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© 2015, South Central Ventures

Looks like we are back to the year of the ‘bubble’

This article was published in Forbes.hr

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Are we again in the ‘bubble’ years?

I would like to share with you few words about one segment from venture capital (VC) world – valuations. In this case about valuation of young companies in which VC’s are looking to invest. Few weeks ago I read very interesting article “The only thing that grows faster than technology are our expectations of it”. Indeed, both young companies and investors tend to valuate projects in exponential manner. It looks like ”name of the game” is burning investment cash to gain more «likes» in social media, more clicks on web, some growth of revenues and hoping future exit/sell on magnitude higher values to next investor or buyer. Seems that both have same goal. Well, they have, but as long as “keep on rolling” functions. If the time goes bad, questions like P&L, liquidity, solvency etc are becoming more and more important.

I believe we are again in bubble years for valuations of young tech companies. After all, it has been already 7 years since last big crisis. Now could be time for correction again. Little bit of China, ISIS, oil, Syrian refugees and it would not be too difficult to see scenario like in 2008. Probably, almost sure, will not be in such a large scale but some fluctuations are possible….

Generally, lot of industries are on crossroads. Seems telco sector is in saturation. Looking for new business model to bring back high margins (if they will manage at all). Insurance companies and banks didn’t have really disruptive changes for years. Will telcos start to sell financing instruments? Some already did, but also utilities and many other services. Mobile tech companies like Apple and Samsung has interesting know-how and valuable client relationships, also entered into payments and non-cash fields. Car industry is switching technologies from gas to electrical. They already entered into banking and insurance segment, offer financing and insurance packages. Pharma business has interesting moments. Having all this in mind, seems that many are looking for strategies where to grow in vibrant environments. Big players, but not only big, represent ideal target market or “end users” for young start-up companies.

Valuing Startups

Now we come to our topic of young startup’s and their valuation. In line with previously mentioned, big players perceive that good strategy is acquisition of start-ups that grew for few months or years. Of course, they would not come in very early stage. They are willing to pay more but if somebody else already risked, investing some serious money before. This often means that a VC has backed the start-up target company.

Usually such startup’s with incredible valuations are showing growth on the «wings of investments”. Very often investments were used to make revenues through good marketing&branding (actually “buying revenues”) and not because of good product or service. Nevertheless while they grow and burn investments, they are looking forward to find bigger player and not to be profitable business. Hopefully, that bigger player believe acquisition is good strategy. And this is how it works. Till the bubble explode.

Sharing Some of Our Own Experiences

After this long introduction I would like to share some of our recent experiences. Every day we are looking into nice young teams with some knowledge in technology and excellent presentation skills. Most of them came with beautiful pitches. Some of them are very interesting, with good ideas. Unfortunately, very often, nothing too much more.

Now days it is old fashioned to ask for business plans. You could be lucky if they have business model canvas. Finances are in excel with at least 5X revenue growth per anum. In line with few sentences mentioned before, P&L is never positive, just catching positive cash flow to next round of investment. And valuations? Incredible. 10x sales (but sales few years in future) is common understanding. Where it disappeared good old due diligence and accounting methods? If I even slightly mentioned NPV, IRR or DCF, very soon I receive comment that this is not used any more. Even trying to come to valuation through market shares and market sizes can’t react wanted target numbers.

So What is the Basis for the Valuation?

Then is moment for raising question “what is the basis for this valuation?” Answers are almost always the same – company XY is just sold for 20X more (from a reliable source, even this is business secret) or this is just 10X sales (from «conservative» excel projection) or just this is “normal”. Finally, you should feel lucky to invest into such company at such a low valuation.
Sorry, I am not buying it. Unfortunately, I am old-hat and like to see short business plan that sounds objective. I don’t mind format, just any readable. It is important to see flow of mind and way of thinking. Hopefully founders with both legs on the ground but looking high in to the sky. Personality, character and behavior of founders combined with realistic business forecasts could mean there is potential deal.

Fortunately, there are teams of serious persons with excellent thinking and strategies. Even then, there is discrepancy in definition of «conservative» projections and realistic market forecast. Sometimes we manage to find win-win position. And just then the real game begins….