Weekly Briefing Note for Founders 11/1/24

10th January 2024
CATEGORY:

This week on the startup to scaleup journey:

  • What founders discovered when answering the valuation question
  • Investment Analysis demo


What founders discovered when answering the valuation question

In November, we made a special offer to founders. To help answer the question, 'What is my startup worth?', we opened up our investment research capability to provide a free, 'peer group valuation trend analysis'. This was for companies looking to raise capital at Seed or Series A in 2024.

The requests rolled in (we limited this offer to the first 25 startups, more on this below) and the ensuing research provided some key insights. The biggest takeaway was that clearly understanding your market segmentation is crucial to good investment preparation. Without this you may miss vital insights on valuation trends, competitive positioning, target investors, and more.

Peer Group method. A peer group analysis is our 'go-to' method when digging for market insights, such as valuation trends. But as the word 'market' means different things to different people (as we highlighted in Founders must think 'market-first' to attract VCs) we must first identify the opportunity space. A typical place to start is your 'Industry classification' and then determine your relevant 'Vertical market' to highlight the point(s) of intersection. For example, your startup's industry might be Financial Services and your vertical might be Crypto Currency/Blockchain. Or your industry might be Automotive and your vertical might be Ride-Sharing.

But the 'Industry + Vertical' description alone is not enough to define the market when looking at valuation trends. We must drill down into the specific segments and then the subsegments to find the 'peer group' of most relevance. Take AI & ML. This is a rapidly evolving vertical market that spans a multitude of industries. When you break down the AI & ML vertical into a 'market map' (the main tool for peer group work), you discover it comprises many different segments and subsegments. And these peer groups can have vastly different attributes and funding outcomes. Understanding these is vital for investment planning.

For example, in Pitchbook's AI & ML market map (which contains over 22,000 companies), the two biggest segments are Horizontal Platforms and Vertical Applications. Each comprises a range of subsegments. It would be almost meaningless for a founder to position their company to a Tech investor as simply an 'AI & ML' business . But by saying you are a 'Horizontal Platform' company that operates, for example, in the  'Foundational Model' or 'Natural Language Technology' subsegments, you will demonstrate the required precision. This is also key to answering the valuation question.

Peer Group Valuation trends. The valuation trend exercise demonstrated that valuation comparators within an industry or vertical can be very misleading if assumed to be representative of the market as a whole. It's not until you compare specific segments and subsegments that you realise that valuation trends can be markedly different from one to the other.

The 3 most common verticals we looked at during the exercise (AI & ML, Climate Tech/CleanTech, Mobility Tech) all exhibited significant variances in median valuations between the highest- and lowest-ranked segments and subsegments.

For example, in AI & ML, when analysing 2023 Seed-stage pre-money valuations, there was a whopping 50% variation from the highest (Horizontal Platforms) to the lowest (Autonomous Machines). Yet, if you had run this comparison in 2022 you would have found almost the opposite: Autonomous Machines startups then commanded a 34% valuation premium over Horizontal Platforms.

In emerging markets, significant shifts can occur over relatively short timescales.

Valuation dispersions. Median pre-money valuation trend data is clearly informative, but it is only part of the valuation story. One of the most interesting aspects for founders to dig into was the 'valuation dispersion' data. This is the standard distribution of all valuations in a given period by quartile. This is often a rich source of insight.

In our AI example, pre-money median valuations in one particular segment had been increasing way above the other segments since the Tech market 'high' of 2021. Valuations had continued to rise by almost 50% through 2022 and by an additional 50% through 2023. If that wasn't exciting enough, there was also a much higher dispersion of valuations in 2023: Even though the median increase was 50%, companies in the top quartile almost doubled their valuations in 2023. A handful of outlier companies even exceeded that.

By evaluating these outlier companies, as well as those that appear in the top quartile, founders can better understand the hottest (most valued) investment themes and why certain propositions might be playing well with investors, and some not so well. (This is an exercise we undertake for founders during Investment Analysis).

