Before you read this, first check what your historical compounded monthly revenue growth rate is.
Got your growth rate figure ready? Let’s continue.
To evaluate an investment opportunity, investors will be looking at all areas of your startup such as business model, addressable market size, team profile, traction, etc. The growth rate, which is under the “Traction” section of your pitch deck, plays a big part in how an investor will evaluate your valuation.
So, the question is how much does growth rate affect your valuation?
Here’s an example:
Assume there are two competing B2B SaaS startups (A and B) with the same monthly revenue of US$10,000 a month but with different historical growth rates. Startup A was able to achieve a 10 percent revenue MoM growth while Startup B achieved 20 percent.
- 10 percent revenue MoM growth for the next 12 months = US$31,000 per month or an annualized revenue of US$400,000 (rounded up for simplicity)
- 20 percent revenue MoM growth for the next 12 months = US$89,000 per month or an annualized revenue of US$1 million (rounded down for simplicity)
Generally, SaaS startup valuations tend to apply a revenue multiple on top of the annualized recurring revenue (ARR). The range of revenue multiples is between two and 10 times and is determined by four core elements:
- Growth rate
- Market size
- Revenue size
- Churn rate
The average revenue multiple is four times, in general.
Let’s get back to the above scenario.
- Startup A, with 10 percent MoM growth and US$400,000 in annual revenue, will multiply with a revenue multiple of four times and have a valuation of US$1.6 million.
- Startup B, with 20 percent MoM growth and US$1 million in annual revenue, will multiply with a revenue multiple of six times and have a valuation of US$6 million.
When both startups raised series A at the same time with 20 percent dilution, Startup A got only US$320,000. Startup B, on the other hand, was able to raise US$1.2 million, which they can spend on scaling up customer acquisition, executing faster technology enhancement, and onboarding more expensive talent.
Eventually, Startup A will be losing clients to Startup B due to the latter’s better product features. This will lead to Startup A managing to break through at only 15 percent MoM while Startup B is aggressively growing at a higher rate of 30 percent.
By the end of another 12 months with those growth rates, Startup A will have monthly revenue of US$166,000 or an annualized revenue of US$2 million. Startup B will have monthly revenue of US$2 million or an annualized revenue of US$24 million. That’s a revenue gap of 12 times!
Guess what their valuations are by then? For simplicity, just apply the revenue multiple of four times to both startups. Startup A will have a valuation of US$8 million while Startup B will have a valuation of US$96 million. Startup B could literally make an acquisition offer to Startup A with 9 to 10 percent equity or an all-cash deal.
Of course, the investor who invested in Startup A’s A round would still be happy, as they invested at a valuation of US$1.6 million and the valuation grew to US$8 million. But what if there was no acquisition offer or investors willing to fund their next round and the startup was forced to pivot? That would be a nightmare.
Dear startup founders, growth is what all investors care about in the end. Not your fancy achievements, key recruits, growing but not paying user base, beautifully designed app or pitch deck, and groundbreaking features. Revenue is the king to stay ahead of the curve.
If growth strategy is not working, fine-tune and change! If you are growing, don’t just be comfortable; escalate the growth to the next level! If you’re not careful, you’ll end up like Startup A.
In the case where there’s no competitor in the country or region, having a first-mover advantage does give you a fantastic head start. But a late-comer startup with a better growth rate will still overtake you in a matter of time.