The Dark Art of Startup Valuation

Delivered February 7, 2025 @ 5:00pm ET

Table of Contents

• This Week’s Highlights in the Democratize Venture …

• How to change your mind

• The Dark Art of Startup Valuation

• Doriot Deal Updates

• New Deal Analysis Dropping Next Week:

Happy Friday everyone and Happy Holidays! My name is Gerry Hays, and for lack of a better description, I’m the custodian and convener of Doriot, a movement to break open the gates of venture and expand opportunity beyond an elite few.

I’ve been in the game of venture as a founder, investor, researcher, inventor, author, game designer, and professor. I’ve built companies and developed a global venture portfolio entirely from the great state of Indiana, all while teaching over 6,000 undergraduates and MBAs at Indiana University, as well as in Croatia, Hong Kong, Slovenia, and Singapore.

Democratize Venture reflects my take on venture — exploring how we can create new, more inclusive systems based on what I believe is relevant and important today — and insights into the mental strategies behind wealth building, a core aspect of venture. Much of what I share stems from discussions I have in the classroom.

This Week’s Highlights in the Democratize Venture Space

👼 Forecasting a more favorable regulatory environment, AngelList and it’s sister company, CoinList, are now collaborating to make it easy for investors team up and invest in new crypto companies without using banks. Instead of getting paid back in regular money, investors would receive crypto tokens, which they can use or trade in the future. Source: Techcrunch

🏦 The Crowdfunding Professionals Association (CFPA) is holding a FREE webinar entitled “Tax Credits for Investment Crowdfunding” on February 12 @ 2:00pm. Tax credits could be a massive game changer for the RegCF markets! Secure your spot here.

🚂 KingsCrowd, an investment data platform for RegCF offerings, is conducting a series of meetups with founders, investors, and members from Feb 11 to Feb 27. The Kingscrowd team is a fantastic group of people, deeply dedicated to the movement to democratize venture.

• ^{Portsmouth, NH - February 11th}

• ^{Denver, CO - February 12th}

• ^{Seattle, WA - February 13th}

• ^{Salt Lake City, UT - February 17th}

• ^{Los Angeles, CA - February 19th}

• ^{West Hartford, CT - February 24th}

• ^{San Francisco, CA - February 27th}

How to change your mind

“The difficulty lies not so much in developing new ideas as in escaping old ones”

-John Maynard Keynes

To close out last week’s newsletter on biases in venture, I want to leave you with one final thought: our ability to be opportunistic investors depends on our ability to change our minds.

This is no small task. In fact, when people encounter information that challenges their existing beliefs, they often experience deep mental discomfort. Here are some key reasons why:

1. Cognitive Dissonance – When new information conflicts with our existing beliefs, it creates mental discomfort. Instead of adjusting our views, we often rationalize or dismiss the new information to maintain consistency.

2. Sunk Cost Fallacy – The more time, money, or effort we’ve invested in a belief, the harder it is to abandon. We don’t want to admit we were wrong or feel like our past decisions were wasted.

3. Identity and Ego Protection – Our beliefs are often tied to our identity. Changing our mind can feel like a personal loss or an attack on who we are, making us defensive rather than open to new perspectives.

4. Social and Group Pressure – If our beliefs are shared by our social circles, changing our mind can mean risking relationships, professional standing, or community belonging.

5. Confirmation Bias – We naturally seek out information that supports what we already believe and ignore or downplay evidence that contradicts it.

6. Fear of Uncertainty – Changing our minds often means stepping into the unknown, which can feel uncomfortable or even threatening.

7. Emotional Attachment – Some beliefs are tied to deep emotions—whether personal experiences, cultural values, or long-standing narratives—making them harder to change with logic alone.

In venture investing, this “discomfort” can lead to missed opportunities simply because an idea doesn't fit within an established mental model. Consider the following:

• 217 out of 242 investors passed on Starbucks when Howard Schultz was trying to raise $3.8 million to get the company off the ground. Were the investors that passed in the “McDonald's, 7-Eleven, or Folgers” camp and didn’t see a need for a stronger or more flavorful cup of coffee?

