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WITN: The New Wrinkle on the Valuation Trap (TCTV)

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It seems Sarah wasn’t kidding about working right up until she gives birth. In this week’s positively-last-before-the-birth episode of Why Is This News?, Sarah and Paul are prompted by the ongoing reports of Dropbox’s mega funding to talk about valuations.

The typical outrage is over whether a company like Dropbox is “worth” $4 billion, but as we argue, that’s misses the point. Venture backed valuations are always a function of a company’s promise and how much demand there is to invest, not what a company is worth right now.

But there are reasons to worry about companies getting into valuation traps as the price tags get significantly over the $1 billion level. We’ve cited Twitter as an example before. It’s the only one of the big five social media companies that hasn’t yet figured out how to make money, but has priced itself well out of the range of an acquisition. It’s go public or bust for Costello & Co. now and that doesn’t leave much room for execution error or broader economic woes.

Phil Libin of Evernote recently opted to do an inside round, forsaking a bigger valuation to avoid having more meddling hands in his company. As he says in this interview: Why do I care about a valuation right this second when I’m building a company for the next 100 years?

Well there’s one big reason many entrepreneurs care about interim valuations so much: They are cashing out significant portions of their shares at these mega rounds. Unlike the last time we saw inflated valuations, this isn’t about paper wealth and bragging rights.

VCs have liquidation preferences that insure they make their money back, the founding team is getting its payout, but should rank-and-file employees be worried as valuations reach new nosebleed levels?