One Venture Capitalist at a breakfast sponsored by the Silicon Valley Bank that I once attended put it very bluntly:

"Valuations do not say much about a potential success of a business."

That is opposite to common sense - after all what commands a high price (valuation) must be a great asset to have, isn't it? So you would expect cash flow rich businesses or companies with superb, easy to monetize, intellectual properties would command the highest prices/ valuations.

Naturally as an entrepreneur You (and me to) look for big capital infusions and great valuations. But is a high valuation just a good thing and what are the factors determining a valuation? But you see companies with just a prototype and no business model (yet) or revenues to speak of. What is the basis of such rounds hitting $100 million valuations sometimes?

Apparently in the startup world things can be quite different. Other factors play a major (and often a more important role than 'real' assets):

- The Opportunity

Say you invent a replacement technology for the good old TV that could be used with the same equipment the TV households have today (really just for the sake of the argument) you are looking at a potential market of billions of dollars. Once you convince potential investors that the opportunity really exists (a good pitch and several good exits in your pasts help to make believe) they will come to share your point of view that it will takes loads of cash to enter this market.

- The barrier of entry

After all raising and spending money halfway intelligently is more difficult than it sounds. So once you have big funds at your disposal it will also give you a barrier of entry for others.

- Competition

Google would have never shelled out $1.65 billion for Youtube if there would have been no other bidder like Yahoo. If there are enough VCs chasing you - prices are in a big flux - valuations are a very flexible thing anyway

So raising a lot of cash and highest valuation is the only and most desirable place to be?

On the pro side there is ample money to spend and a wonderful cushion if things go worse as expected. With the money raised you can get better and more experienced people into your company. You can also buy some other upstart competitors and you the security that money won't stop you so soon.

But there are considerable cons:

- Dilution

I saw the founders of Voxify once at a panel discussion. While it's a very cool company - it struggles to drain substantial money out of it. So they raised 6 (!) rounds of funding for product dev and sales empowerment. Founders are now left with very little equity and stick to the company because of the great spirit.

Many term sheets also include Put/Call options so that if you miss teh challenging milestones you give away extra equity.

- Expectation Management

VC investor are interested in a hockey stick development in their portfolio. So if you raised on $100 valuation you are being expected to get $1Billion in 3-5 years. Not just a 'made-up' valuation but a buyer or an IPO markets that pays that prize. Given the insecure state of financial markets that is no small task finding an M&A buyer.

- Time constraints

Again this is expectation management - if you raise on high valuations investors tend to be more focused on a timely exit as a smaller one. High rollers simply have more potential downside.

- Down Rounds

The not so nice things for founders. Despite a healthy sales of a company and maybe some little profits that company may not be self sustaining - it needs to raise funds again (and often on lower valuations than in hype times). Depending on the market you are in you are either simply diluted again, diluted again and the initial round is repriced or you may loose most of the equity as the company drifts toward bankruptcy and you have to grab the chance that is coming along.

- Laziness

A lot of money on your bank account often makes lazy. You do not have to come up with cost savings or innovative business models - you will have investor's pressure at some time but you will tend to buy best-of-class and make compromises towards a better product development and less towards a better (more effective) sales force.

- Decision finding

I have found it to be VERY difficult to make good management and business development decisions (i.e. which product features should we build, should we go into other markets, which level of seniority should we hire) if the company makes no or very little revenue but has ample money to spend. Once you have a good revenue stream you can guide your employees much easier - whatever makes money on the short or mid-term is what you have to go for (as a startup you have less to care about long-term (3y+) projects.

- Downscaling

If you realize a little late that you have overspent compared to the real needs of your business it is very tricky to downscale and keep a start-up attitude in your company.

My conclusion?

A healthy, high valuation is a good thing if you are willing to go full risk and seriously believe that your business will find a gold mine of monopoly profits (think Paypal or Ebay). If you feel your business is more serious cash cow but won't take over the world stick to angels and grow your cash flow. Your investors will be happy and you will be happier too.