A flat round (in 2022) does not mean you're a failure

This past month I’ve probably had some version of the following conversation a half dozen times:

Founder: I need to figure out whether to raise more now or to wait until next year when hopefully market conditions pick up. My existing investors have told me I can take more money from them at the last round price, but I don’t know whether or not to be insulted by that. We’ve grown the business a ton since last year, a flat valuation makes me feel like we’re getting zero credit for all that work. 

Me: Well, what do you think of these investors? Are they helpful, are they supportive, do you trust them?

Founder: For the most part, yeah. I like them a lot and feel supported by them. But I just feel like we’ve “earned” more than what they’re offering.

I believe that in the venture-backed tech field, our brains have been largely broken by the combination of an unrelenting 10-year bull run and an increasingly large available surface area for status signaling. Put another way: Everyone you know has been raising dramatic up-rounds for years, and everybody else knows about it on Twitter.

Check the below graph. I post this all the time here, and I apologize for being repetitive and boring. But the reason I’m obsessed with this graph to remind all of us (including myself) that the current market condition is profoundly different than most prior periods that we can recall in recent memory. Multiples are not just lower than 2020-2021, they’re lower than they’ve been at any point in time since at least 2016, which is earlier than many of today’s Series Seed, A, B, and even C stage companies were founded.

You might be asking yourself what (if anything) public market valuations have to do with early stage startup pricing. There’s many answers to that question, but the one that I find most illustrative is: Even though most venture funds can’t also invest into public equities, some can, which means they are to a degree substitute goods for one another.

As of today, you can buy SentinelOne (NYSE: S) for $13-14 a share, which is around 6x current run rate ARR (around 4.5x next year’s projected GAAP revenues) for a business that’s growing at around 120% YoY at scale. Yes they are burning a lot of cash, but so is your private startup (probably). And yes, before you ask, their unit economics are awesome, their NRR % is too, and the TAM is huge (This is not investment advice.)

Shares of SentinelOne are down 75% from the start of the year. That’s not the multiple — that’s the valuation. The multiple is down to about 1/6th its prior level (from over 30x) because the company has grown significantly since then.

I might not be a professional public markets investor, but when looking at a potential private SaaS investment right now, I have to remind myself that buying SentinelOne shares at 6x ARR is a theoretical alternative use of that capital. And I could execute that order within about 3 minutes if I liked, versus two months of diligence and document preparation to do a private company deal. Do we like XYZ Corp’s Series A shares better than SentinelOne at 6x? Because that’s the benchmark, in enterprise SaaS at least.

Recently I became aware of a secondary sale of preferred shares in a very, very, very good private company that had previously raised financing in mid-2021. In the time since it last raised, revenues are now about 3x as high, the company is growing faster on an annualized percentage basis than it was last year, and key KPIs like NRR and burn ratio have improved. In a static market with no change in market conditions, this business would be worth today somewhere between 3x and 5x as much as when it raised last year.

In the cold reality of 2022, the deal was done at a flat valuation. No improvement in equity value despite very significant improvement in business metrics. Note that this was much more robust valuation persistence than a public markets growth tech company would have exhibited — if this company traded like SentinelOne or Twilio, there’d be no market to buy shares at the flat round valuation.

So what does this mean for private company founders? 

1. If you were to go out to raise right now, the climate you will encounter may (depending on when you founded your company) be different than anything you’ve ever experienced in your fundraising career. If you founded your company after 2019, you’ve absolutely never seen anything remotely like this before. Whatever your valuation expectations were a year ago, throw them out the window. And I don’t mean throw them out the window as in “if you were hoping to be worth $100m, get ready to accept $80m”, I mean “if you were hoping for $100m, you might only have bidders at $40m, if you have any at all”. Think hard about whether you even want to be out fundraising in a macro like that.

2. One thing you may have heard from your existing investors is that they’ll give you more capital now at a flat round price. You might be wondering why they would do something like that if valuations are as I’ve described above. One big reason is that they’re afraid that if you go out now to raise externally, you might not raise any money at all, or only at a massive down round price. Your investors can avoid that highly dilutive and embarrassing event by dripping capital in at a price that allows them to mark the investment flat, and buy more time for the markets to improve. That allows them to avoid marking their investments down to their LPs, which would make them look like crappy investors. Actually, the LPs themselves may not want to see those declining valuations, because they have their own bosses who they don’t want to appear foolish in front of. If this sounds like a bit of a shell game, that’s because it is.

3. None of this is my way of telling you that your company is worthless, or that you suck as a founder. The point is merely to suggest that it’s not helpful to tie your ego or your sense of progress to whatever the valuation number ends up being. That’s just as silly as the public company CEO who spends all day reacting to the stock price. Markets come and markets go. If you raise a flat or down round, it doesn’t mean that you have failed — a flat round in the current conditions might actually indicate that you’ve succeeded wildly!

There’s a meme going around now that the reason rounds aren’t getting done is because although investors are prepared to deploy capital at reduced prices, founders “haven’t fully gotten the memo” and consequently deals are getting pushed while everyone recalibrates around price.

I originally resisted this interpretation because I’m allergic to any reasoning implying that investors are wiser or more knowledgeable than operators. 

But now I think there really is some truth to this. We’re all undergoing The Great Recalibration; we don’t quite know what sort of environment we’re in or how long it will last, but we at least know that our old methods for measuring success (“number go up” means I’m a good CEO) no longer apply. The only way forward — for founders and investors — is to disentangle your ego from whatever feedback the market gives you, and do whatever is necessary to move ahead and thrive.

“You're never as good as everyone tells you when you win, and you're never as bad as they say when you lose.” - Lou Holtz