An old friend reached out to us recently. After years at a financial institution, he had just taken a job at large, traditional company and was charged with looking at “Technology Companies”, and wanted to talk to us about how to value start-ups. Our initial instinct was to tell him to Run.

We are in the extended, late stages of a somewhat implausible technology cycle. We remember in the late 1990’s when every company wanted to reinvent itself as a Technology Company. That cycle did not end very well, and people charged with digital transformation and innovation suddenly found themselves as unwanted cost centers.

Admittedly conditions are different today. Over the past 20 years, companies have learned that they cannot reinvent themselves into something they are not. Putting treads on a hippopotamus does not create a tank. Wings on a bicycle usually just crash. Instead, companies have invested heavily in R&D and IT systems. They have greatly improved their websites and their digital operations. Twenty years ago people made jokes about John Deere being a technology company, today they are a case study into how traditional, real world companies can monetize their data.

Still the temptation to do something is immense. The stock market seems to only have eyes for technology companies. And so we see companies once again dipping their toes into technology. Over the past ten years, dozens (probably hundreds) of non-tech companies have set up venture teams. A topic for an upcoming post. But even more common is the willingness of large companies to engage with small start-ups. Hence our friend’s outreach.

The interaction between large companies and small start-ups merits a Substack newsletter in its own right. This is a complex field with pitfalls for both sides. For our purposes here, we want to focus on that valuation question.

Often, large companies who deal with start-ups recognize that their relationship conveys immense value to the start-up. And so often, these large companies want to invest both to insure the stability of their technology provider but also to capture some of that value.

The problem is that valuing a start-up is always done on a basis that essentially makes no sense to an established company. Sure, the start-up can provide a five year plan, and the big company can perform their Discounted Cash Flow (DCF) analysis, but the number of assumptions and unknowables in that calculation render the exercise absurd.

Push a venture capitalist hard enough and they will usually admit that their valuation methods are “more art than science”. This is both a cop-out and a realistic assessment. There really is no ironclad way to make these decisions. This is especially true for early-stage companies, and doubly especially true in today’s seed-stage investment market. For later stage companies, a DCF may make sense, but even then we have to assume growth numbers that make traditional companies blush.

All this often leads to a disconnect between the start-up who has a pretty clear idea what they are worth among venture investors and the large companies who are uncomfortable with the valuation methodologies, let alone the final valuation.

When start-ups we work start dancing with elephants (or hippos fitting tank treads) we often caution them to be very conscious of the amount of time it requires to close any deal. This is as true for sales as it is for an investment or ‘partnership’. We have seen many start-ups founder on the rocks of large company decision cycles. And for the large company, they are often going out of their way to be as flexible as they can, with well-meaning champions risking their reputations and careers.

There is no simple way to bridge this gap, patience and flexibility on both sides is usually the best direction we can give.