Yesterday at a luncheon, a fellow angel investor and I were discussing deal flow when the senior editor of a respectable news house introduced herself to us. As many journalists do, she brought up the “high” valuations that are accorded to
Yesterday at a luncheon, a fellow angel investor and I were discussing deal flow when the senior editor of a respectable news house introduced herself to us. As many journalists do, she brought up the “high” valuations that are accorded to Indian start-ups and inquired as to whether they are “sustainable”. My fellow angel investor immediately asked if the journalist had ever read the agreements that founders sign to qualify for lofty valuations? Just as he had correctly anticipated she hadn’t, and therein lies the reason that befuddles the most astute investors.
What most people do not realize is that any money raised by a start-up could be considered debt on the company. All investors need to do is, decipher the clauses that will protect their investment. In fact, if founders insist on obnoxious valuations, there will be clauses that will not only guarantee the preservation of capital but also promise a return on the investment! Be rest assured that there are stern punishments for the founder’s equity value if things go pear-shaped.
How stern a punishment can be, is best demonstrated by liquidation events, for example, take the cases of CaratLane in 2016 or Tapzo in 2018. In both exits, the proceeds are nearly equal to the amount of money invested, which definitely means that the investors invoked their capital and ROI protection clauses. This ensures that founders, ESOP holders and even the earliest investors will be left with nothing but a story to reminisce with friends in the years to come.
Therefore I strongly advocate reigning in valuations and giving founders the freedom to experiment and make their own mistakes, so they can develop robust businesses. The founder that finds solace in lofty valuations will find that the higher the valuation chair, the sharper the thorns that could cut the butt that sits on it.