Ted Rogers' Blog

Valuation Sanity

Posted: September 17th, 2011 | Author: | Filed under: Brazilian Venture Capital, Macro Environment | 10 Comments »


Three years ago, when I told people that I was doing venture capital in Brazil, they would usually ask “Why?”

Two years ago, when I said the same thing, they would say, “Interesting.”

Now, they say, “I am too."

The influx of venture capital to Brazil, while great for entrepreneurs and our venture ecosystem, seems to have brought with it inflated valuations.

Last week I had a call with an entrepreneur that said he wanted a R$30 million pre-money (pre-investment) valuation for his company. His 2010 revenue? R$1MM. That represents a 30X multiple on revenue – not EBITDA, not net income – revenue. 

Very high, I thought, but maybe the growth was so extraordinary that the valuation was justified. I asked, and was told that revenue would be $R20MM. Oh good, “In 2012?," I asked.   “2016”, was the answer.   

Wow.   To understand how ridiculous that is, consider that Google is currently valued at less than 19X trailing income.

It was a friendly call and I never get indignant about business but, in retrospect, that’s not cool. It’s not healthy to expect that valuation and it’s not smart to ask for it (the investor will think that you think they are a fool).

We want to work with driven entrepreneurs building world-changing companies. We will work hard to make those companies hugely successful and drive extraordinary financial returns for our entrepreneurs. 

But remember that venture investors like Arpex are also running a business, a business that will fail if we invest at unreasonable valuations. 

After the call, I sent an email to my partner saying, “Good company, crazy valuation.” And he shot back, “Too bad — the market is being destroyed before it exists.”

Let’s remember that investment transactions do not need to be zero-sum games, in which one side wins and one side loses.   At its best, venture capital is the ultimate win-win proposition for investor and entrepreneur — that can only happen at reasonable valuations.

  • Eric Willis

    Ted,

    You would know a lot better than I would obviously. However, I think a lot of this has to do with the inflated Seed or Series A valuations being given to some startups back in the U.S.

    Thus, founders here in Brazil are attempting to use those valuations as a guide without completely understanding the vastly different dynamics (the teams being funded and the plethora of exit opportunities… that just dont exist here in Brazil yet). 

    Obviously this influx of new capital definitely has been impactful (as you noted), but I also think there are just lots of inexperienced entrepreneurs here that dont understand how raising funds at a highly inflated value can be very dangerous. Rodrigo and I from WareHouse Investimentos were just having a discussion about this very thing a couple of weeks ago or so.

    I also was having a discussion with a Brazilian entreprenuer who could not understand why Dropbox raised a series A at 4 Billion when they could have very well raised at a higher value by taking offers from other firms. His thought (flawed) was that you always take the most money at the highest value.

    • http://www.vc-brazil.com/ vcbrazil

      Eric — I don’t have a response to what you just wrote because I agree 101%. 

      I could not have written a better comment on the situation than you just did.

      Best,

      Ted

  • http://twitter.com/ericnsantos Eric Santos

    Ted,

    Not much to add after your entry and Eric’s comment. Definitely some people down here are reading too much of Techcrunch. :P What I’d like to point out is that some of the so-called new angels in Brazil are also having a distorted view of the industry. Sadly, I’ve heard from many entrepreneurs that some people are trying to pull early stage deals asking for more than 50% of the shares (…), or sometimes they accept owning “only” 40%, but at pre-money valution of 400K or less. That’s not very healthy either… 

    Best,
    @ericnsantos:twitter  

    • http://www.vc-brazil.com/ vcbrazil

      That’s true. In reality, valuation is “situation-dependent” — there may be some situations in which, e.g., the investor 1) is essentially a co-founder, 2) is risking 100% of the capital and 3) will add tremendous value to the business. In that case, owning above 50% might be justified. On the other hand, there are situations where the opposite is true and, for the same amount of money, the investor should own less than 10%.
      Abs
      Ted

  • http://twitter.com/joseangel_yanez José Angel Yánez

    I’m cofounder of zunwave.com and comercialink.com, and as entrepeneur two things come to my mind: 1) “problem/solution fit”, 2) “market/product fit” I’m not a big fan of big of crazy valuations and big rounds, instead I’m a fan of crazy useful applications and big companies. People must stop reading techcrunch a lil bit and start building more business oriented apps and companies. Founding should be used to create big companies, not to make companies big by money itself.

    • http://www.vc-brazil.com/ vcbrazil

      Jose — your comment reminds me what venture capital used to be: it started as a small niche for funding certain types of good businesses that couldn’t find other financing. The business was paramount, the financing was secondary.
      Now the financings, and the funds, have become as high-profile as the business itself and the noise around big funding rounds and valuations etc. often distracts from the fundamental question: is there a good businesses being built?

  • http://www.pierreschurmann.com Pierre Schurmann

    Ted,

    It’s true that valuations are rising, but to me the hardest part is the fact that entrepreneurial
    readiness (or understanding) of the investment cycle is still very low. 

    The good news is that Ive have seen some cases where a deal were substantially adjusted (to a closer reality) after 
    the entrepreneur knocked in the available doors and got a reality check.

    My  hope is that, as in all markets, valuations will correct themselves. 

    Best
    Pierre

    • trogersxyz

      Hey Pierre — good point — and I believe that part of our job as investors is to help entrepreneurs better understand the investment cycle.

      If entrepreneurs fully understand the math behind early stage investing – and the context of the full investment cycle – investors and entrepreneurs will find agreement more easily on valuations.

      Abs

      Ted

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