Sharks, sorcery and speculation: what lies beneath most startup valuations

In 1954 one of Hollywood’s greatest artistic geniuses, Walt Disney, had a fantasy. Disney dreamed of building a giant amusement park unlike anything that existed in America. His chosen site was on 160 acres of farmland in Anaheim, an area southwest of Los Angeles settled by German immigrants.

The problem was how to find financing for his project. His brother Roy Disney didn’t support the idea and the banks scoffed at Disney’s projection of a million visitors a year going through the turnstiles of the Magic Kingdom. William Paley and David Sarnoff both turned him down because they imagined a park that looked something like the tawdry sideshows and daredevil rides at Coney Island.

Walt Disney turned in desperation to Leonard Goldenson (Founder of TV network ABC), who agreed to buy 35% of Disneyland for US$500 000 and guaranteed the bank loans for several million more. In addition ABC got what they really wanted and desperately needed; the first crack at Disney movies and the rights to a weekly Disney Show that aired on Sunday evenings, as well as to ‘The Mickey Mouse Club’, which ran five afternoons a week. Disney was wrong. He far underestimated the annual attendance at Disneyland. The first year he opened the gates to the Magic Kingdom, six million visitors showed up.

Fifty-eight years later, cumulatively Disneyland has had 650-million visitors, with 16.6-million visiting every year. Walt Disney Parks and Resorts generate US$12.9-billion in revenue annually, twice more than the better known movie studios. The Walt Disney Company is the most valuable media company in the world at US$115-billion market cap.

The banks and his brother were all wrong. Walt Disney was right. But he had to give up 35% of Disneyland to prove them wrong. In the end there were no fancy financial tools to explain Walt Disney’s Disneyland deal. Desperation put sword to that. He wanted to build his Magic Kingdom, there was only one person at the table willing to give him the money, so he took the deal. Later stage or growth businesses are easy to value. PE firms are usually awesome at spreading sheet analysis and all that jazz. Early stage ventures, especially internet? Not so much. They are typically speculation at best.

When Andy Bechtolsheim gave the then green Google founders their first US$100 000 he probably expected to lose it. Ninety-nine percent of startups fail. But instead he is sitting on ~$2Bn in Google stock.

Apparently Nigeria has sharks

I have heard a lot about valuations in the Nigerian and African internet space from within the blogging community and for the most part they are always based on speculation and conjecture. Never has anyone actually asked me directly about valuations at seed level in Nigeria and Africa. There are very few deals that, via back channels, I don’t happen upon. Privilege of the position I guess. A few weeks back I posted an honest tome about my experience with attempting to angel invest in Tiketmobile. One thing I didn’t do, but probably should have, was actually post the valuation I set on Tiketmobile at the time.

The general feeling from the ripple effect across the web was my terms must’ve been soooo onerous or ‘sharkish’ that they were probably right to turn it down. In fact we must all thank God they were saved from slavery and eternal servitude at the heels of that ‘ignorant, arrogant Igbo boy’ (me). US$20 000 for 20% of a two-person startup which had been in operation for almost a year and had exactly US$0 in revenue. That’s a US$100 000 valuation post money. No liquidation preferences, all common stock, I don’t even think at the time I insisted on a board seat. No other controlling mechanisms put in place to exploit these bright young things. Considering it’s my US$20 000 in the transaction, how I was going to swindle them I do not know. Perhaps I am just such an awesome shark, I would’ve come up with something. Wait. Perhaps I’m a wizard* [glances side to side nervously].

shark
/SHärk/
Noun
A long-bodied chiefly marine fish (subclass Elasmobranchii) with a cartilaginous skeleton, a prominent dorsal fin, and toothlike scales….
A person who unscrupulously exploits or swindles others.
Synonyms
swindler — sharper

Mis-understanding, or the evils of socialism

Something I don’t really understand is how, if someone offers to risk (invest is a euphemism, it’s always risk), their own cash at terms which ‘they’ think are largely reasonable and the other party turns it down, how is this then labelled as exploiting and swindling others? When Tiketmobile, TaxiPark and others turned me down, I accepted it. There was no force or hard feelings. They reviewed their options and took a different route. On all occasions I told them I respected their decisions. I myself probably wouldn’t have had the courage at that stage to walk away from investors.

Also I think terminology is being used incorrectly and should be clarified a little more. In my world.

