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Local venture capitalist blames Silicon Valley for over valuation of SA startups

Over valuations are becoming increasingly prevalent among early-stage entrepreneurs in South Africa and Silicon Valley is to blame.

So, says venture capitalist Clive Butkow of Kalon Venture Partners, who — when asked last week by Ventureburn on what drives over valuations of local startups — blamed the unrealistic perceptions on local startup founders who spend too much time in Silicon Valley where venture capitalists are quick to throw out large valuations without writing out a cheque.

“Often we do find the entrepreneurs coming back to reality and revising down their ask,” he said, adding that over valuations are also driven by founders who raise smaller amounts from angel investors that “totally” over value the business.

In many cases it forces the VC to invest in what he calls a “down round”. This is when a company raises a round of capital at a lower valuation then the previous round.

“Our advice to these entrepreneurs is to raise their seed or Series-A rounds overseas rather than in SA,” said Butkow.

Local venture capitalist blames the unrealistic perceptions on local founders who spend too much time in Silicon Valley where VCs are quick to throw out large valuations

Butkow’s comments follow those made in October last year in which two leading SA venture capitalists charged that inaccurate valuations from SA angel investors are skewing the value of companies venture capital (VC) funds are keen to invest in.

Read more: SA venture capitalists slam inaccurate valuations by local angel investors

Butkow said there are essentially two types of valuation which venture capitalists encounter — a founder valuation and a market valuation.

In the first — a founder-valuation, the valuation is based on how much a founder believes their business is worth.

The second, a market valuation, is essentially how much a founder’s business is worth to investors when taking into consideration investment risks. “In other words, a startup is worth what someone is willing to pay for it,” said Butkow.

Butkow said he and his team use forecasts from the startup to calculate future cash flows (free cash flow), net present value, internal rate or return with a variable weighted average cost of capital (WACC) which is driven by the level of risk the deal entails.

“Before we use their (startup’s) forecasts we do a stress test in their numbers to assess feasibility based on our experience and the vertical of tech they are operating in,” he said.

A Software as a Service (SaaS) business for example would have a different valuation methodology to a software B2B business, he added.

But while Butkow admits that a valuation is more art and experience then a science, he said entrepreneurs often “drink their own cool-aid”, as few have the experience to know how long it will take to get traction in the market.

As such many entrepreneurs tend to overestimate the revenue their startup is expected to generate, while under estimating the costs that it will incur in doing so. Said Butkow: “Our rule of thumb is to halve the revenue and double the expenses and time to break even.”

Like this, many startups may need to rethink the value of their startup.

  • SA Entrepreneur

    I think someone needs to unpack how local entrepreneurs are treated by local VC’s vs global VC’s. To much has been locked into NDA’s, big lawyer agreements which has restricted the reality coming out. This has been covered to a degree in the past but continues #collusion #exploitation #zavcleaks

  • Heard It All Before

    This borders dangerously on arrogance, possibly also over-the-top caution, and sends the completely wrong message to local entrepreneurs who actually know better but still need significant funding – Either way it explains why South African venture capital lags so far behind their US and European compatriots. There is so much opportunity in this country, and this is what VC’s are waxing lyrical about? Come on.

    Growth in most prominent digital sectors is set to hit double digits in the coming 5-10 years (in compounded annual growth). Perhaps certain local startups are aiming for more than just SA to steal a march on that opportunity? If their valuations are somewhat reflective of their capital requirements, how can you blame entrepreneurs when the their hands are so incredibly bound as their ability to operate in bigger ponds is mooted by our constantly fluctuating & devaluing currency. This is why venture capital exists! It would take a minimum of at least $1m just to make any significant headway into the US market, and that doesn’t guarantee a profitable CLV. If local VC’s want less to moan about, stop putting up airy-fairy #struggleporn LinkedIn updates, doing the odd way-too-high-level talk here and there (that most entrepreneurs don’t know what to do with), and writing opinion posts like these – this type of content is all about the author and not about actually providing value to the local entrepreneurs that desperately need it. Why not actually educate the entrepreneurs properly, about the right way to do things, rather than moan about valuations? (I’m willing to bet the amount of valuation feedback is also slim to none. Let alone is that there probably isn’t even a single free resource on their website that could help startups? No). Content like this should be based on providing value, not just adding to the noise out there in an inclusive manner that serves the VC before their market.

    Local VC’s need to start getting on board with the context of the worldwide playing field they’re now a part of thanks to cloud infrastructure (whether they like it or not), or forever watch game-changing South African startups make American investors bags of money in the coming years because they were the ones willing to back brilliant founders. And believe you me, South Africa definitely has those. Sure, that’s going to take capital and risks, but why else are you doing what you do? Do you just want to back another mundane strictly-local business that’s the “Uber of something”, or do you want to cast your net a smidge wider on a shoot-the-lights-out international rocket ship that makes your fund?

    With respect, big visions require big balls, not a big mouth.

  • 0xbeef

    South African needs to learn to fly west a few has done already local VC’s are just sick individuals with zero respect, just a bunch of loan sharks ready for a bite.