Most startups were overpriced before 2021 and now it’s causing problems

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under normal conditionsthe higher the startup score, the better for all stakeholders. High scores indicate the success and potential of the business; they attract new clients and new talent; they create a reputation.

And if the company’s valuation continues to rise, everyone will benefit from it.

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Thus, founders and investors have always been interested in believing in optimistic estimates of the company’s true value.

Post-monetary valuations were inflated due to market expectations in 2021, but they were also inflated due to the underlying mechanics of the valuation model itself.

To cope with the looming challenges of a normalizing market, founders must understand the impact of both levers.

Wonderful 2021

New investors in a business will always strive to limit their risk as much as possible.

For founders, employees, and venture capitalists, 2021 should have seemed like a miracle year. The initial caution that gripped hearts at the start of the COVID-19 pandemic has faded, valuations have risen, and funding has once again flowed freely.

Volume of venture investments nearly doubled to $643 billion in 2021., up from $335 billion a year ago. Last year also saw 586 new unicorns, up from 167 in 2020. 1033 US IPOs against 471 a year earlier.

However, as the transition from 2020 to 2021 has shown us, things can change quickly.

In 2022, stock prices and market capitalization of public technology companies will drop sharply due to rising interest rates, geopolitical events, and the normalization of technology conditions. In a normalizing market like this, once inflated valuations can be a big problem, especially for founders, employees, and early investors.

Why startups are by definition overpriced

To understand why overestimations are a problem, we need to first look at one of the underlying mechanisms at work.

Unlike public companies, which constantly rise and fall in value, a startup’s valuation usually changes only after the closing of a new funding round. Calculating the new value of a startup is quite simple:

New Valuation = (Price of Shares in Last Round) x (Total Company Shares)

This is known as the post-monetary valuation model and is generally accepted as the industry standard.

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