Why a High Valuation Is Bad for Startup Founders

One of the common reasons VCs decline to invest in a startup is an inflated valuation. Of course, the higher the valuation, the smaller the investor’s share, which is beneficial for the founder. But there are several ways in which an overinflated valuation can actually harm a startup.

1. Paradoxically, the valuation negotiation is often about a few percentage points. These points significantly affect the investor’s return but don’t drastically reduce the founder’s share. Let me explain with an example. You want to raise $1M at a post-money valuation of $11M (giving the investor a 9.1% stake), but the investor wants a post-money valuation of $6M (16.7% stake). In reality, the negotiation is over 7.6%, which after three rounds of investment will translate into just a 3.9% difference in company ownership. So, the team’s stake is a negotiation between 90.9% and 83.3%, while the investor’s return drops by 1.8 times.

2. A high valuation sets high expectations. Investors in the current round will expect that the next round’s valuation will be at least twice the current one, meaning you’ll need to show very high growth rates. In our example, the post-money valuation in the next round would need to be $22M and $12M, respectively. You’ll need to demonstrate growth twice as fast as your competitors.

3. If growth isn’t phenomenal, the gap with market averages widens. As shown in the calculations above, if you don’t show exceptional growth, your valuation will increasingly diverge from market norms in subsequent rounds. This means fewer investors will be willing to invest, leading to more meetings and more rejections—until eventually, you may face a down round or even bankruptcy. I’ve seen persistence on valuation lead to a later drop in valuation of 5–10 times.

4. You corner yourself with less room for error. The next funding round is usually 18–24 months away. This isn’t as much time as it seems, considering you must grow twice as fast as your competitors. There simply won’t be time to pivot. This can lead to founder burnout, demanding investors, and team conflicts.

5. High valuations reduce exit opportunities. The higher the company’s valuation, the fewer strategic buyers will exist in the future. With a very high valuation, your only likely exit is an IPO—a rare event (last year, fewer than 40 tech companies went public).

I’m not saying you should sell your company cheaply. It’s great if you can achieve a valuation even 20–30% above market—it’s not critical. But given the issues above, is it really worth chasing an excessively high valuation given the upcoming financial crisis?

Wishing you success in raising funds. And if you need my consultation, feel free to reach out via email dk@askvc.org. I’ll be happy to help. :)