Optimizing for partner, optimizing for price.
Application infrastructure is making everything cheaper to build
Lately, application infrastructure has made it easier than ever to launch a prototype on the internet. Browser-based IDEs are in a race to develop tools that make programming fast, easy, and faster and easier. Guilds, to borrow Dave McClure’s term, of entrepreneurs are gathering in hubs like Techstars, YCombinator, and 500 Startups to draw support from their fellow classmates, share brand value, and supplement their own skills with the institutional wisdom of the crowd. As the obstacles to getting an application out the door have been overcome, one by one, the world of web and mobile products has trended towards the entrepreneur in a big way. Venture capital has noticed, and is adjusting accordingly, if belatedly, as I’ve noted in the past.
Entrepreneurs are banding together, driving valuation prices up
But I’ve noticed another trend has followed these. I’d like to call it the “collective bargaining agreement” of seed investing. At the last major entrepreneur-guild Demo Day, it was amazing to see how the prices had substantially risen from the one before it. But that wasn’t entirely surprising. After all, the early stage valuations for mobile and web apps, even given recent public tech stock volatility, has steadily risen over the last half decade. What surprised me, though, was how these entrepreneurs went about closing their deals. Almost the majority of them approached the negotiation with a price in their minds, and the conversation hinged around whether or not that was a price the investor could meet. These prices were non-negotiable more often than not.
When fundraising, an entrepreneur can optimize for price, or optimize for partners
Some entrepreneurs want to optimize for price above all. The difference between a $6M cap and a $12M cap (or a $20M cap) is psychologically and materially important to them. They believe they can get to revenue quickly. They continue optimizing for the highest possible valuation whenever possible. This is one extreme. Other entrepreneurs want to optimize for partners above all. They have a wish list of 5-6 investors or firms who they think are strategic, a cultural fit, or they just want brand association with, and are willing to meet those investors at the valuation where they are most comfortable. Investors want to get the most of a company for the least amount of money, so these entrepreneurs tend to get their valuations pushed down. This is the other extreme.
What we can learn
There is an optimal point in this curve for each entrepreneur out there, but the unionizing of the entrepreneurial side has pushed the conversation hard towards the former. This means that smaller funds, or those whose mission and mandate is to be more price sensitive, are increasingly disqualified from the collective bargaining agreement type of seed investing. Entrepreneurs in these guilds should be careful about this trend, as short-term price optimization is attractive, but not always the best path, when there are really good partners out there. Investors should be wise to this evolving reality, and should communicate their expectations clearly and aggressively, as technology hastens the pace of seed investment dealmaking.