The perception gap

April 19, 2023

How do you explain the difference between VC valuations and other types of valuation?

 It’s surprisingly simple…

Angels and VCs are high risk/speculative investors and the best really know what they are doing.

They are making high numbers of bets on outsiders but because of their skills they can reduce the risk on the investment once they own a stake in the business.

That’s pretty smart, but it means that the price they pay to get a seat at the table is not based on the same factors that others might apply such as prudent investors as defined in tax law or trade buyers (often measuring on payback as much as strategic fit).

Let’s use a simple case study:

A bunch of entrepreneurial techies have a big idea, the right characteristics and importantly know how to talk to investors.

They explain the big idea which resonates with the investors.

The best teams get the investors into a competitive auction for the stake on offer.

The result:  a good sum of money is invested for a relatively low equity stake.

Voila!

The post-money valuation is based on the % of equity bought for £Xm.

Suddenly a true start up is on its way to being a unicorn.

All the shareholders on the cap table understand this and no-one is being misled, but there is a whole load of hope value in that post-money valuation.

In practice, the day after the deal the situation is this…

The bunch of entrepreneurial techies are in the company and working.

The big idea is closer to getting there ONLY because there is now some fuel in the engine, not because anything has been been achieved.

In practice the company is the same as it was but there’s now lots of cash in the bank too.

So whilst the VCs see and understand the post money valuation, for others (including the tax man) the situation is very different.

The reality for prudent investors and others is that the business really is still just a bunch of techies, a good idea and loads of money in the bank.

So the equity value has not, in fact, grown at all!

If your team would like to have a training session on how different audiences can legitimately value companies and shareholdings in very different ways, let us know and we can jump on teams to explain.

And if you have a client that needs to transact in shares e.g. the transfer of shares amongst founders or for employee incentives at the right price, when angels or VCs are buying in at extraordinary valuations, we can definitely help.