50% monthly growth, that is certainly worth a premium. Ultimately, it’s up to each of us to decide if the deal is worthy of investment.