Version française/French version: LINK
The derisking strategy of startups funded by venture capital funds consists of rapidly developing an innovative offering to become an acquisition opportunity for large corporations. Even though self-financing in ‘bootstrapping’ mode leads to slower growth, 60% of exits come from companies not funded by VC funds, taking 11 years to be sold with a median value 43% lower than that of startups financed by venture capital. Startups funded by venture capital, on the other hand, are sold after 9 years for a median amount of €38 million and a revenue multiple of 4.1. Therefore, it is necessary to approach the symbolic threshold of €10 million in revenue to succeed in selling a ‘typical’ startup. The business model and industry impact valuation multiples. Reverse engineering successful exits allows you to optimize the trajectory of startups funded by venture capital funds.
E. Krieger
A startup funded by venture capital funds is designed to derisk an innovative offering and grow rapidly enough to become both an acquisition opportunity for a large corporation and a threat if a competitor of said corporation sets its sights on your company.
This derisking strategy can also be achieved through quasi self-financing, in ‘bootstrapping’ mode, a metaphor referring to the adventures of Baron Munchausen. In this case, the startup does not rely on venture capital funds. However, the acceleration will not be the same.
According to the investment bank Avolta, 60% of exits in 2022 are the result of companies not funded by venture capital funds. However, these companies take more time to be sold: a median timeframe of 11 years compared to 9 years for VC-funded companies. They are also sold for €21.6 million, a median amount 43% lower than the exit value of venture capital-funded companies. Being funded by a VC is therefore a sign of an ambition to achieve a higher return in a shorter period.
Venture Capital-funded Startups: A Highly Coveted Minority
Here, we focus on startups funded by venture capital funds: what do they look like at the time of their sale or IPO?
Avolta provides valuable insights into the profile of these VC-funded startups at the time of exit:
- These companies are sold for a median amount of €38 million based on a multiple of their revenue of 4.1. In the case of an Initial Public Offering (IPO), their median valuation in 2022 is even €60 million.
- In the case of an IPO, only 10% of listed companies see their market capitalization increase compared to the offering price. Thus, in 90% of cases, this valuation subsequently decreases, preventing investors and co-founders from realizing their profits based on these €60 million, which remain virtual. These volatility and liquidity issues explain why nearly 90% of exits take the form of M&A (merger and acquisition), selling the startup to a group that will pay with ‘real cash’ or securities much more liquid than those of a ‘small cap.’
- Applying a median multiple of 4.1 to a median exit value of €38 million, the median revenue for the last twelve months of these startups is €9.3 million. This means that it is necessary to approach the symbolic threshold of €10 million in revenue to succeed in selling a ‘typical’ startup.
- These startups have raised €4 million, still in median value, to generate these €9.3 million in revenue, but only 58% of these companies are profitable at the time of exit. Taking into account investments (Capex) and working capital needs, nearly 50% of these startups continue to ‘burn cash,’ which is not a problem as long as investors feed the ‘derisking’ machine, precisely to sell it based on a high revenue multiple.
- The multiples to apply to the revenue of startups at the time of exit vary depending on the business model and industry. Thus, subscription-based business models are valued at 3.4 times revenue, but with very large ranges between the first and last quartiles. In the same vein, FinTech startups are valued at 5 times revenue, and this median multiple is even 5.1 for health, still with significant interquartile ranges.
Generating Revenue and Profits: A Necessary Step?
Investing each million in the capital of a ‘median’ startup allows generating €2.3 million in annual revenue at the time of resale. However, in some cases, beyond the need not to always focus on the median, these inferences based on revenue make little sense when the startup’s business model does not inherently rely on revenue generation.
Indeed, the logic of revenue does not necessarily apply to ‘deep tech’ companies or startups whose development relies on a considerable and initially poorly monetized audience. In this case, the goal is to sell to a large corporation that will know how to monetize technology and/or a customer base, similar to WhatsApp, sold for $19 billion to Facebook without any revenue but with 400 million members and as many commercial synergies with the acquiring company.
Similarly, for a ‘deep tech’ startup, achieving a considerable revenue will not be the essential valuation criterion, even if proof of commercial interest must also be established, but not to the point of having to achieve €10 million in revenue before being able to be sold. It always comes back to the need to acquire a ‘critical mass’ of technical and commercial credibility, from which several industrial players will bid to acquire a gem and leverage technical and/or commercial synergies through this acquisition.
Reverse Engineering Applied to Successful Exits
These different orders of magnitude do not necessarily apply to your startup because development times, required amounts, and valuation multiples can be very different from these median values. However, if you want to accelerate your development with venture capital funds, you will have every interest in engaging in a reverse engineering exercise based on this exit or ‘liquidity event’ goal. This type of exit is precisely the goal of your investors, and your development strategy will be to optimize these exit timelines and profits. Here is the process to follow and the main parameters of the equation:
- Calculate your equity needs and anticipate your various financing rounds from creation to exit.
- At what price does your company need to be sold (or listed) to meet the profitability requirements of your investors?
- Depending on the revenue multiple that will apply to your company, what should be the profile of your company at the time of exit? Describe this profile in terms of revenue, operating profit, geographical coverage, audience, or development stage in the case of a ‘deep tech’ company.
Good luck with this reverse engineering exercise for the exit of your startup and for the crucial decision to use venture capital funds to accelerate your development!
