There are some discussions going on about the valuation of web start-up funding rounds. Most people predict that it will go down. But should it really be the case?
A web start-up investment has a particular cash flow profile for investors: very negative today and 4-7 years down the road very positive (hopefully). With this particularity in mind, the current crisis should in theory lead at worst to a small decrease in web start-up valuation levels (for a comprehensive site on valuation go here):
- DCF tells us that there should be only a small decrease in valuation levels today: the cost of capital for the next few years cash flows is increasing but the remaining elements are not affected (e.g., LT cost of capital)
- Multiple approach, if correctly used, should marginally affect today's valuation levels. (however it is not - during a bubble investors overestimate valuation and during a downturn they underestimate it because they use the current market multiples)
- Option valuation implies that today's valuation levels should increase because volatility has gone through the roof (mind you while it is the best methodology in theory to value start-ups, it's nearly impossible to apply in practice)
But what about reality?
VC funding is a market in which each player (VCs and entrepreneurs) has a framing at any particular point in time. In the past few weeks, a majority of VCs have changed dramatically their framing. They are afraid of having difficulties to raise their next fund. This fear is even stronger for poor perfomers. This leads today to an effective decrease in supply of VC capital and of valuations expectations. Let's call this the "fear framing". I am not saying that it is an organized process by VCs ; it's rather an "unconscious" process for the vast majority of them.
While in theory "fair" valuation levels should not be dramatically affected for web start-ups, I am afraid that some entrepreneurs will get caught in this "fear framing" and accept "unjustified" valuations. Others (if they have enough cash to survive) will only accept "fair" valuations.
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