Have startup valuations fallen enough to feel sane again?


Welcome to the new week.

While recording Equity this morning, I noted with surprise an interesting bit of data that got me wondering about the current premium that venture investors are paying for startup shares, and if we can see anything new compared to 2022 data, especially given that complaints about YC startup prices are once again news.

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What follows is a somewhat numerate consolidation of several pieces that The Exchange put out last week. Read on if you have a minute and a fresh coffee, and thank you as always for your patience.

Today’s startup prices

One way to think about startup valuations is to bucket them by their venture stage, using median results to create a mental market map. To pick a recent example, Carta bucketed median pre-money valuations for Series A, B and C startups into $40 million, $90 million, and $173 million buckets, respectively.

Each figure is down from recent highs: $49.4 million for Series A in Q1 2022; $161 million for Series B in Q1 2022; and a staggering $416 million for Series C rounds in Q2 2021.

Those valuations, however, are imperfect. First, Carta doesn’t have insight into every deal out there, as it can only see the ones that its startup customers raise, so there’s some very understandable data completeness issues in its very useful dataset.

Second, just looking at the sticker price isn’t enough. We need more data than just the trailing median price range to really understand how startup valuations are earned.

How prices come to be

Why do we need all that data? We also want to know what the startups in those Series buckets have under the hood: the why behind the what. That’s why Point Nine Capital’s SaaS napkins, which provide time-bounded data on the inputs that yield the valuations, have become a staple for us data nerds who track the startup fundraising game. And the historical record of SaaS napkins — basically all the data concerning software startup fundraising that can fit on a small piece of paper — lets us compare and contrast norms across time. It’s helpful.

For example, 2019’s napkin indicated that SaaS startups looking to raise a Series A round needed annual recurring revenue (ARR) of $1 million to $1.5 million, growing at around 3x per year, to earn a check. In the same year, Series B startups needed ARR of $3 million to $5 million, growing at about 2.5x yearly.

The numbers were pretty damn different in 2022. Point Nine’s SaaS napkin reported that startups needed ARR of $0.5 million to $2.5 million, growing at 2x to 3x per year, to raise a Series A last year. Meanwhile, to land a Series B, a startup would need ARR of $3 million to $5 million, but with a growth range that could stretch from 1.5x to 3x per year.

In fewer words: Between 2019 and 2022, the metrics that a SaaS startup needed to hit got both looser and broader, which means startups last year could hit round benchmarks with less, and more, than in 2019.

Why do we care?

Lower revenue standards may impact something we’ve investigated previously: Over time, the premium that Series B startups have commanded over their public-market comparable peers has grown dramatically. This Redpoint data set indicated that the revenue multiple premium that Series B and C startups have over high-growth public software companies expanded from +60% in 2019 to +460% in 2022. Part of that massive appreciation was predicated on the public companies’ revenue multiples falling while their private counterparts saw their multiples more than double.

How did that happen? Public-market multiples corrected from their 2021 peak faster than the private markets last year, leaving startups swimming in water that, while cooling, was still artificially heated.

There is some good news to be found, though: The market for software stocks has found a trading range in the past year. You can see this in the changing value of the Bessemer cloud index, which is worth about as much today as it was back in May 2022. Sure, that implies some contraction in the effective revenue multiples of public software companies, but it’s a period of relative calm after a massive hike in the value of software companies that started in early 2016 and ran through the very end of 2021.

We’re now in a market where public companies are finding some stability, giving us firmer footing to contrast them with startup valuations, which, as we’ve seen above, have struggled to neatly track the public markets.

We can now figure out where the tension is in the startup funding market with regard to valuations:

  • Presuming that Series A startups need the same ARR of $0.5 million to $2.5 million to fundraise today that they did in 2022 (SaaS napkin), and their median pre-money valuation was $40 million on a median round size of $6.9 million in Q1 2023 (Carta), we can infer a median postmoney valuation of $46.9 million and an ARR multiple range of 18.8x to 93.8x.
  • Presuming that Series B startups need the same ARR of $3 million to $5 million to raise today that they did in 2022 (SaaS napkin), and their median pre-money valuation was $90 million on a median round size of $12.9 million in Q1 2023 (Carta), we can infer a median postmoney valuation of $102.9 million and an ARR multiple range of 20.6x to 34.3x.

Is that expensive? Let’s find out:

  • Bessemer reckons that the average revenue multiple of companies in its cloud index (all public) is 6.6x today, predicated on average revenue growth of just under 26%.
  • Altimeter’s Jamin Ball’s weekly data dump tells us the median multiple for public-market software companies is 6x (rising to just over 11x for the five most richly valued software companies, for reference).

Let’s use 6.6x for our math because it’s more generous to startup prices. Combining our two sets of revenue multiples, we can see that Series A valuations could be floating at a premium of +184% to infinity, and Series B rounds might be in a more consolidated range of +212% to +420%.

At the lower end, these prices are getting closer to a point that’s somewhat reasonable! Series A outliers are spoiling the punch a bit, but compared to data that we’ve previously consumed in our very rough math stemming from combined, disparate datasets, startup price premiums are coming down. This is healthy and implies that startup founders, venture investors and exit markets are getting back in sync, albeit slowly.

Now, what is a fair premium for startups? The old idea that startups should trade at a discount to their public peers is long dead. Instead, the market appears to be asking how much larger a premium should startups be able to command, given their far greater growth rates. The answer is less than they used to, but it’s still far more than the less than +100% ratios we saw in the middle 2010s (Redpoint data).

I am not going to sit here and tell you that startup valuations need to decelerate by a +100% multiple. I refuse to be that doomy on a Monday morning. But the work is probably not quite done yet.

That said, better is better, and it could lead to more startups closing a Series A or B this year instead of failing to reach valuation terms with their next investor.

(This article was corrected to rectify two references to Point Nine Capital. The previous version erroneously reffered to the firm as Nine Point.)