A conversation I had with a founder friend last week reminded me of a recent episode of the HBO show Silicon Valley. In the episode the main character, Richard Hendricks, who plays the role of CEO of a hot tech company decides to accept a financing offer despite the presence of a seemingly better deal that valued the company higher and provided it with more money.
The rationale for him was that while more money at a higher valuation was attractive in the short term, it posed more risk and could potentially have torpedoed the company by the sheer weight of unrealistic expectations.
An interesting concept, and one I think worth further discussing. After all, expectations represent the anchor that we (and others) use to define whether efforts are successful or not. Unrealistically high expectations reduce the probability of ever perceiving success while low expectations rarely translate to any “success” representing anything meaningful.
In the public markets, companies that beat analyst expectations often see their stock prices soar, while ones that fall short see their shares take a beating. In the world of sports, the more success a team or athlete enjoys, the more we expect of them, regardless of how unachievable or unreasonable the expectation.
In the world of startups where large funding announcements and “Unicorns” dominate headlines, the concept of expectations often gets overlooked.
Now going back to my friend. He had been working on finalizing a rather large seed round and was just about to sign off on a term sheet from a reputable seed venture capital firm. All great news, but at the last minute, he was sent another offer that provided nearly twice as much money at a valuation that was nearly 70% higher than the first. The new investor had a good reputation, and seemingly could bring good value to the company.
While he acknowledged that his visceral reaction was to accept the new offer, he hadn’t committed and asked me what I thought.
Similar to the public company example above, I explained that private market psychology is no different. When investors invest in private company rounds, they are buying a call option that presumes that the price of a share will increase in the future.
While there aren’t any private market analysts pegging specific valuation or sales targets for companies, there are very real intrinsic expectations. Companies like Clinkle and Color, both of which received substantial sums of capital early are examples of companies whose expectations were set so high by their investors and team that even moderate success would’ve been considered failure (yes, there were other reasons for them not succeeding as expected, but expectations exponentially amplified risk in both cases).
This is not to suggest that founders take lower valuations. In fact, I’m a big advocate of founders that are not afraid to think and dream big. But this should not stunt pragmatism. More importantly, founders cannot afford to ignore the role of expectations in the world of financing.
As for my friend? I don’t know what he’ll ultimately do, but I am confident any decision will include comfort level for the type of expectations he’s signing the company for.