The Reality of Valuations

Originally a thread on X/Twitter:

2020 + 2021: Most “valuations relative to traction” were crazy

2022 + 2023: Bridge rounds helped startups grow into their valuations

Now + 2024: Most “valuations relative to traction” will be reasonable

But some startups can raise at high multiples due to momentum:

Every talented Investor eventually comes to the realization that Momentum is one of the most powerful forces in the growth (and therefore valuation) of a Startup.

Momentum is a very simple Physics concept that ports nicely over to the business world.

The Physics formula for momentum is: P=MV (Momentum = Mass X Velocity) but the easier way to think about it conceptually is “mass in motion”.

In business terms, it matters how large a company is (mass) and how fast it’s growing (motion).

The reason why “mass in motion” matters is best described by Newton’s First Law of Motion.

“An object at rest stays at rest and an object in motion stays in motion with the same speed and in the same direction unless acted upon by an unbalanced force.”

In simple terms, this means that for any given driver of a startup’s growth, it should continue on its current trajectory unless an “unbalanced force” emerges.

The implication is that a startup’s forward growth rate is highly correlated to its current growth rate.

So many early stage startups with 10X+ revenue multiples are growing quickly and Investors can get excited about how much larger it will be in a few years.

$1MM ARR becomes $3MM ARR becomes $9MM ARR becomes $27MM ARR.

And each industry has its own “physics of growth” that determines whether a company’s go-to-market motion gets easier or more difficult with scale.

This has a profound impact on a startup’s valuation for all the obvious reasons!

In general, DTC businesses get more difficult as they scale unless they can generate viral growth loops.

In general, B2B businesses get easier as they scale due to social proof from “logo collecting” and the fact that many buyers want to be “first to be third”.

There are also startups that have the potential to grow even faster than simple Momentum would suggest.

The commonality in these hyper-growth companies is that there are multiple drivers all experiencing Momentum at the same time.

Imagine a startup with two or more key drivers each growing at 2X. Compare it to a company with only one driver growing at 2X.

In 3 years, one company is 8X its current size while the other has experienced 64X growth!

The math of “Multiplicative Momentum” is so stunning that it needs to be experienced to be believed.

But once it’s been experienced by an Investor they know how to spot these types of companies and are willing to pay-up early.

I’ve seen a marketplace model where a hypergrowth acquisition engine created negotiating power with vendors and transactional pricing power with businesses that wanted access to its active customer base.

“Customer Momentum” X “Margin Momentum” = Magic.

I’ve seen a payments platform that was scaling its merchant base quickly that also benefitted from the merchants experiencing hyper-growth at the same time.

“Sales Momentum” X “Partner Growth Momentum” = Magic.

And valuations are not a simple function of revenue.

A startup has to manufacture a product at a lower cost than it can sell it for, scale to overcome G&A costs, and then generate profit by capturing additional market share with positive operating margins.

Everything matters.

The TL:DR is that valuations are a reflection of what a startup is likely to look like AFTER deploying the money, not what it looks like at the time of funding.

A startup with Momentum and an improving go-to-market-motion can command a high valuation for a good reason!