🧵 on startup 'valuations'.

Why are loss-making startups run by 20-somethings 'valued' as unicorns while similar profit-making companies are valued at half that?

Thread below has the dope, but the longer read is 👇🏽
sajithpai.medium.com/exhaust-fumes-…

1/23
First, the title 'Exhaust Fumes'

Comes from a great quote by @fredwilson

“Early stage valuations aren’t really valuations. They are the exhaust fumes of a negotiation about two things — the amount raised and the amount of dilution.”

Let us understand this.

2/23
They say that chess is a game that can be learnt in an hour, but it takes a lifetime to master. Venture valuations are similar.

Here is the simple part of startup valuations. Take capital invested, and divide by stake diluted.

3/23
So how do VCs arrive at these two numbers - capital required & target stake?

4/23
These individual 'valuations' are staged across different rounds by different VCs.

Multi-party Staging is one of the great financial innovations of the 20th century, like microfinance.

5/23
Here is a staging chart for India.

6/
VCs dont use a financial technique like DCF or anything similar to 'value' a startup (or really price the shares). Instead, they jointly collaborate in 'long-term multiparty staging games' to take the startup from idea to IPO.

7/23
'Valuations' in the inbetween stages, especially early-on are not exactly 'valuations'; at least not in the sense of public market valuations. They are notional at best.

8/23
Journalists & academics have struggled to grasp much of this. Here is Prof Aswath Damodaran from his 2016 piece - aswathdamodaran.blogspot.com/2016/10/ventur…

9/23
My views on Prof Damodaran's piece.

10/23
Unlike in public markets where you dont know who you are selling to, and you dont care about what the CEOs / operators think of you as investor, we VCs do.

11/23
This explains why VCs indulge in actions like writing off the value of their investments and / or selling the shares back for a nominal price to the startup, If you were to go by Prof Damodaran’s logic you would not be able to explain the below.

12/23
The best VCs play infinite games with other VCs and founders.

Because, access to high quality founders is the single most important lever in the venture business.

13/23
Let us unpack this. Why does access to high quality founders matter?

2 learnings from history.

14/23
Via @benedictevans

6% of deals produce 60% of returns. There is a brutal power law that operates in every fund. A minority of our investments make all the money, and more.

15/23
Great VC funds have persistence. Because great founders want to work with great VCs, to increase chances of success. This reinforces the position of the top funds.

Sequoia, Benchmark are virtually impregnable.

Because founders hate PE investors, PE funds have no persistence.
This is why it was said A16Z overpaid for deals. To get into the top founder's good books.

17/23
Yup, let us now wind down.

It is important to DCF as a technique relevant only to low growth predictable revenue, high cost of capital contexts.

18/23
Here is @chamath

19/23
And hence a framework for understanding how DCF has its space, and the long-term multiparty staging plays that we use in venture has its space.

20/23
Phew.

I want to thank @mjmauboussin @refsrc @maikeya and Anand Vyas for their reviews of the draft. Their inputs were hugely helpful in shaping the piece.

21/23
For those of who you are venture nerds and want to learn more, I also have a sample portfolio construction sheet, to give you a sense of how VCs build out and think through a portfolio, enjoy.

22/23
docs.google.com/spreadsheets/d…
Here is the piece again.

If you have ever wanted a piece that explains startup valuations to share with your friends, families or colleagues, well, here it is now.

23/23. Fin.👋🏽

sajithpai.medium.com/exhaust-fumes-…

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More from @sajithpai

7 Apr
I got this whatsapp message yday👇🏽fm a founder grinding it out, 1 month of runway left. But absolutely unwilling to give up.
We saw 2 great stories recently fm the ecosystem - as Meesho, Cred became🦄. Congrats to them, & let us celebrate their achievements.

But let us also celebrate the founders grinding it out without much love. Life is hard for them. It is tough mentally & not easy to keep pushing.
It takes a special grit and determination to chug along, to motivate your team on dreams and vision alone without hikes, or even delayed salaries; holding on to them when other startups and Big Tech are throwing money at them.
Read 5 tweets
13 Mar
🧵

On my fave startup + tech podcasts:)

1/18
Barton Biggs, research guru turned hedge fund manager famously classified people into visiles & audiles (ref ‘Hedgehogging’).

Visiles absorb info via eyes (reading)
Audiles via ears (talking / listening)

(Youtube wasnt too popular then for it clearly breaks his split!)

2/18
Now I am a visile & I have struggled w podcasts:)

Podcasts are great content of course, & lots there you don't get easily in writing. But I have wondered as to why I should take out 40-50mins to listen to a podcast when in that time, I can instead breeze through 3-4 posts?

3
Read 18 tweets
2 Mar
Was interesting to read (yes, i got it transcribed) the @jeremysliew + @HarryStebbings chat on 20VC where they discuss the 2012 Lightspeed round into Snapchat that Jeremy led.

Link to transcript: notion.so/sajithpai/Podc…

Link to the investment memo: thetwentyminutevc.com/wp-content/upl…
What I found most interesting was this account of Jeremy Liew's persistence in trying to contact Evan Spiegel. VCs chasing founders who dont give them any bhav:)

Remember something like this for Sarah Cannon leading Index's recent round into Notion.
Liew's laws of consumer social investing!
- can this become part of pop culture?
- can this become a habit?
- is there a scalable, repeatable way to grow?
- does the founder have a unique insight that explains the success, that explains what's going on?
Read 6 tweets
28 Feb
Thinking aloud.🧵

Useful to see
- Bitcoin
- the sudden spurt in collectibles (StockX, GOAT, Artsy, RallyRd) including NFT + the entire financialisation of everything trend
- Gamestop + WSB
as decentralised coordinated accelerated creation of value.

Let us unpack this.
Value of anything incl currency, stocks has a broad subjective basis.

That said, to ensure that we dont start questioning the value of currency or what we are buying in every transaction, we base value in some centralised authority's diktat - state / central bank / market.
That means the gatekeeper / centralised authority (who also maintains the ledger) has a fair amount of power.

Historically transactions in stock market / art / currencies have all been intermediated or coordinated through a central authority (NSE / NYSE / Christies etc.)
Read 11 tweets
28 Feb
I thought this was an outstanding podcast - one every dev tools startup founder should listen to or read the transcript of. Brief 🧵 on what I found interesting.

Features @jeffiel of @twilio and @davidu + @smc90 of @a16z
a16z.com/2021/01/12/ris…
.@jeffiel: AWS + APIs have given us the supply chain for building software.
Rule 1: Build the software that faces your customer.
Rule2: The act of building software is but the act of listening to your customer.
Read 10 tweets
26 Feb
New post + 🧵

This one is on product-market fit or PMF, that most discussed yet misunderstood concept!

Hitting PMF is about getting to 2 different fits
- the 1st is product to problem fit;
- & the 2nd is getting the go-to-market (GTM) to market fit.

linkedin.com/pulse/how-foun…
1st fit: product / solution to problem fit - ensuring that you are able to create a product that solves some or most of the customer problem that spurred you to start up. This is the Minimum Viable Product or MVP as it is called.

(also ref to as the value hypothesis)
2nd fit: GTM to market fit, where you reach the ideal combo of customer segments, sales channels & customer acquisition approaches (collectively GTM) getting you to +ve contribution margin (i.e., revenue minus COGS minus direct mktg costs) for every new customer. This is PMF.
Read 8 tweets

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