Average Valuation for Incubator Companies up 40%

By Matthew Milner, on Wednesday, November 13, 2013

Here’s a mystery to solve:

Last month, on a sunny Sunday afternoon, I strolled up Broadway and bought a pound of shrimp from a fancy seafood market called Citarella.

These weren’t just any shrimp. They were “Extra Jumbos” from the Gulf of Mexico. I spent $10 for them — and later that day, they found their way onto my grill.

Yesterday after work, I headed back to Citarella for another pound of the exact same shrimp. (Yes, they’re that good.) The price had climbed to $15. I chalked up the increase to normal fluctuations – change of seasons, increase in demand, etc. – and moved on.

But when I made it home after shopping and got back online, I encountered a second price spike — and this time there was no easy explanation for it. In fact, it was shocking: in six weeks, the price of an equity crowdfunding deal I’d been following had climbed more than 40%.

What in the world would make the price of an early-stage investment climb so dramatically, so quickly? Unless a private company is showing signs that it’s the next Facebook or Google, its price either grows slowly over time, or more frequently, remains relatively static. Was something “fishy” going on?

Let’s solve this mystery. And then let’s see what it means for your portfolio.

A “Mutual Fund” For Start-Ups, Take 2

The “deal” I’m referring to above is a bundle of start-ups. It’s similar to a mutual fund.

There are 11 start-ups in the bundle — and they’ll soon graduate from a prestigious mentoring program called TechStars.

The start-ups, all based in Seattle, Washington, have impressive people involved: engineers from MIT; managers from Microsoft; even a founder who successfully sold his prior start-up.

They also have promising ideas (including a video “lifelogging” platform for Google Glass), and the backing of top-notch professional investors including SoftBank Capitaland RRE Ventures.

The opportunity, in brief, is to invest in all 11 companies at once. One investment, one check, 11 companies — with TechStars providing vetting and ongoing management, and one of our preferred crowdfunding platforms, AngelList, providing hosting and administrative help.

With start-up investing, where only a small percentage of companies will succeed, this type of diversification and professional management can be a smart move.

Sound Familiar?

If you read Crowdability’s popular post from September 18, “A ‘Mutual Fund’ For Start-Ups,” this type of opportunity might ring a bell.

Back then, we wrote about a bundle of early-stage companies from a differentTechStars’ class – one from Austin, Texas.

They had the same great mentoring as TechStars’ Seattle class, the same kind of great people and promising ideas, and the same odds of success. They just graduated a little earlier.

And yet, the Seattle class is 40% more expensive than the Austin class.

What Does “More Expensive” Mean?

But what does “more expensive” means in the context of start-up investing?

Simply put, when you’re investing in an early-stage company, the lower its “valuation,” the greater your upside potential.

As a simplified example, if you invested in a company when it was valued at $5 million, and it sells for $20 million, you’ll earn a 4x return. But if you invested when it was valued at $2 million and it sells for $20 million, you’ll earn a 10x return.

For the bundle of start-ups from Austin, the valuation was $3.2 million. That’s reasonable: as a comparison, the average valuation of companies listed on AngelList since 2010 is $3.8 million.

But for the bundle from Seattle, the valuation climbed to $4.5 million – there’s the 40% increase we keep mentioning.

Maybe such a fast and significant price increase is palatable for a pound of jumbo shrimp — but for start-ups, that’s worthy of a red flag.

A Sea of Liquidity

Shrimp aren’t liquid just because they come from the sea. They’re “liquid” because millions of pounds of them change hands constantly, with many factors determining the price range at which they’re bought and sold.

Start-ups raising crowdfunding capital aren’t liquid in the traditional sense; their shares rarely change hands. But crowdfunding creates a new type of liquidity: a sea of real-time feedback from online investors.

Essentially, start-ups raising capital can see, in real time – and probably for the first time ever – what the actual demand is for their funding round. Not just what a few professional investors think – but what the world of investors thinks.

They can base it on such data as the number of visitors they’re getting to their funding page, how many people are “following” their deal and requesting regular updates about it, and how many people are clicking “Invest Now” and wiring in their funds.

If a start-up is “hot,” it can finish its crowdfunding round quickly – in a matter of days, for example, sometimes even less. Or, as we’re seeing in the case of TechStars, perhaps it will raise its price. This transparency and deal liquidity is a unique and fascinating byproduct of equity crowdfunding.

Seattle Vs. Austin

In the case of TechStars’ Seattle class, this liquid feedback is telling us something clear: at the moment, investors see value in companies that have graduated from TechStars, and value in the “bundled” approach to investing.

Was the Austin class “underpriced” at $3.2 million? At the time, given the available information, probably not. But the market has quickly woken up to the opportunity — and $4.5 million is the number the market has settled on as the “fair” price.

Take Away

If you’re interested in getting access to TechStars’ most recent bundle of companies,you can learn more here. (Crowdability has no official relationship with TechStars or AngelList, and no financial interest in either them or the start-ups in TechStars’ Seattle or Austin class.)

Early-stage valuations in the $2 million to $5 million range are “normal,” so a $4.5 million valuation shouldn’t scare you away.

That being said, we need to keep an eye out for valuations creeping (or springing) up, and for “bubbles.” With the sea of real-time feedback becoming the “new normal” for equity crowdfunded start-ups, it’s easy to see how “hot” private deals could have their price bid up.

While it’s great to see more companies getting funded, the fact is, early-stage companies with late-stage (i.e., high) valuations means more risk for investors!

This is a new and exciting world. It’s filled with risk and opportunities. We hope Crowdability’s articles are helping you better understand and navigate the equity crowdfunding ecoystem. Please email us with your questions so we know what you’re wondering about. We’ll do our best to write articles that address your questions.

You can always reach us at [email protected]

Best Regards,
Matthew Milner
Matthew Milner


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Tags: Equity Crowdfunding Mutual Fund Mutual Fund For Startups Techstars

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