• In the early days, Brian Chesky was prepared to sell 10% of Airbnb for $150,000. Michael Seibel of Y-Combinator introduced him to seven Bay Area investors — all passed. Today, that stake would be worth $5 billion. Did they pass because they couldn’t imagine people choosing anything over hotels? For the wealthy, with reward points and perks, hotels are a no-brainer. Less so if you’re not wealthy and that was the market AirBNB was tapping into.

I often tell students that we all need our "non negotiables" — the core beliefs that anchor us in a chaotic world (religion, health, family, truth, code of ethics, etc.). But beyond those, especially in a world that moves at breakneck speed, we must develop the ability to unshackle ourselves from old (and even) current ideas and paradigms to give time and money to new markets and systems. In the case of startups, this isn’t just useful — it’s survival. My friend Prakash captured this last point perfectly in this short LinkedIn Post.

The Dark Art of Startup Valuation

The one thing I know about the venture business is that no matter how good you are at picking winners, if you don’t price the equity correctly, you won’t make money. And getting the price right comes down to valuation. This is becoming increasingly difficult amid the growing hype surrounding AI startups.

AngelList’s latest valuation report puts pre-seed valuations in the Bay Area at $10 million and seed rounds rebounding to $20 million. A pre-seed company — often with just an or idea or minimal viable product (MVP) — now commands eight-figure valuations, while seed-stage startups, still searching for product-market fit, are valued like late-stage companies from a decade ago.

By historical measure, these valuations are staggering. But history is irrelevant — founders are getting these deals.

It just goes to show you that Startup valuation is a dark art — an exercise in future projection riddled with unknowns. But there have to be some assumptions behind the valuations, so let’s build the case for a $10 million pre-seed valuation in the Bay Area.

Suppose an investor puts $500,000 into a SAFE with a $9.5 million valuation cap, targeting 5% ownership. Before the company exits, it will likely raise a Seed, Series A, Series B, and maybe a Series C, taking on another $50-$100 million in venture capital. This dilution cuts the investor’s stake to 2.5%.

A pre-seed fund needs at least 25 equivalent investments to be properly diversified because 80% of the deals will fail to return capital. That’s a total cash outlay of $12.5 million. To just break even, assuming 2.5% ownership at exit, one portfolio company must sell for at least $500 million. But no one invests in venture to break even. Breaking even in venture is losing.

Given the risk and uncertainty at the earliest stages, a sophisticated pre-seed investor should be aiming for a 10x return on the total portfolio. That means turning $12.5 million into $125 million over ten years. To get there, at least one company in the portfolio must achieve an exit of $5 billion or more.

These are tough odds. Only 1 in 10,000 startups reaches a billion-dollar exit.

This isn’t to say there won’t be winners. The first wave of AI companies might mirror the first wave of internet startups in the '90s — most overvalued, most failing, a few defining the next decade.

And, maybe Bay Area VCs know something I don’t. Time will tell. What is certain is that valuation continues to be a dark art.

Doriot Deal Updates

HappyPillar, a parenting app that uses AI and evidence-based strategies designed by licensed therapists to help parents manage their children's behavioral issues and promote healthy emotional development, was just featured in Forbes and gave a sneak preview that their numbers are looking solid for 2025! You can review the Doriot Deal Report here.

Overplay, a company that allows users to transform any video into an interactive game with no coding required, just announced a partnership with NASCAR, allowing drivers to create their own games for their fans. You can review the Doriot Deal Report here.

New Deal Analysis Dropping Next Week:

Bepo, a digital platform enabling customers to tip service workers electronically, is currently raising on Wefunder. Next week, we’ll take a deep dive into the online tipping market, the company, and its team to assess whether Bepo has what it takes to become a major player in the space.

Namaste -gerry ([email protected])