• Seed = US$1-50k.
• Angel = US$50k-US$1Mn.
• Series A = US$1Mn+

But onto valuations. Nigeria as a society is very very secretive. For the internet space, I think this is prohibitive. It could be security or it could be culture but most prefer to operate outside of the limelight. That lack of transparency forces us back to the dark ages, where sorcery and speculation reign supreme. In the valley it’s easy to gauge the seed, angel, series A, series B round ranges because companies report them. Investors blog about them.

The open sourcing of venture capital is possibly one of the most important mega trends to happen in the valley of the last 20 years. Jim Clark of Silicon Graphics, Netscape and WebMD fame changed the VC game on this one. For him, we are forever grateful because Venture capital is becoming more and more founder-friendly. In that respect, I am not too Nigerian. I am always happy to over-share if I think it gets the debate going. If I get heckled in the process then so be it. But one thing is my veracity can never be challenged. Because I am always happy to talk numbers. Show me your deal I will show you mine…

Y Combinator terms imply valuations of:

We decide who to fund after each day of interviews. Yes decisions will include the amount we’ll invest and the percent of the company we’d want for it. We usually invest $11,000 + $3000n, where n is the number of participating founders, up to three (i.e. two founders get US$17 000, three or more get US$20 000), in return for between 2% and 10% of the company. The average is 7%.

So the average Y Combinator seed deal is usually US$20 000 for seven percent.

So in the USA the incubators’ seed funding rounds range from US$250-300 000 post money. Y Combinator has done 511 of these deals and has a portfolio value of US$11.5-billion. Not bad, not bad at all. But that’s in the valley where exits and follow-on rounds of financing are abound. In fact in the last five years, approximately US$1-billion has gone into angel rounds in the valley and more money than ever is pouring into the hot internet deals.

Seed deals in Africa…

….Are a little different. Tiketmobile was offered US$20 000 for 20% and a whole package of other incubator-like goodies. A US$100 000 first round valuation in Africa is actually quite common. I am privy to deal terms of other very well-known and respected incubators. In fact 88mph, the widely respected Nairobi-based incubator, set out its terms clearly.

As it noted in a previous Ventureburn article:

Typically we will invest about 20-30k in a startup. It depends on the quality of the team.

We’ve raised it up to 100k because we want to get a more serious quality of entrepreneurs, and not only green out-of-college entrepreneurs, so to attract those we had to make the carrot bigger.

We’ve set some guidelines before, like in the past we’ve said we’ll give US$6 000 to US$10 000 per founder and take between 8%-15%. But the guidelines never hold because you get such a wide array of entrepreneurs in terms of quality and which stage they are in, so we can’t just set straight terms yet — 88mph’s Nairobi director Nikolai Barnwell

As a rule of thumb, I think in Africa it is reasonable to see US$10 000 — US$30 000 for a seed stage (angel) round in an untested two to three person team with valuations ranging from $80-150,000 post money. That’s what it is like today. Do I expect that to change with time? Definitely. As the space begins to gain traction, the valuations will increase. Money will flood in. All boats will rise. Until then, the valuations are set by the market. Supply and demand.

In Nigeria you could get more, you could get less. I know of a seasoned Nigerian internet entrepreneur who skipped seed and angel funding and raised US$3-million series A right out the gate. I also know of a newbie internet founder who gave away 35% of his business for N1-million (US$6.3k). The market decides. Not I or the other ‘sharks’ at Spark whose investors prefer not to buy land in Banana Island but RISK our own capital to try and build companies, trying to build an ecosystem. But hey — capitalism has never been popular.

And just for public record. At Spark, our initial seed stage deals are priced anywhere between US$30 000 and US$50 000 money in at US$80 000 to US$200 000 valuations. Where our angel deals are priced at US$300 000 US$1.5-million, we have committed US$1.4-million to our companies in five months. No speculation. No conjecture. Facts. Anyone know any different? I am happy to have that conversation. Show me your deal I’ll show you mine.

But finally. On a serious note. There are no real financial tools to price seed stage internet startups. Anyone who tells you there are is mis-informing you. Looking around you and seeing what other deals are being done is usually the best bellwether. But at the end of the day, the supply and demand of the market dictates the final terms.

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This article originally appeared on Jason.com.ng and is republished with permission.