Are Seed Stage Valuations in London too High?

“All intelligent investing is value investing- acquiring more than what you are paying for” –Charlie Munger- Vice-Chair of Berkshire Hathaway.

 All angels and most micro VC’s care a lot about valuations and now most of those I speak to believe valuations that startups at the seed stage in London are asking for are way too high.

Our own London Co-Investment Fund has now completed 31 seed stage investment so far this year alongside 8 Co-Investment partners such as London Business Angels, Firestartr, Seedcamp, Angel Lab, Playfair, Crowdcube and Forward Partners. The latest investments include the likes of Splittable, Lexoo and Dataloop.

Therefore we are in a good position to share some insights on valuations for seed rounds between £250K-£1.5M pounds ($400K-$2.5m US dollars). Our figures are as follows:

Average size seed round                                                      £ 722,000 ($1.1m USD)

Average Pre-Money Valuation                                             £2,781,000 ($4.2m)

We have only invested in the seed rounds of 8 pre-revenue companies (those who have no sales or with less than £5000 MRR) but in these cases the average size round has been much lower and the average pre-money valuation has been about £1.6m and under £1.2m for those who raised less than £350,000.

There are obviously some wide variations in these numbers and it is true to say hot teams in hot sectors such as Fin Tech do raise more and thereby inflate our averages but in all I would say if you are raising in London and want your fundraise to attract the interest of investors and close quickly then these are your bench-marks

Seed Stage Target Pre-Money Valuations

Pre- Revenue                                          £1m- £1-8m

Post Revenue (with £5K+MRR)      £2m- £3.5m

Most seed investors are value investors so going below the benchmark might make you even more attractive especially if your market size and exit ambitions are in this climate are modest.

Why are UK investors so worried about valuations is a good question. After all, there is a view, held by some very good and experienced investors, that every year the UK might produce 15-25 tech startups that just might have the right combination of “Smarts” to create and capture sufficient market value that they just might go on to give a lucky seed stage investor a fabled “unicorn” sized return. If that is the case why worry when a start-up asks for a seed stage investment at a valuation that way surpasses the averages posted above.

Start-ups also argue that is it not the case that we are all part of the same global market so valuations for comparable businesses at similar stages in California, New York or even China should set the benchmark for start-ups in London. They also might say it is also the case that if a tech start-up founder, gives away too many shares at seed stage because the valuation is too low, then it will limit their ability to raise at a latter stage from top notch VC’s whilst at the same time leave them with insufficient stock options to attract and hire the best people.

Finally the start-up may point out the cost of building a start-up in London particularly the cost of talent, of accommodation and the cost of getting yourself noticed in an ever increasing noisy world is shooting up. So the forthright start-up may pipe up and say that London investors must “get real” and accept that an ambitious start-up needs more money and as such the valuations will also have to be much higher.

I am sympathetic to all these arguments but they will not wash. Here is why?

1. You are in London not New York or SF. If you want a NY or SF valuation then move there to start and build your business. Well respected UK VC’s, such as Hussein Kanji from Hoxton Ventures, recommend that you should start your world beating tech business in a market with 300m+ consumers and 20+ times the amount of venture capital as the UK. Go figure.
2. You are probably never going to be a "unicorn" . They are suppose to be rare for even most great start-ups are not solving big problems for sufficiently large enough markets to even contemplate the likelihood. No problem in not being a potential "unicorn" but there is if you ask for a funding at a valuation that only makes sense if you have to become one.    
3. The maths, if you don’t go “Unicorn Hunting”, will not add up. Most seed stage investors believe you are much more likely to get good returns by investing in companies that are likely to exit at between £10m-£50m. Most tech exits that do occur in the UK are at this level, (like the recent case of Helping buying Hassle their rival on demand platform for cleaners) and so if you do the maths the valuations have to reflect this if the seed stage investor is going to get the 10 times return or even 5 times returns needed to make seed investing worthwhile.  
4. No exits. The number of tech companies that IPO in London last quarter is….none. Most probable exits for EU tech start-ups are trade sales and then most likely to a USA tech company or fast growing better funded USA start-ups. These exits to USA companies don’t happen as much as you think and when they do they tend to pay less to buy a EU start-up than what they pay for a home based company. Until European mega corporations conclude that the best way they are going to get ahead of their USA and Far East competitors is by copying them by investing in, or better still buying, early stage disrupting tech start-ups, then there will less early stage exits in Europe. So the number 1 method of valuing a company- predicting what it would be worth on exit and the probability of that happening – is going to be lower in London than the USA. Investors pay more for stock if it is liquid or has a good chance that the profit on investment can be cashed in soon. The chance of that happening in Europe is not as high as the USA so there is no case for making the valuation comparisons. If you want someone to blame for poorer valuation in Europe then don’t blame investors, blame Vodafone, blame Siemans, blame Nokia …
5. The EU Venture Capital market is inefficient and probably not yet fit for purpose of funding startups to become truly global companies. Not enough money at seed, not enough investors at series A and not enough investors at series B. etc. What this means is that the likelihood of finding follow-on funding is lower and the ability of later stage funders to extract terms that are less favourable to a seed stage investor is greater. Experienced angels in London have tales to tell how latter stage VC’s use all the tricks in the book to massively reduce their capital gain due to them when the company they have invested in does well enough to secure Series A or B funding. The fear of being "shafted" by VC’s is so prevalent that early stage investors believe they need to grab more equity in a seed stage deal to protect themselves from this behaviour. I don’t condone this attitude and believe in many cases it is counter-productive for the seed investors, but it is there and should be recognised.

In summary, seed investors in the UK are less likely to make high returns than there American equivalents unless they can get better valuations than can be found in the USA. If a start-up accepts this fact, then why not set a valuation that will attract an UK/ EU seed investor interest. If not then the start-up may find they will be raising their seed round for sometime. Finally, even if a start-up is successful in getting a high valuations at the seed stage then watch out for the increased probability of a down-round at the next fundraise. Intelligent Series A VC's also want value, as does Series B investors ....