The risk of embarrassment before family and friends has increased for ambitious young entrepreneurs, due to a new phenomenon that I’ve noticed in the world of startups. Not so long ago, the billion-dollar startup was so mythical that it was called a unicorn. Today, Fortune magazine keeps a running list of private companies topping $1 billion valuations, which numbered 174 the last time I looked, including the following American companies in the top 10: Uber, Snapchat, Pinterest, and SpaceX.¹

The result is that young entrepreneurs tend to get way ahead of themselves in valuation, which risks confusing—and angering—investors. Here’s the problem: It used to be that if I had nothing but a great idea for a company, I might be fortunate enough to find someone who would put up $500,000 (or less) for 50 percent equity. Seeing unicorns in their dreams, today’s young tech entrepreneurs want valuations of $10 million—and often much, much more—just for the idea. Recently, an entrepreneur who believed he was going to conquer the world of energy asked me to invest capital in an idea that he wanted to value at $50 million. It is a big idea to be sure, but $50 million for a company that just six months before had one of the principals invest $150,000 for 33 percent—that seemed a bit off the mark!

In all fairness, one thing I have learned is that the world is not round, by which I mean that not everything is rational and sometimes the pieces don’t easily fit together to solve a puzzle. It is possible that those two entrepreneurs will solve the world’s energy crisis and make billions of dollars, but their overconfidence, and the overvaluation it promoted, was of deep concern. True, I had a bit of that myself when I was 25, but as I have commented elsewhere in this book, one of the advantages of grabbing onto mentors when they are available is that they can add a dose of humility and perspective that younger entrepreneurs are often lacking.

The recent inflation in first-round valuations has been startling, even for professional investors. Consider how the average valuation of Y Combinator’s startups has changed over the past few years. Y Combinator is a prominent incubator that offers advice and seed capital to promising tech ideas. In 2015, the average valuation of Y Combinator’s 500 startups was reportedly $6.4 million,² which I believe is up from roughly half that amount just a few years earlier. It’s true that this is an exceptional set of startups; they have to jump through a lot of hoops to be one of the lucky 100 or so selected from thousands of applications every year. But if the Y Combinator team deems your idea good enough, they’ll invest $120,000 in exchange for 7 percent of your company, and other investors are likely to follow. With such prominent alumni as Airbnb, Reddit, and Dropbox, venture capitalists keep an eye on the companies that Y Combinator selects.

When a kid thinks his company is worth $10 million and turns to friends and family for capital, they are not likely to question that valuation in any depth because, for amateurs, it seems like the outcome is binary. The business will either be a huge success or a write-off, and in either case the valuation isn’t critical. They just want to be helpful to their brilliant nephew who graduated from Caltech or their best friend’s daughter who graduated from Stanford with a master’s degree in computer science. Let’s say friends and family invest a total of $1 million. The company is launched and makes rapid progress. The young wizard goes out for the next round of capital, tapping friends and family again, this time for a total of $2 million. The company has done so well that its valuation is now $20 million. Mind you, it might not have sold a single thing—the product might not even be finished—but success is absolutely assured!

By then the company is really cooking, and the founder goes out for a third round of capital, maybe $3 million or more, and seeks a $30 million to $50 million valuation, but because the capital needs are growing, it is time to seek investment from professional venture capitalists or a private equity firm. The pros are actually impressed. “This is a great business,” they say. “It’s worth $10 million—maybe 15.” This happens all the time. Professional investors employ well-tested models for assessing risks and almost always arrive at a lower valuation than the optimistic entrepreneur. Suddenly, the business founder is faced with the unpleasant task of reporting this down round to friends and family. Even if there are down-round protections that adjust early investors to a lower share price, it is still tough to give friends and family bad news that will undermine their confidence in the entrepreneur’s judgment. They will ask: “After all the progress we have made, how can the company be worth what it was when we started? And how can it be worth half of what it was valued at in the last round when all we have done is improve the product and increase our prospects?” The answer is simple: The friends, family, and founder were clueless and naïve to begin with about the real value of the company because their main mission was to get the company launched, and they had no experience or capacity to really assess the risks inherent in the investment.

The bad news may impact investor relations, but the damage to employee morale may be even worse because the most recent hires with high-priced options will invariably start considering fleeing the company for a better opportunity. That might leave the business with the least talented employees who have fewer opportunities to go elsewhere.

The solution is simple, in my opinion: When you set out to round up some capital for your new company, you can dream of a unicorn but look for the funding that you actually need to launch your startup on more modest terms, to keep it growing, and to build the evidence that will prove that it’s a potential big winner to professional investors. In the end, if the company is going to be a screaming success, there will be plenty of profits to go around.

Treating your investors with respect will build trust that can pay dividends for a lifetime. Being greedy will close doors to good people for a lifetime (although I am always shocked by how often investors who have been screwed go back for more). Yes, investors are aware that entrepreneurs are passionate about their ideas. But someone will be more likely to invest in your idea—and keep doing so in the future—if you show some humility and try to look at your venture from the point of view of someone risking money to help you turn it into not just a reality but one that delivers exciting returns.

Overvaluing your company is a rookie mistake that will not only risk your relationships with friends and family but will also raise questions among professional investors about the competence of the management team, which would be you.