A simple calculator to infer venture capital expectations for startup fundraisings.
In today’s innovation economy, startups are launching and getting funded everyday — in 2020 alone, 16,773 startups raised over $259 billion dollars, continuing a trend of rapid growth and up almost 3.5x since 2010. And while a few companies, like Space X and Epic Games, both of which raised over $1.5 billion last year, serve as bellwethers for this emerging investment landscape, most startups aren’t yet household names or billion-collar businesses. Some have estimated that over 100 million startups are founded each year, but only a fraction get funded and a much smaller number, 2,077 in 2020, to be exact — can grow large and successful enough to be acquired or IPO. These odds create an incredible challenge for venture capital investors — finding the signal amongst the noise — but one they are paid quite handsomely for if they are correct. What if you’re not a venture capitalist, but like anyone in innovation, strategy, business development, insights, marketing, etc. engaging with startups and new markets is increasingly part of your remit?
As all markets continue to evolve at a breakneck pace, it’s hard for non-venture capital investors to know whether a startup is an emerging threat, an opportunity, or unlikely to be successful. At Radicle, we’ve made it our mission to help the world’s leading companies better navigate the future. One way is by introducing frameworks that identify weak signals of potential future opportunity and disruption. For example, with our Investor Signal Score, we can score every company and compare one company against another based on the quality of its investors (we’ve scored every investor based on its success and selectivity), which is of course, only one way to look at a company but in startup markets where great founders seek out great investors, we believe it to be a signal as to a high quality team or differentiated approach.
Here, we introduce another framework, VC-implied TAM / Revenues. An investment in a startup is a bet on a future state in which a company’s approach, philosophy and service strike a chord with the general public and give way to a new status quo and a household name. And as any professional gambler can tell you, it’s essential to accept that no potential future is inevitable, and that there will always be a great deal of risk inherent to the game: most startups will fold, some will bring modest returns, and the rare exception will crush it. Can we infer expectations from venture capital investors to help us better understand these future states? Can we use that understanding to better inform our strategy? That’s our goal.
Venture capitalists dedicate their careers to identifying and investing behind this signal. They keep their finger on the pulse of new markets and search for these signals by regularly reviewing fundraising announcements in startup newsletters like Axios Pro Rata, Term Sheet, and Strictly VC. In these daily newsletters, the dozens of announcements from companies that recently completed a round of financing give VC firms the chance to stay fully apprised of the ever-shifting marketplace. Venture capitalists pattern-match — for better and for worse — to make quick calculations around the implication and inference of a given fundraising. For example, a $50m Series A fundraising is big — something interesting must be going on there — whereas a $2m Series A is small — less interesting things. A venture capitalist sees a fundraising at a given stage, compares it to what they know the typical fundraising at this stage looks like, looks at the quality of the investors, and extrapolates forward to an expected outcome and market opportunity.
Most people impacted by startups aren ‘t venture capitalists: they’re startup employees, competitors, and customers. For most of these individuals, the numbers that venture capitalists extrapolate off of seem small. Take Airbnb, in 2009 they raised $7 million from Greylock. In 2009, Hilton did $7.6 billion of revenue. $7 million is a lot less than $7 billion but Greylock is a smart investor and a $7 million Series A investment was significantly greater than the median Series A investment. So perhaps there was something there?
Despite that fundraising numbers seem small when you work for a company doing billions of dollars in revenue a year, for those not working in venture capital, the assumption that startups are irrelevant or that there simply isn’t enough time to keep up with the landscape has become a dangerous game. If we’ve learned nothing else from the past two decades, it’s that small but innovative companies can blossom at the blink of an eye, and that what appears small today could very well become the next big thing. Returning to Airbnb, they’re currently valued at $90 billion. What did investors in 2009 think? Would an understanding of the magnitude of the vision have influenced how incumbents like Hilton and Starwood responded to the threat?
Companies that choose to ignore these potential pioneers are therefore taking two massive risks: first, they’re making themselves vulnerable to the disruption that comes when any established company sticks to the status quo as smaller companies arise in their market with groundbreaking methodologies and second, they’re spurning the opportunity for significant returns by investing into these companies.
Let’s look at Plaid. In 2014, Plaid raised ~$12 million from high quality investors like NEA and Spark Capital. Back in 2014, what future state did the Plaid founders and investors envision? Likely a big one with a $1bn payoff for the investors. But if you were Mastercard or Visa, you likely didn’t expect the API market to be significant enough to warrant a billion-dollar outcome (Fast forward to 2020, Visa tried to acquire Plaid for over $5bn).
Our calculator infers Venture Capital expectations by taking into account a variety of factors like the size of the investment and the type of business. It’s a simplified version of an algorithm we use in our customer-facing work. Emphasis on simple. We’ve reduced the number of inputs required to give you a directional perspective on what investors are expecting. While we can’t claim that our calculator has oracular powers — if it did, why would we share it? — we know that it provides a clear directional understanding for each startup’s potential.
How does it work? Enter the funding amount, the round, the type of business, and the market dynamics (e.g. winner-take-all or not) and our calculator will tell you what venture capital investors are expecting: future valuation, future revenues, and how big the market is to support these expectations
In a world where so many startups announce financing each day, and even more are coming into existence, it’s not easy to set realistic expectations, especially for those of us who are new to the game. This simple calculator is built to streamline the process of evaluation and provide the tools you need to make fully informed decisions. You can download it by clicking here.
Let me know if you have any thoughts or questions.
Stu
stu@radicleinsights.com
Assumptions:
We’ve tried to simplify this model greatly so it can provide directional perspectives without requiring too many inputs. Some of the inputs we incorporate include:
- Investments size: the published size of a given round (e.g. a $6 million Series A)
- The round of investment: Seed, Series A, etc.
- The type of business: there are many, many different types of businesses but here we include four: D2C Consumer Product, Hardware, Consumer Software, and SaaS Software / Marketplace. The type of business influences our returns expectations as well as the revenue multiple that the business will trade on at steady-state
- Market dynamics: Is this a winner-take-all market or not? This influences market share assumptions at steady state.
