Getting a business from the idea stage to reality is never easy, and now the economy has added a new twist: Valuations are suddenly dropping for all types of businesses at the startup stage.
The valuation--a documented estimate of a company's worth in the marketplace--is an essential piece of the idea stage of a business. Historically, recessions have not affected them because angel investors and venture capital firms largely base valuations on the experience of the management team and the size of the opportunity, not the prevailing market conditions.
But this recession appears to be different.
For the first time in my career, I'm seeing idea stage valuations drop. I've spent time talking to investors and entrepreneurs about it, and several factors seem to be driving the trend.
First, the availability of investment capital has dropped at the source. For example, money raised by VCs from limited partners has dropped by well over 50 percent from 2008 to 2009, according to the National Venture Capital Association. This has dried up the appetite for raising new funds and focused VCs on supporting their existing portfolio with later stage investing.
Second, angel investors have seen their stock market portfolios drop in value, making them hesitant to sell stock in order to invest. While there is still plenty of investment activity among angels, they are more hesitant to pay high prices to buy into a startup if their public market investments are not performing well.
Finally, as in most recessions, entrepreneurs have less leverage because there are more early stage startups than in previous years. In other words: the ratio of new startups to investment dollars is higher. Top entrepreneurs with proven track records have historically not suffered from this capital market dynamic for idea-stage fundraising, but the pessimism about the U.S. economy and the prospect of a double-dip recession has terrified some investors, and now, even the top dogs are feeling the pinch.
The typical scenario: Early stage investors believe that it will now take 10 to 12 years to build a business, rather than the usual five to seven years, and so idea-stage valuations are affected regardless of the quality of the management team.
So what's an entrepreneur to do? You can take it in the chin and accept a lower valuation when you raise money. Or you can fight back with compelling logic and business results.
For example, you can make the case that recessions don't usually last 10 to 12 years and your business won't need capital in such large amounts that you will need to rely on the venture capital industry's recovery.
Or, if private investors push down your valuation, try again six months later--with better results and a stronger proof of concept.
Asheesh Advani is the founder of CircleLending and Virgin Money USA, and the author of Investors in Your Backyard.
Asheesh Advani is CEO of Covestor, an online marketplace for investors. He founded CircleLending, which was acquired by Virgin.