Early-stage startup valuations rise, but so do ‘down rounds’

Typically, when things are going well in the startup world, venture capitalists optimistically boost valuations of early-stage companies to reflect the promise of the young fledglings.

Photo via Eddie S

That’s exactly what’s going on right now for those companies raising money, with a new report out today from the law firm Wilson Sonsini Goodrich & Rosati indicating that pre-money valuations on series A financings jumped to $9.2 million during the first quarter. That was up from $8 million in the fourth quarter of 2011 and nearly double the $5.5 million median pre-money valuation placed on series A companies during the same period last year.

In fact, valuations have more than doubled from the first quarter of 2010, a darker period when the country was still in the throes of the recession.

Is this a good thing? Well, it certainly indicates a new-found optimism in entrepreneurial ventures, though it may also signal that things are getting a bit frothy.

That is until you look at a few other stats in the report. Interestingly, at the same time that valuations rose for series A deals, so-called “down rounds” — follow-on investments in a company made at a lower valuation — increased.

During the first quarter, a whopping 35 percent of venture financing deals that WSGR tracked were classified as “down rounds.” That’s an increase from just 15 percent  in the fourth quarter. Meanwhile, “flat rounds” — where the valuations stay the same — increased from 12 percent to 18 percent of all deals. Up rounds tumbled from 73 percent to 47 percent. Furthermore, series B and series C financing deals also saw valuation declines in the first quarter.

That’s a very strange phenomenon, but WSGR pointed out that most of the down rounds occurred in the clean tech and life sciences industries. Those two sectors have been struggling, according to the report. Meanwhile, even though series B rounds decreased overall, software companies saw valuations increase during the first quarter when compared to the fourth quarter.

The report follows news that Seattle entrepreneur Tony Wright — who will be our guest on the GeekWire podcast this weekend — plans to move to Silicon Valley in part because of more favorable deal terms. Seattle entrepreneur Chris DeVore, who will also be on the show, also called out a practice this week on his blog that he dubbed “grinding.”

“Entrepreneurs are at their most vulnerable when they need money, and “grinding” — taking advantage of that vulnerability to try to eke out a little more return for yourself — is the worst kind of relationship-poisoning, short-sighted behavior you can engage in,” he wrote.

[Editor's note: Wilson Sonsini Goodrich & Rosati represents GeekWire]

  • http://jobferral.com Stephen Medawar

    I want to ask a question, but it is difficult to convey tone over the internet. So, I will preface my question by saying: I am asking an honest question with no sarcasm or skepticism.

    Are 70 deals a significant enough sample size to represent the market? I don’t know how many deals take place in any given quarter.

    • johnhcook

      Thanks for the comment Stephen. I noticed that number too in the footnotes. I am not a statistician, so can’t say whether that makes up a valid sample size. Just as a reference point, the NVCA’s MoneyTree report for Q1 indicated that 758 deals were completed during the quarter. So, given that, perhaps about 10 percent of the deals were represented here. Hope that helps explain things, and I welcome other feedback. 

      • Craig Sherman

        Great question.  Just to clarify, the data in our report come from deals in which we were either
        company or investor counsel.  According to VentureSource,
        we were company counsel in roughly 29% of the venture equity financings
        completed nationally in the first quarter of 2012 (based on law firms that were
        company counsel in four or more financings in the quarter).

  • Guest

    The whole enchilada is truly going out of whack with a pending 24x/revenue valuation looming with Facebook’s IPO (Google is somewhere around 5x).  Never mind Instagram’s valuation which must have been some multiple of infinity, given there was zero revenue.

    Frankly, I’d take a reasonable and sane valuation in Seattle, coupled with supporting investors, over a pie-in-the-sky valuation and roll-of-the-dice (come-and-go) in the Valley any day.  Enough mixed metaphors for one day.  Time for a beer.