Since the market pullback started a few months ago, a lot of ink has been spilled about the compression of revenue multiples in startup valuations. Certainly, by the end of 2021 they were getting out of hand on a historical basis, and so independent of Ukraine war, Fed rate hikes due to inflation, and other recent events, they were likely due for a pullback anyway.
I’m not seeing much multiple compression at the seed to Series A stage. But I am seeing the pace of deals slowing - lead investor diligence that would have taken 2-3 weeks in 20212 is now taking 2 months. There’s still a lot of capital in the funds to deploy that was raised in 2021. This creates an interesting bifurcation where some deals come together slowly, and then suddenly very quickly once a critical mass of investors determine it’s a high quality deal, and the amount of committed funding has reached a size that will provide sufficient runway to weather the pullback (investors are looking for 24 months now rather than 12).
The valuation retreat is of course more severe in later stage companies, in part because the public market multiple reduction weighs more heavily upon them, as they are much closer in time to potentially going public.
Not as much has been said about growth rate, and to me it remains the most important factor for analyzing the valuations that we see. Whatever range is common for a given sector, differing revenue multiples are justified by a belief in the acceleration rate of the whatever KPI you’re measuring (e.g. revenue), not just the growth rate. This factor, altogether separate from public market activity, also helps explain why early stage startup multiples are less impacted right now.
Early stage startups have a wider spread of growth velocities than later stage startups, and many are still accelerating. Later stage startups are usually growing at <2.5X a year, and already have flat or slowing velocity, with fewer outliers.
I find it difficult to intuit the truly vast difference between a company that is able to sustain a 10% month-over-month growth rate for a few years between rounds, vs one that is at 15% (or higher). Let’s have a look:
The vertical axis here shows the change over the first month value. A startup growing at 10% month over month will have tripled its revenue run rate in a year, while one growing at 15% month over month will have grown 5.4X. Both of these sound really good compared to public company growth rates, right? But they are completely different animals. If they can sustain that rate for two years, the first company will have grown 10X while the second company will have grown 29X.
Top tier early stage investors will always pay high multiples for extreme growth rates if they believe those growth rates are accelerating or can at least be held steady for a few years. And during a bear market, that is much easier to believe for an earlier stage company, which is starting from a smaller initial customer/revenue number and has more “low hanging fruit” (often at a lower CAC), than it is for a later stage company.
In short, in order to decide whether a particular seed to Series A valuation is reasonable in this market, I’m paying very close attention to the factors driving the acceleration of revenue over time.