Has anyone had issues with too high of a seed-stage valuation?

I was sitting down with an experienced entrepreneur a few days ago who was telling me about a guy he was advising who was having no luck raising a Series A round. Apparently, when he got seed money from friends, family, and fools, he was a great salesman and got a pretty high valuation. Now, as he is dealing with sophisticated investors, the valuation he is pushing is 2x - 3x what his company should really be worth, and nobody will give him money. Further, even if he does raise a Series A of 1.5M or whatever he needs, he's still going to need another round of 5M or so to do what he is trying to do, and eventually he'll have to take a down-round, which will obviously not sit well with his current investors.

My response was: "Wow, I hadn't really thought about it that way. I guess I had just assumed that it was advantageous to the entrepreneur to give away as little equity as possible to get as much seed as possible from the get-go." My friend went on to explain that, no, having too high of a valuation is one of the worst mistakes young entrepreneurs can make, and that he has seen companies literally torn apart because early investors refused to take a down-round and would sue to prevent it. Obviously, when investors are suing their entrepreneurs, no sophisticated investor will touch the company.

Has anyone seen or experienced this issue?

Absolutely. If you set your valuation way outside the normal parameters, then institutional investors will stay away.

http://venturehacks.com/articles/seed-valuation http://www.entrepreneurship.org/Resources/Detail/Default.aspx?id=11242

Yes, this is entirely possible. Entrepreneurs should not simply solve for the highest possible valuation.

Another risk is that deals signed might trigger undesirable things when doing a down-round in the future.