Navigating the startup valuation shadow: Strategies to overcome overvaluation

Miguel Fernandez
Miguel Fernandez
Co-founder & CEO
Posted on
May 25, 2023
min read
Navigating the startup valuation shadow: Strategies to overcome overvaluation

2021 and 2022 produced a boom in venture capital funding and new startups being created—but, unfortunately, 2023 brought on a long-term crash we may not have experienced the worse of yet.

By now, most SaaS companies have realized that venture capital has become much more difficult to find in 2023. The drop in total VC dollars funded in the US between Q3 and Q4 in 2022 was 14%, while global VC funding dropped by a whopping 53% YoY from Q1 2022 to Q1 2023. 

This is a huge contrast from the boom times we were experiencing just a year or two ago when venture capitalists and startup founders alike were in a frenzy to keep the good times rolling. 2021 saw venture funding blast past all expectations, with global venture funding increasing by 92% between 2020 and 2021. 

This presents a very complicated problem for SaaS founders. In addition to the typical downturn struggles of trying to keep the lights on and secure any funding at all in 2023 and beyond, SaaS companies that were able to get funding during the good times also have to deal with a much more sneaky problem: the risk of a valuation shadow.

A valuation shadow is a tricky situation where an overvalued startup gets stuck trying to live up to its valuation—which, in some cases, can be downright impossible. As the shadow of overvaluation looms over the startup, the company frantically tries to hit the revenue and growth targets necessary to make the valuation accurate and satisfy investors—causing stress, frantic decision-making, and often, total failure. Essentially, the company eats itself from the inside out.

So what can founders do to prevent this situation or escape it once it’s happened? Keep reading to learn more about how to tell if your startup has been overvalued, how to get out from under the shadow (even in a down economy), and how to prevent overvaluation in the future.

What causes a startup valuation shadow?

Valuation shadows are incredibly common now, mainly due to the sudden contraction of the economy in recent times. During 2021 and 2022, many VC investors and startup founders assumed the high-growth, high-reward period would continue forever, and estimated valuations accordingly: If a company grew by 50% YoY from 2020 to 2021, investors would assume it would hit or even beat that growth in 2022 and 2023. 

Then, the economy started dipping, and many companies that saw huge growth two years ago flatlined, or even saw negative growth. Hundreds of companies from tech giants like Microsoft to smaller players like Clubhouse have made layoffs in late 2022 and 2023, while investors changed their tunes as well: 25% of investors believed startups were overvalued in 2021, while 55% thought the same in 2022.

This caused thousands of companies to be cast under a shadow of a valuation set in an economic boom that they’re now forced to live up to during a recession. But, the economy is just one reason why a startup may be overvalued—and usually, it’s actually only one part of an equation that involves multiple reasons. Here are other common factors that contribute to startup overvaluation. 

Choosing the wrong investor

Wrong investors can cause a valuation shadow in a variety of ways, most of which have to do with misalignment. An investor may be inexperienced or unfamiliar with your industry, which causes their valuation to be out of touch with what’s reasonably expected for a company like yours.

They may also have different goals for your company than you do. A common scenario is an investor who’s concerned with achieving as much growth as possible in as little time as possible fighting with a founder who is more concerned with creating a product that’s absolutely perfect or nurturing a long-term plan. These investors may overvalue a startup to encourage fast growth. 

Inability to grow into expectations

Even if a startup has the potential for success, it may not always be able to meet the high expectations set by investors. Sometimes this occurs because of controllable factors: A founder may simply mismanage their money or their team, or insist on a product or business strategy that just doesn’t make sense. Founders may also disagree with the investor’s prioritization of growth. 

Other times, this happens because of factors that are outside both the investor's and founders’ control. Market conditions can rapidly pivot, such as they have between 2021 and 2023, and so can the conditions that make a company valuable. If a new product, law, or cultural shift occurs that rapidly displaces the need for your product, there’s not much you can do to live up to a valuation from a time when your product was demonstrably more valuable.  

The inability to grow into expectations can also occur simply because the investor’s valuation was never accurate to begin with. If your company’s true, reasonable value is $50 million and it’s valued at $500 million, there’s not much you can do to close that gap.

Market hype

Due to buzz over certain industries and competition between investors, market hype can cause investors to value certain businesses far beyond what’s realistic.

This is especially common for startups that are in trendy categories at the time of valuation. Right now, AI companies are seen as the “next big thing”, and investors are giving them high valuations accordingly. A year ago, crypto and blockchain technology was popular, and those companies got to see competitive valuations that far exceeded what they were capable of living up to once the hype died down.

