This week on the startup to scaleup journey:
Do valuations matter?
Venture investing is driven by power law where a very small number of companies in any portfolio return most of the profits. But identifying which companies will become the 'home runs' or the 'outliers' is almost impossible at the outset. This drives the mindset that each investment must have the ability to 'return the fund'. What does this mean? VCs will talk about their 'fund model'; this is a simple formula that helps them determine the basic financial parameters that will 'return the fund'. For example, a $150M fund may invest $5M in a $20M pre-money valuation deal to own 20%. They might expect some dilution over time and if that gave them say 10% at exit, the company would need to be worth $1.5B or more at exit to 'return the fund'. Using the same calculus for a smaller $50M fund would imply an exit valuation target of $500M. Even though this is a very simplistic example (and ignores other factors like follow-on investments), the reason why valuation matters here is that it determines the % stake at the outset for a given ticket size. This is the only real factor a VC can control that has a direct bearing on the eventual outcome and so they put great store by it. VCs that can't secure their initial target stake will often pass on a deal even if they think it's a great company, as it could put overall target returns at risk.
Weekend Fund, an early-stage US VC, publishes advice and learnings crowdsourced from other VCs to help the investor community follow key trends. Some of these insights are eye-opening and provide a behind-the-scenes look at how VCs think on a whole range of topics, from deal sourcing to portfolio construction. A recent survey, "Do valuations matter?", assessed the current mood by asking: What drives valuations? Should they impact investment decisions? How do fund managers approach the “valuation question”? In terms of the key valuation drivers, the consensus seems to be, in order: 1. Investor willingness to pay (how compelling the story is). 2. Competition amongst investors (FOMO). 3. Demand for companies of similar quality, scope, scale, (and) market, and 4. Fund model (as we describe above). In reality, all these factors play a part in determining valuation and thus an investment decision. In the current market, the fund model is having ever greater sway. Nikhil Trivedi at Footwork VC says another important consideration for investors is that the valuation should set the company up for a successful round in the future. The higher the valuation for this round, the higher the valuation hurdle the company needs to clear for the next round. Many companies that raised at the peak in 2021 will struggle to ever grow into those valuations - even if they exceed all expectations. Some may never meet fund model thresholds and will be forced into down rounds.
How should these insights influence how founders think about valuation when talking to VCs? The hardest mindset shift is to appreciate the difference between the attractiveness of a company and the attractiveness of an investment. For VCs, not all great companies make great investments, especially if they are carrying an 'above-market' valuation. This factor has greater weight the later the stage of the company, where bigger VCs will more likely adhere strictly to their fund model guardrails. Smaller funds, those typically operating at pre-seed and seed, may focus less on valuation (and thus % stake) and more on just finding the right company. The smallest of these funds are less likely to lead rounds (and set the price) and will often be happy just to get an 'allocation' of a great opportunity. Whatever the fund size, if a founder believes their business doesn't have the scope for the sort of valuation growth that would deliver the returns sought by institutional funds, then mainstream VC may not be for them. They will need to target investors that see value not just in pure financial terms, but in other forms of ROI. For example; corporates looking for strategic value or Impact Investors looking for ESG contribution. In short, valuations do matter, but are only ever part of a more complex picture.
The unexpected benefits of PR
PR is one of the most powerful activities in the startup growth toolkit. Yet it is often underappreciated by founders and investors alike. The first problem is that its impact is hard to measure: In the early days of the startup where every $ counts, if there is no clear ROI then it's an activity (and expense) that's hard to justify. Secondly, in an age where founders can communicate easily with the world on so many other fronts (social media posts, blogs, podcasts etc.), why is press coverage even important when the founder themselves can create so much awareness? And for founders that have no direct experience of PR from a prior life, it's yet another topic to master when there are other pressing matters to deal with. As a result, PR often gets kicked down the road until the company wants to make a big announcement, such as major product launch. But experienced founders build PR into their marketing communications plan at an earlier stage. They understand that good PR delivers significant benefits way beyond customer acquisition - the most common reason why PR is eventually incorporated into the growth strategy. In fact, customer acquisition may be the least important reason in the early stages.
The key to effective PR is understanding the target audience you wish to influence and the best channel to reach them. PR should always be targeted and never just 'monolithic'. Startups have many potential audiences (e.g. Investors, early adopters, prospective and current employees, potential acquirers, and of course, prospective as well as current customers). As VC, Mark Suster, points out in one of his historic posts on PR, each audience is looking for different content and is accessing different media channels to do so. For example, getting coverage in TechCrunch on your disruptive breakthrough will probably get noticed by VCs but will be unlikely to drive new sales enquiries. Early adopter types will likely be reading the technical press instead. And there are other benefits: Recruiting is made easier when prospective candidates have already read about the company and its vision. Employee morale is lifted when current employees see their company described in glowing terms in a prestigious publication. Potential acquirers begin to track startups at an earlier stage than most imagine and will often monitor industry press. And when you eventually want to leverage top-tier media outlets - such as the Financial Times, Wall Street Journal, Forbes, BBC, CNN etc. - they are far more likely to write about you or have you on their show if you already have a media profile.
So, how to deliver all this? Setting out to build and execute a PR strategy without professional support can be a big challenge - especially for those that haven't been exposed to the PR world before. Equally, recruiting a quality PR agency is not easy as this is a field awash with pretenders. But great firms exist and founders should seek referrals from other founders or advisors in their network. The most talented operators can help deftly tailor your company story for different audiences and facilitate access to the most influential media outlets. They will help you develop a regular drum beat of coverage, so valuable during funding campaigns. But there's nothing more concerning than a sudden burst of news, especially a contract award, followed by months of radio silence. This will get noticed by investors during due diligence and will immediately put the company on enquiry. A strong cadence on the other hand will signal momentum. As Suster says, "Great PR could add $10 million to your valuation or increase your chances of closing a round 2x and either case is a reason to make sure you have good press. It’s much harder to get funded as a company nobody has heard of."