Why do valuations differ between my city and Silicon Valley startups?

For all the science and indication that startups are valued through some clear set of measures, and that VCs know what companies are worth, a valuation is literally just what someone is willing to pay for the business. Sure, there is a general conventional wisdom to valuations (no revenue = value is what it cost to build; service business = 2x revenue; tech enabled company = 3–5x revenue; truly innovative tech with market share = 10–15x revenue) but that’s really just a guiding principle.

What people are willing to pay to invest in businesses is as varied as where they are from.

Let’s take the exact same company and put it in two places. All things being equal in what they’re doing, the only primary variable is that one is in Silicon Valley and the other your city (let’s presume a less expensive place to be).

  • Cost of Living
    • Lower salaries implies the company can do just as well raising less money
    • Founders are comfortable setting the bar lower as what’s needed to be “wealthy” upon an exit might be far less
  • Investor Experience with Tech
    • More experience with technology means the investors can better value that side and appreciate the capital requirements to effectively serve the market
    • Less experience with technology tends to cause investors to question what’s really required
  • Fund Size
    • Larger funds can both support larger valuations AND follow on those initial investments – meaning investors want liberal terms that at least ensure the company gets to the next stage of funding
    • Smaller funds might be able to support the larger valuation but they’re likely unable to follow. No ill intentions here, it just means that investors might shade toward being more conservative in their terms as this is the only investment they can make – from this they need their return.
  • Philosophy
    • A Lean/Bootstrap ecosystem encourages holding out longer, focusing on customers and revenue, impacting valuation
    • A disruptive and expensive ecosystem tends to demand capital investment earlier; enabling investors to both accelerate companies earlier AND take a larger share for doing so
  • Regional Market
    • In the early stages, startups tend to find customers and partners nearer and familiar. Are there many? Are those that are there even within the ideal industry of the business or will the company effectively not scale until they break into other markets?
  • Angel Rounds
    • Terms from Angels set later stage valuations. Angels that write smaller checks or expect more equity, impact room in later stages.

Those, just a FEW of the things to consider but you get the idea that it’s not only possible, it’s very very likely that valuations differ from place to place.

The challenge is that this can actually be a problem!

The company that raises more, simply because it is considered to be of greater value, is likely to garner more attention in the media and with other investors.

The place where companies naturally result in higher valuations, suggests to local investors that startups are possible of being worth more – or less – affecting the level of risk taken or capital deployed by wealthy individuals.