Grow to Win
The role of revenue and growth rate in driving startup outcomes
In the booming VC market of the past 5–8 years, the promise of easy money, quick acquisitions, and big IPOs caught the public’s imagination. We’ve all heard the narrative: “Build a good product or new tech and you’ll get scooped up by a large corporation for a hefty sum. Revenue (and figuring out a business model) will come later.”
Now that we’re several months into the Covid-19 pandemic in the U.S., it seems like the right time to get back to basics and consider whether this was ever true, and what the data might tell us about venture capital and entrepreneurship in the coming years. Available data on VC-backed companies that were acquired or went public over the past ten years can help provide a clearer picture of some key metrics that are common to a successful exit. While the definition of success differs company to company, and may vary among different stakeholders like VCs, founders and employees, for purposes of this post I’ve chosen a cutoff of a $500 million exit value.
Perhaps unsurprisingly to readers of this blog, the data suggest that the story of rapid, high value exits for venture-backed companies without revenue is more myth than reality.
First, let’s consider revenue, reviewing 357 VC-backed acquisitions over the past ten years. While the available dataset is necessarily limited — recent revenue information is often not disclosed at the time of acquisition — the information that is available paints a clear picture: 76% of startups acquired for $500 million or more had revenue in excess of $100 million. In contrast, only 6% of those acquired had revenue of less than $1 million.
When we view the same data in the scatterplot below, we can see that though there are exceptions, revenue was correlated with exit value in the successful mergers and acquisitions of the past decade.
If we exclude the outliers in the data set, we can get a clearer picture of what is happening in the bottom left portion of the above graph, as shown below.
Breaking results down by industry, it’s clear that startups in the pharmaceutical industry are a major outlier. Within our data set, nearly half of the companies with less than $100 million in trailing twelve months (TTM) revenue, and nearly all of those with less than $1 million in TTM revenue, were companies in the pharmaceutical industry. Given that many startups developing new drugs will likely not have revenues until their drugs are approved, which is some cases may happen post-acquisition, it makes sense that their path to exit looks different than those in other industries.
Another reason why a startup may be acquired with little to no revenue is based on the strategic rationale behind a corporate acquisition. If a startup has developed a product or tech that could potentially be a feature within a larger corporate offering, the startup may not need to have excessive revenue for it to be an acquisition target for a corporate, even at a sizable price. When news broke that Facebook would be acquiring Oculus, for example, Oculus had not even finalized its consumer product and had only minimal revenue from their first virtual reality development kits. Oculus had not yet proved product-market fit nor showed that consumers would adopt VR, but it was solving a major strategic issue for Facebook. Facebook saw VR as strategically essential to the future of communication. As Mark Zuckerberg said at the time, “Oculus has the chance to create the most social platform ever,” so it was deemed to be worth the $2 billion price tag for the team and technology to help Facebook establish themselves in this space. We can infer that other startups without revenue may also have fit a strategic narrative, but for those startups, this outcome was like winning the exit lottery.
Shifting to IPOs, the data paints an even more revenue-centric picture of success. 96% of companies that went public in the past ten years at a value of more than $500 million had prior twelve months revenue in excess of $100 million, with 50% in excess of $500 million. Given the relatively limited data set of 57 IPOs, there are no discernible patterns in terms of industry.
We see a similar correlation between revenue and exit value, as in the M&A data set, reinforcing the intuitive conclusion that higher revenue correlates with a larger IPO exit value.
And similarly to M&A, if we eliminate outliers in the IPO data set, we can see the correlation more clearly.
In addition to revenue, looking at the number of years between a company’s founding and their exit can help shed light on whether the rapid growth trajectory is as present in successful exits as many believe it is. Lifespan prior to exit isn’t a perfect parallel for growth rate, but we will use it as a proxy given the limited availability of revenue growth rate data. If a company develops meaningful revenue in a short number of years, the startup logically will have demonstrated a high growth rate.
For VC-backed companies that were acquired, the data shows that more than 50% had a lifespan of 10 years or less before they exited. If we look closer, nearly 40% had a lifespan between 5–10 years, which seems to be the “sweet spot” lifespan for a startup with a successful exit via M&A and matches other data sources. There are exceptions to this pattern of course, one being that only 601 days passed from the launch of Oculus’s first Kickstarter to their acquisition by Facebook, but this is the exception rather than the rule.
IPO data paints an even clearer picture of rapid growth. The data shows that nearly 50% of VC-backed companies that went public over the past ten years did so 6–8 years after they were founded. Though the dataset is fairly small, it reflects the somewhat unsurprising conclusion that growth is even more essential for companies looking to enter the public markets than those that could be acquired. This may be because the public markets require more rigor.
Looking at this data in tandem with that of the revenue of companies that completed an IPO, WeWork provides an interesting counter example. The company had a significant amount of revenue in the period prior to its attempted IPO ($1.54B in the first 6 months of 2019) and had grown rapidly since its founding in 2010, but the public markets still rejected the company, most likely because the underlying business model did not make sense. Brand recognition or hype may help a company to IPO or be acquired when it may not have made it otherwise, but we can derive from the WeWork case that there still is some part of the public market that will screen companies unready for IPO or without a strong underlying business.
In future research, we can explore this data to understand other patterns, including data points that don’t fit these overarching trends. For the companies that exited in less than 5 years, for example, we can look at the profiles of these companies and their acquirers to see whether there are elements like industry, business model, or product type that may be correlated with an early exit. Similarly, we can examine companies that exited in 5–10 years, and those that took 10 or more years to try to understand any other characteristics of these categories. It would also be useful to assess actual growth rates of these companies instead of using estimates by lifespan. This would allow us to arrive at a minimum global estimate of compound growth rate for the larger exits. It would also enable us to compare growth rates more accurately across different industries (e.g. energy vs. enterprise IT) or business models (e.g. hardware sales vs. SaaS).
Looking at this data in sum indicates that the majority of VC-backed companies that had successful exits over the past ten years did so in 5–10 years and had at least $100 million in trailing revenue. Some may hope they are the exception, and they may get lucky and be right. But odds are that they will fit this pattern, so banking on being the exception to the trend should not be the plan. Real businesses are built to stand on their own with solid revenue and strong business models. As investors go forward in the coming months or years, this data can hopefully serve as a reminder that in bear or bull markets, revenue and growth rate are strong fundamental signals of future success.
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