Once upon a time, reaching a $1 billion valuation was a Big Deal. But the shine that a so-called unicorn valuation conferred on a startup eroded as more and more private companies reached the threshold — often with less and less to back it up.
TechCrunch, where the term “unicorn” was born, noted the dilution of the denomination by working to collect notes instead on startups that had reached a $100 million revenue run rate, often measured in the form of annual recurring revenue, or ARR.
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That project was continued by a venture capital firm, dubbing startups that reached the nine-figure revenue mark “centaurs,” for obvious reasons. The refocus was useful, as there was more to learn from startups that reached $100 million in revenue than those that were awarded $1 billion in valuation.
But what about former startups that reach 10 figures of revenue? What can we learn from them?
Friends & Family Capital (multistage, mostly focused on companies with eight-figure revenue growth at 80% or more) ran an interesting analysis of private companies that sought to find out. Friends & Family compiled its findings into a report that I recently digested. TechCrunch also spoke with John Fogelsong and Colin Anderson from the firm about what they learned from the data.
The result is a series of notes about startups that don’t stop at $10 million or $50 million worth of revenue before they sell to some larger firm. Here’s how the biggest private-market companies got there.
Where winners spend
Given that we are discussing companies that reach $1 billion in revenue (the dataset includes 20 such companies, contrasted with a far greater number of private-market companies in revenue buckets from $100 million to $1 billion), and not some net income result, we’re more discussing growth than profitability. As such, the metrics that we care about are often more tuned to top-line expansion than net margins.
From that perspective, it’s interesting to see where companies that reach $1 billion in revenues do and do not spend. Something that stands out from the dataset is the ratio of R&D spending among companies that reach 10-figure revenues on sales when compared with their marketing efforts (S&M expenses), measured on a median basis.
They spend about twice as much on selling as they do on building. As you can see from the following table, the ratio holds up throughout various stages of scale:
Sure, there’s a little nuance in the numbers, but from $100 million to $1 billion in revenue, companies that reach truly huge scale spend twice their building budget on distribution pretty consistently (again, on a median basis). Certainly, more product-led startups reaching mammoth size could change the data in time, but it’s clear today that most startups will require huge capital budgets for S&M spending to reach the size they dream about.
How are companies that reached $1 billion in revenue different from other unicorns that have not yet reached the same scale? They spend more on S&M. The median company that reached $1 billion in revenue spent 47% of its top line on sales and marketing costs when between $250 million and $500 million in revenue. At the same scale, unicorns that have yet to reach $1 billion in revenue spent 39% of their top line on sales and marketing.
In a sense, the smaller companies are more efficient — but at the cost of growth. While the median that reached $1 billion in revenue was growing at 58% in the $250 million to $500 million revenue range, the unicorns that Friends & Family analyzed that had not yet reached the $1 billion revenue threshold were growing at just 32%. The greater S&M spending among startups that reached $1 billion in revenue had an impact.
This brings up a nearly tautological point that Fogelsong and Anderson made during our chat — that growth matters. Of course it does, you’re thinking. Yes, but to reach standout scale, companies simply cannot afford to reduce spending on reaching and closing new customers even in the name of efficiency. This pushes back against the venture narrative of today, which putatively argues that startups should trim losses and conserve cash. Not if they want to reach 10-figure revenue, we’d argue.
Higher-than-average S&M spending is not the end of the matter, however. R&D expenses at the median company that reached $1 billion in revenue tracked higher at nearly every revenue interval from $100 million to $1 billion that we have data for, when compared to startups that only reached lower revenue thresholds.
The best companies, measured in revenue terms, spend more on S&M and more on R&D than their smaller peers.
There’s a lesson there about the union of spending and growth at startups. Not that we should be surprised; after all, startups that grow the fastest tend to also raise the most!
The hidden cost of mega-scale
Notably, the startups that eventually reach $1 billion in revenue reach free cash flow positivity (FCF+) a bit earlier than their smaller brethren. Median companies that Friends & Family analyzed that had reached the $1 billion revenue threshold hit FCF+ when they generated revenues of $250 million to $500 million. Unicorns that had not yet reached billion-dollar revenues did not manage the same result until over the $500 million mark, again using medians from the shared dataset.
How did the companies that reached $1 billion in revenue manage to achieve positive free cash flow earlier than the companies analyzed that are smaller? Partly thanks to smaller general and administrative (G&A) spending on a median basis, as you can see in the above table.
The data is not clear enough for us to say this or that is the key reason why a startup that eventually reaches $1 billion in revenue is FCF+ sooner than smaller companies. But lower G&A spending is part of the puzzle.
All this is well and good, but we’re not discussing profitability here, just free cash flow status. Why does that nuance matter? Because the entire corporate population that we’re discussing pays out quite a lot to workers in the form of stock. Here the data is varied, with the median $1 billion revenue-reachers at times spending more as a fraction of revenue in share-based compensation than their smaller competitors (from $500 million to $750 million in revenue) and less in others ($250 million to $500 million in revenue). What matters is that startups that reach nine to 10 figures worth of top line tend to pay out more over time as a fraction of revenue in share-based compensation.
This makes sense. After all, the more value that a company has — which tracks with revenue — the more that it can afford to give out. But also, it’s likely not a shock that as the companies in question reach greater levels of FCF+, they’re also paying out more in share-based comp. Why? Because share-based compensation doesn’t count against cash flow.
This is a somewhat “hidden” cost at these companies: dilution. While some folks aren’t too worried about the use of shares as a way to limit cash consumption, it’s a cost all the same. Growth is expensive, period. Even the best companies consume gobs of cash and investor ownership to reach full size.
We cannot chew through every data point in the report that we find interesting, but I do want to snag one more before I let you go. Observe:
What we can see here is an acceleration in the rate (measured in time) at which startups go from birth to $1 billion in revenue, measured on a median basis. It has fallen from the high teens to the high single digits, counting in years. This is a large part of why startups are worth more today — they grow faster, which means that they have more value.
So the next time that you hear an investor complain about valuations, just ask them if they would like slower-growing companies. They can’t have both!