Individual companies are also capable of being overhyped. If there’s a lot of buzz going around about a certain company and investors are competing to join in on the fun (a dream situation for many founders), the valuations these investors give can quickly skyrocket into unrealistic territory. 

The consequences of a valuation shadow

So why is a valuation shadow so bad? Isn’t it good to have more money?

Well, not exactly. The following are some of the biggest negative consequences a valuation shadow can have on a company.

1. Overspending and long-term financial problems

When startups become overvalued, they often end up burning through money without achieving significant growth. This is because founders and investors become too optimistic about the company's potential and may invest heavily in marketing, hiring, and product development without a clear plan for sustainable growth. 

When they don’t meet their revenue targets, they often just double down on these expenses, as the assumption is that sooner or later, it will pay off. As a result, many overvalued startups may find themselves with bloated expenses, unable to generate enough revenue to cover their costs.

2. Impossible growth expectations 

Startups are always under a lot of pressure to grow, but a valuation shadow multiplies this pressure exponentially. When startups are under pressure to grow on a timeline that’s highly realistic or even impossible, bad decisions start being made. 

Burning through money, releasing products that aren’t ready yet, and frantic pivots to new verticals can not only fail to achieve growth targets—they can also erode a company from the inside out, causing a stressful work culture, negative atmosphere, and disjointed, ineffective procedures. 

3. Inability to secure more funding—despite needing it more than ever  

Investors like companies with a high valuation, because that generally means the company is successful and growing. But, if the company cannot sustain growth to match that valuation, funding quickly dries up—despite the fact that overvalued startups often need it more than ever before. 

Overvaluation can lead to a vicious cycle: Startups burn through cash to achieve growth targets, they fail and try to get more funding to maintain their spending levels, they become more overvalued, and after investors catch on that they’re not hitting targets, they become increasingly hesitant to invest in the company—causing the company to run out of money and crash.

This is known as the startup death spiral, and it usually goes along with making increasingly risky decisions with your business strategy.

Strategies to prevent and overcome the valuation shadow

So, does overvaluation mean your company is absolutely doomed?

Not necessarily—especially if your SaaS company isn’t terribly overvalued. While some startups became outrageously overvalued due to hype in 2021 and 2022, the majority of startups are under a much smaller valuation shadow—more like a small storm cloud than a hurricane. 

The good news is that these more minor valuation shadows are possible to get out of, and are even easier to prevent in the first place. Here are some tips to prevent and overcome a valuation shadow.

Re-evaluate your financials

Re-evaluating your financials is probably the first thing you should do if you suspect your startup’s valuation has been overshot. Take a hard look at the company's financial metrics and try to determine the true value of your business based on your current performance. This may require reassessing revenue projections, re-evaluating expenses, and determining a more accurate valuation. 

From there, you can begin taking action steps, like cutting unnecessary expenses, discussing how your financial picture has changed with your investors, and addressing problem areas, such as an underperforming team or product. 

This is also a good practice to apply at any point in your financing cycle, including when you’re trying to prevent overvaluation in the first place. Try to put emotions and excitement aside and regularly review revenue projections and other financial metrics with an objective eye. Compare your results with what an investor is offering you and ask yourself if their offer is truly realistic. 

Focus on generating revenue—not growth

Startups and investors alike often focus on growth at all costs, which doesn’t always work in an economically challenging environment when your revenue just doesn’t make sense with the cash you’re burning to sustain growth. 

If you’re in this scenario, you absolutely need to pause the growth and focus on getting more revenue. What this means for your business will differ depending on your unique situation, but in general, a few good places to start include:

  • Pause expansion efforts that don’t have an immediate link to generating more revenue.  This may mean pausing hiring, office renovations, or expansions into new experimental markets or products. 
  • Find out what’s working best and double down on it. If one product, revenue stream, pricing model, or audience is outperforming the rest by a wide margin, think about pausing other initiatives and focusing on those. You should also try to figure out why the successful tactics are more successful, and apply whatever makes them tick to your other initiatives. 
  • Experiment with ways to improve the attractiveness or accessibility of your product so it can convert a larger audience. Being more flexible about pricing, delivery, timelines, or who you’re targeting can make a big difference here. For example, offering the ability to pay in installments can drastically increase conversions.
  • Bring in fresh ideas. Conversely, if nothing else seems to be working, you may actually need to spend this time experimenting. A new executive team member, pivot, product direction, or marketing campaign can be risky, but it can also be the last resort that saves your company. 

