Undoubtedly, there are few among us unfamiliar with the magical incantation, “hocus pocus”, usually spoken by a magician concurrently with some occurrence, such as pulling a rabbit out of a hat or producing a dove from behind a handkerchief. As a noun, it may also be interpreted as a specific act of trickery or nonsense, as in “what kind of hocus pocus is this?”
Recently, I witnessed the bewitching charm of a wizardly venture capitalist seeking to invest in an early stage healthcare technology firm founded by a proven entrepreneur who became spellbound by an enchantingly high valuation. The financial investor was intent on prevailing over a strategic party that wished to couple access to a much needed distribution channel with an equity investment, albeit at a much lower valuation. The entrepreneur was unduly focused on minimizing ownership dilution; a seducingly high valuation meant that he would share less ownership with his new partner.
Offering an unrealistically high valuation to an early stage company with a differentiated suite of products and an expanding customer list, but little revenue and foreseeable operating deficits, will cast a trance on anyone that does not remain keenly focused on the distinction between ownership dilution and economic accretion. While the sorcerous use of preferred securities will enable any investor to assign a preternatural valuation that allows an entrepreneur to retain a higher percentage ownership of the company, it could jinx the company’s chances of maximizing value creation if it unmindfully erects a barrier to future strategic collaborations that are premised upon an investment in the company at a reasonable valuation.
Raising capital from an alluring strategic investor at a mundane valuation may help accelerate revenue and earnings growth thereby transforming initial ownership dilution into longer term value accretion, and …….. no hocus pocus is required.