There is a long article on Square and Box in TechCrunch this weekend. I am not sold on the arguments the author makes about the commodity nature of both products. But the author makes a point at the end in a section called "The Valuation Trap" that I very much agree with:
"A second iron law of startups might be that the higher the valuation of a startup, the fewer options it has for financing and exits…… once a company has raised mezzanine capital and is valued in the billions, its options are essentially to go public or find a very interested buyer with deep pockets. There are few other options on this side of the startup pipeline."
The past three months have not been good for highflying tech stocks and now we are seeing IPOs being postponed. Both Square and Box have recently done that.
Another thing that Square and Box have in common is very high burn rates. The author of the Techcrunch post says that Square lost $100 million and Box lost $160 million in 2013.
The combination of sky high valuations, equally high burn rates, and a disappearing IPO market is not a pleasant one. I am fairly confident that both Square and Box can and will navigate the valuation trap, but it will require making some hard choices in the coming months.
So, the moral of this story is that you can push valuations when you have investors knocking down your door, but unless you are cash flow positive and expect to remain so for the foreseeable future, you do that at your own risk. You will need to find someone to top that price down the road and that person may not be there.
Epilogue: I am a VC. I am talking my book here. I don't like to pay sky high valuations. And I like to argue against them. So understand this post in that context. But I am also an investor in companies that have found, and may or will find themselves in the valuation trap. I have lived it, felt it, and suffered from it. It is a real issue.
This article originally appeared on Fred Wilson's blog, A VC.