This week on the startup to scaleup journey:

• Helping founders answer the valuation question
  
  

Helping founders answer the valuation question

For boards looking to green-light funding campaigns, valuation remains a big point of anxiety. Continued pricing instability in private markets is frustrating attempts for startups to settle on a clear funding strategy. Many campaigns have been delayed.

Existing shareholders have never been so uncertain about the next funding round. This has led to an increasing number of 'unpriced' rounds via convertible loan notes and SAFEs - even as an entry point for new investors.

But why should startups delay if they have a hot proposition? Why should they entertain future valuation discounts (CLNs, SAFEs) if their market price is actually holding up?

The reality is that many startups are finding it difficult to read the current funding market. Some sectors and stages are indeed trending down but many are trending up. Some are way up.

What is my startup worth?

Six months ago 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.

In the light of a continued squeeze on funding we are repeating this offer to help founders plan ahead (see offer below).

Informed by earlier findings, What founders discovered when answering the valuation question, our analysis will consider new forces at play:

• Deal count has fallen to 2017 levels with increasing competition for capital. On the flip side investors are prepared to make record offers for great propositions
• The rise in AI is dramatically distorting the current valuation picture. AI startups are seizing a big share of the current investment pie
• Clear market positioning is crucial as certain markets have developed a wide spread of valuations across adjacent segments

Investment down but valuations hit new peaks

PitchBook reports that European deal count was 2,395 for 1Q24. This is down 27% v 1Q23. We need to go back 6 years to see transaction volume this low (1Q17 = 2,420 deals). Now, 2 years into 'the correction', we are witnessing just how much of a hard reset this has been for the entire venture ecosystem.

But on a positive note, overall capital invested showed a marked sign of recovery in 1Q24. Overall deal value hit €16.4B, up 20% compared to 1Q23 (and up 17% over 4Q23). And, to keep with the same comparison, the 1Q24 figure was 3x the level of investment for 1Q17 (€5.3B). In fact, 1Q24 was the third highest first quarter ever (after 1Q21 and 1Q22).

So yes, the bar is much higher than it has been for years. But for those startups that are now coming forward with compelling investment propositions, the rewards are there:

First, the combination of higher capital investment across fewer deals means that median deal sizes were up strongly across all stages in 1Q24 compared to 2023 overall, exceeding all prior records: Pre Seed €0.8M (up 44%). Seed €2.1M (up 30%). Early €1.9M (up 38%). Late €4.4M (up 41%). Growth €9.7M (up 61%).

Second, median pre-money valuations were also up strongly in 1Q24 compared to 2023 overall, again exceeding all prior records (except at Late Stage): Pre Seed €4.0M (up 58%). Seed €5.4M (up 9%). Early €7.3M (up 39%). Late €10.8M (down 3%). Growth €22.5M (up 10%).

The rise of AI is distorting valuations

As Pitchbook announced in its latest US funding report: "For valuations, it’s AI versus the rest of VC." European data to be published soon will likely reveal a very similar sentiment.

Median pre-money valuations for US early-stage AI startups jumped 51% from $47 million in 2023 to $71 million in 1Q24, compared to a 29% increase across all verticals, according to PitchBook’s Q1 2024 US VC Valuations Report. Late-stage AI valuations appear to be accelerating even more rapidly, and 35% of unicorn rounds are now AI companies.

Even startups that have little or no revenue are courting deals at significant valuations.

As Pitchbook reported, AI was the "obsession du jour" at the 2024 Milken Institute Global Conference in Beverly Hills this week. This is an annual gathering of some 5,000 investors, allocators, and bankers. Ten panels had AI listed in the event title, and many more veered into a discussion of it.

“Like the internet becoming commercializable with the browser, these discrete things spawn a whole new way that the world will be. We think this is one of those points,” said Ravi Mhatre, managing partner at Lightspeed, referring to OpenAI's launch of ChatGPT-4.

There is a real sense amongst VCs that the generative AI boom is a transformational moment for many industries. Sarah Tavel, General Partner at leading VC Benchmark Capital, in a recent interview, says we have to start changing the mental model of startups. For decades the industry has seen application software as a productivity improvement tool. But what AI enables is not just a productivity enhancement but "a tool that actually does the work".

AI is thus hugely disruptive and in many cases it is a service that no longer fits the 'per seat' business model. In the enterprise, Tavel talks about the "unbundling of the employee". Today, it's a spectrum of capability (as AI is still in its infancy) but there are already dozens of use cases where whole functions are being automated in such areas as HR, recruiting, sales, language translation and many others.

Many of the big rounds to date have been in the infrastructure layer, especially for training the big LLMs. But Benchmark's contention is that the application layer will now drive most of the value. There is already a second wave of startups coming into the market with much more sophisticated middle-layer capabilities, not just a simple API into an LLM.

Tavel also claims that the go-to-market strategy becomes easier: "It's not about an employee adopting something new but selling a complete work package" to the enterprise. The workflow is not enhanced, it is replaced.

As a result, VCs are now facilitating a land grab for hot application spaces. Huge funding rounds are being justified on the basis that the opportunity size is 10x or 50x bigger than selling software as a productivity tool.

Clear market positioning is crucial

When looking at valuation trends, 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. We know this already spans a multitude of industries. When you break down the AI & ML vertical into a 'market map', you discover it is comprised of 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 now contains over 23,000 companies), the two biggest segments are Horizontal Platforms and Vertical Applications. Each has 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.

For example, in AI & ML, when analysing 2023 Seed-stage pre-money valuations at the global level 6 months ago, there was a whopping 50% variation between Horizontal Platforms (the highest) and Vertical Applications. Now there is parity after the demand for Vertical Apps has shot up.

OFFER: What is my startup worth?

To help make sense of this rapidly evolving funding market, Duet is once again making available its extensive investment research capability. For companies looking to raise capital at Seed or Series A in 2024/5 we will provide a free, no obligation, peer group valuation trend analysis.

Our aim is to provide founders with the very latest market data, customised for their specific sector and funding stage. This is the hard evidence that boards seek but is often so difficult to obtain.

Founders interested in receiving this customised market trend data should contact John Hall at john.hall@duetpartners.com.
(Offer open to the first 25 applicants, closes 30/6/24).

Let's talk!