Startup Value Accrues in the Later Years #BusinessTips

#Entrepreneur

Yesterday I was meeting with a pair of entrepreneurs and the current fundraising/valuation climate came up. These entrepreneurs had been grinding on their startup for many years. Only, it wasn’t the proverbial hockey stick growth with everything up and to the right. It was slow to get going, but thankfully, now things were growing super fast — the hypergrowth badge was unlocked.

We talked about how some of their friends had raised money at crazy valuations — 25x or 35x annual recurring revenue (ARR) — just 24 months ago. Today, we’re a long ways from seeing that again, if ever, with valuations in the 4-8x recurring revenue range. I emphasized that while the valuations might be more rational now, the amount of enterprise value they were creating was still huge. In fact, most of the startup’s value accrues in the later years, assuming growth rates stay high.

Let’s look at an example with $1 of ARR being worth $6 in enterprise value (for simple math):

• Year 4
  • $1M ARR
  • Add $1M of new ARR
  • $2M total ARR
  • $12M valuation (6x ARR multiple)
• Year 5
  • $2M ARR
  • Add $2M ARR
  • $4M total ARR
  • $24M valuation
• Year 6
  • $4M ARR
  • Add $3M ARR
  • $7M total ARR
  • $42M valuation
• Year 7
  • $7M ARR
  • Add $4M ARR
  • $11M total ARR
  • $66M valuation

In this example, there wasn’t much value created in the first four years. Yes, the early years were critical for building out the technology, recruiting a team, signing the early customers, and assembling the pieces for growth. Looking at the next four years, the valuation shot up dramatically as the business scaled, with the majority of the value accruing in the last 24 months.

This phenomenon of when value is created makes startups especially hard. Tremendous amounts of work in the early years, and no knowing if or when things will take off, is a hard risk/reward equation for most people. When it works out, it’s an incredible accomplishment. Entrepreneurs would do well to know that most startup value accrues in the later years.

Entrepreneur

via https://www.aiupnow.com

David Cummings, Khareem Sudlow