Lately, in spite of the down economy, I've been seeing what I would call rich valuations for companies in the digital media space. A certain white-label social networking site, a microblogging site, and a behavioral analytics firm all reportedly raised significant amounts of money at relatively high valuations (and some of these are pre-revenue). From an entrepreneur's perspective, that's fantastic news right? Raise as much money as you can while giving up as little of the company as possible. What could be better?

Charlie O'Donnell, now with FirstRound Capital, wrote an insightful piece about this earlier this year, when he was still CEO of a startup. The article, titled, "Bizarro Fundraising: Aim Lower, Raise Less, and Lower Your Valuation," seems to go against the prevailing notion that entrepreneurs should try to raise as much as possible at the highest price. His basic message was to raise less money at lower valuations with more modest milestones so that the company can execute on more modest goals and be in a better position to raise money at better terms in the next round. There was some debate in the venture community but I have to say that it certainly made sense to me, and not only because I am an investor.

A high valuation is problematic for a number of reasons. The first, and probably most important, is the impact on the company's ability to attract quality talent. That's not to say that you couldn't (I'm sure the aforementioned microblogging site is seeing a flood of resumes). However, most people in the startup world join startups for the equity upside in a liquidity event or IPO (although the garage sale furniture and stale pizza at 1 a.m. is tremendously appealing). When a highly priced round is completed, guess what--the strike price of the options also go up. In effect, the hurdle for the options to be "in the money" has gone up and the value of the options has decreased. The motivation for the employees coming in after the financing has been materially altered.