Investment Planning. A valuation trend analysis is just one of many analyses that can inform the funding strategy. During Investment Analysis we use the same peer group approach to identify other important investment trends, identify target investors, assess competitive positioning, and more. Many founders asked about these related topics during the exercise:

1. Investment Trends. In addition to the valuation data, the other 2 key trends to consider are 'capital invested' and 'deal count'. Again, it is vital not to be misled by overall trends at the industry or vertical market level.

In our AI example, comparing the 3 largest segments (by $ amount invested at Seed stage), we know that Horizontal Platforms commanded a 50% valuation premium over the smallest, Autonomous Machines, in 2023. And on deal count trends, whilst Vertical Apps and Autonomous Machines were down over 50% in 2023 vs 2022 (in line with the Tech market generally), Horizontal Platforms decreased by only 34% in the same period.

But Vertical Apps dominate in both total amount invested and absolute deal count, by around 2x that of Horizontal Platforms. Even so, it is Horizontal Platforms that are driving the strongest upward trends in both valuation and deal sizes - at least for now.

This underlines the fact that the biggest segments are not necessarily the ones commanding the most founder-friendly deal terms.

2. Target Investors. The trends in valuations and average deal sizes usually map directly across into target investors. The larger the deals, the larger the funds that tend to pursue them. Where there is a wide variation in deal sizes between segments and subsegments, so too there is often a wide variation in the investors (and investor types) that are active there.

Again, if we look at the AI example: An analysis of the top 20 investors in each of the 3 largest segments shows a significant variation in investors at Seed stage over recent years. There were 44 unique investors that occupied these 60 slots, but only 3 had invested across all 3 AI segments. 10 had invested across 2 segments. The majority, 31 (70%), had only invested in 1 segment.

In this context, there is really no such thing as a generalist 'AI & ML investor'. Rather, in this particular emerging market case, investors are choosing specific segments or subsegments that they find attractive and are then sticking to them. When compiling investor target lists, this is a vital insight.

As markets become more established we usually discover higher degrees of crossover. For example, in Climate Tech and CleanTech, identifying investors that have already invested in several adjacent segments and (especially) subsegments can be an effective way of compiling a target list. i.e. The maturity of a market can have a major bearing on investor selection.

3. Competitive positioning. The big investment dataset companies, such as Pitchbook and CB Insights, have the facility to auto-compile market maps using advanced algorithms. Such market maps reveal all the segments and subsegments, the companies that fall into each one, plus all the aggregated investment data. Founders are always keen to see which subsegment their company appears in. This can reveal some key insights:

First, other occupants of the subsegment should include all their key competitors. It is not unusual for founders to identify new or emerging competitors using this method. This happened several times during the valuation trend analysis.

Second, breaking segments down into subsegments can help significantly when designing a competitive positioning slide. In the current environment there is increasing focus on the competitive landscape during investor due diligence. Using a market map to show how companies fit into the overall market demonstrates strong competitive understanding, as well as having great visual impact.


In summary. A peer group analysis is a powerful tool for understanding valuation trends in a specific market. By creating a market map that incorporates market segmentation and sub segmentation, founders can analyse the most relevant peer group for this and the many other topics to be researched during investment preparation. These include understanding the key investment trends, identifying target investors, communicating competitive positioning, and much more.



Investment Analysis demo

valuation trend analysis is just one of many analyses that should inform the funding strategy. During Investment Analysis we use the same peer group approach to discover other important investment trends, identify well-matched investors, assess competitive positioning, and more.

To help founders understand how market maps and peer groups can be used to deliver the critical data points required for funding preparation, we have created a short (30 min) online demo of the key features. This addresses the many questions we were asked during the valuation trend exercise.

Our aim is to provide founders with an insight into how some of their peers are using the very latest market research to prepare for capital raising in 2024.

Those interested in a demo please contact John Hall at john.hall@duetpartners.com.

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