Don’t be tempted by giant offers—only take as much as you need

It's tempting for startups to accept large funding offers, especially when they come from well-known investors. Many startup owners see their funding offers as a reflection of their personal success—so, if an offer is huge, it boosts your ego and makes you feel like you and your company have “made it”.

Many founders also believe that not accepting a big offer is “leaving money on the table”, or that accepting lots of money can offer a good financial safety net. And, of course, many founders simply trust an investor’s valuation, even when it doesn’t quite match their expectations. 

While it may sound counterintuitive, it’s really best for your company’s long-term health to refuse big offers and only take as much funding as you need. Try to do a calculation of how much money your business will genuinely need to achieve its goals until the next funding round, based on metrics like your ARR, projected growth, and current runway. For a breakdown of what to take into consideration when searching for funding, check out this post or this webinar

Consider alternative sources of financing

While venture capital’s generous funding rounds are the gold standard for startup financing, they’re also the biggest cause of valuation shadows—and the least likely to help once you’re under a shadow. 

A great strategy to both prevent and overcome a valuation shadow is to opt for alternative financing. By allowing you to access more cash without committing to a full VC round, alternative options like debt financing or revenue-based financing can help you avoid VC overvaluation and prevent your company from going further under a valuation shadow.  

Revenue-based financing in particular is a great option that allows you to fund important revenue-boosting initiatives and operations without requiring you to take on debt or give up equity. It can also be much easier to qualify for than debt and VC funding. Capchase Grow can help you get revenue-based growth financing based on your ARR and pairs you with a growth advisor to guide you through the process.

BNPL for B2B: A non-funding solution for startups

For startups looking to escape the valuation shadow and conquer overvaluation, more funding isn’t always the best solution. Generating more revenue is a much more sustainable and healthy approach to getting more cash, but this can be difficult to do when a cash bottleneck from a valuation shadow is already straining your ability to take the steps necessary to generate more revenue. 

Although this may sound tricky (or even impossible), there is one way SaaS startups can do this B2B BNPL.

B2B BNPL (buy now, pay later) allows businesses to access more cash upfront and increase revenue by allowing customers to pay in monthly installments for long-term annual contracts. So, while the SaaS vendor benefits from closing long-term high-value deals, the buyer gets the convenience of paying in smaller, more affordable installments. 

This can provide a variety of benefits for a SaaS business that is struggling with a valuation shadow and missed growth targets. B2B BNPL can allow startups to:

  • Close more deals, since more customers are able to afford the upfront payment for your product. 
  • Increase ACV by getting more customers to agree to long-term, high-value contracts.
  • Speed up sales cycles and lower CAC by reducing the friction associated with agreeing to a high upfront payment.
  • Build a more predictable pipeline with less churn, higher LTV, and more long-term deals.

This makes B2B BNPL the perfect solution for companies who need more revenue quickly, without needing to make any major pivots in their business—the ideal combination for a startup that needs to grow into it’s valuation.

Get help overcoming overvaluation with Capchase Pay

Overvaluation can be a major challenge for startups, especially now during these uncertain economic times. Whether your valuation shadow is caused by investor miscalculations, bad business decisions, uncontrollable shifts in the economy, or a variety of other reasons, it’s very important to get out from under the shadow before it causes a death spiral. 

Luckily, while difficult, overvaluation can be treated by focusing on revenue, understanding what is and isn’t working for your business, and making more strategic decisions in the future when looking for financing.

Whether you’re looking to supplement your finances while you’re struggling to restore equilibrium in your business, or you’re trying to boost revenue to catch up to your valuation, Capchase can help. Try out our runway calculator to see how much revenue-based financing you’d qualify for, or, better yet, get more money from boosting your revenue with Capchase Pay, a BNPL solution built specifically for B2B SaaS companies.

With Capchase Pay, CIENCE, a B2B lead generation company, was able to:

  • Shorten sales cycles shorten by 50% from 4 weeks to 2 weeks.
  • Generate $3.7 million in pipeline in one month.
  • Target SMB customers who otherwise wouldn’t be able to afford a full annual contract upfront.
  • Reduce time to cash from 15 days to same day.

To get started using Capchase Pay to boost revenue, shorten sales cycles, increase your ACV, and increase cash flow without taking on more debt or losing equity, schedule a chat with our team today