Journalists frequently ask me if I believe that venture capital valuations in this current environment are excessive.According to PitchBook, the average venture capital fund has a return of 1.5x on committed capital over a decade.How can investors make a good return on their investment when entrepreneurs are using unicorn ambitions to boost private company valuations?We can use traditional financial metrics for venture capital valuations at the growth stage. Everything is predictable by definition. Price-to-revenue, industry multiples, and other financial metrics make it easy to calculate.Venture capitalists must stop imagining that a valuation too high is okay.What tools can investors use to ensure fair pricing at seed and early stages? Forecasting is almost impossible in these early stages.Venture capitalists must stop believing that a high valuation is okay. These are three common lies investors tell themselves to justify a potentially unreliable valuation decision.Lie 1: It was done by the devilIt must be a good deal if a big-name VC believes the price is fair.It's wrong.Although the lead investor may have some experience, the price she set might not be fair. The lead investor may already be an insider and have committed small amounts, or simply don't care.Investors who have invested capital in the startup are called insiders. Because they want to see the startup succeed, insiders are in conflict of interest. They also want to see the stock price continue growing and show momentum.This is why venture capitalists often don't want to be involved in subsequent rounds. Pricing decisions are no longer objective, as investors are on both sides at all times.Although inside-led rounds are common for many reasons, such as speeding up the funding process so that management can concentrate on building the company, these decisions cannot be relied upon to provide an objective indicator of market valuation because they are not made at arm's length. This goal can only be achieved by a third-party valuation or a test in the open market.A small investment can also allow some firms to relax their pricing rules. A funding amount that is less than 1% of the fund's size could be viewed by the VC team as a way to put a marker down, and not care about the attractive multiple. It is a good idea for lead investors to compare their fund size with the firm's latest.Investors may not be concerned about the valuation for other reasons. Some VCs are just logo hunters and want to be able say that they invested in a company. Your own returns could suffer if you outsource valuation discipline and financial results to a lead investor that doesn't value them.Lie 2: The price has remained flat since the last round.We believe it is a great deal if the previous round valuation was $50 millions and the current round valuation at the same level.This is again a mistaken thinking. The last round price may have been too high.
