Today’s entrepreneurial ecosystem is experimental. It’s experimental because 500,000 companies are started every year with a hypothesis for solving a problem and, in that same year, an equal number of businesses fail.
From a macro perspective, these innovative companies test the market and either have groundbreaking success or enlightening failure. Those that fail send a powerful signal to the market that helps evolve our collective thinking about business and investing. Another powerful signal is the valuation multiple paid to invest in these companies — how is the market pricing innovation?
At EquityNet, we have a front row seat into this global experiment and used our proprietary data to uncover insights in the businesses raising equity crowdfunding and the investors funding these individual research labs (startup companies).
This study includes data from the more than 10,000+ businesses that have used EquityNet to raise funding between 2007 and 2021. The data includes funding goals, pre-money valuations, number of employees, and more in the fundraising deals that helped raise more than $500 million cumulatively.
Summary of our Key Findings
- The average valuation to revenue multiple for crowdfunded businesses in all industries is 11.9x in 2020.
- Valuation multiples of privately held companies are correlated with price-to-earnings multiples of S&P 500 companies, although discounted significantly.
- Valuations have risen over the last decade while crowdfunding goals have remained relatively constant.
- The average funding goal between 2007 and 2020 was $2,018,245.
- On average, the valuation investors on EquityNet got was $1.3 million less than the valuation entrepreneurs sought.
10 Employees: Sweet Spot for Crowdfunding Stage
According to the Bureau of Labor Statistics, there are 9.5 million businesses in the U.S. with employees. And while it’s likely that only a small fraction of that statistic employs more than one employee, those that grow to more than five employees are likely in a better position to raise angel or venture capital.
Interestingly, of those companies raising crowdfunding, the average number of employees is ten. From looking at the data, this number appears to be the optimal headcount when raising equity crowdfunding to optimize the valuation per employee.
A higher valuation per employee could signal the company’s ability to create value while remaining lean and can likely sustain operations longer.
12x Revenue: Valuation to Revenue Multiples
In public market equities, price-to-earnings ratios are helpful to gauge the company’s earning power per share compared to how expensive it is to take part in that earning power. Since private equities don’t usually have market data price quotes, P/E ratios are not as easy to come by.
In a similar analysis based on the average pre-money valuation compared to average annual revenue, we were able to get a proxy P/E ratio. In 2020, the average valuation to revenue multiple for the companies in our study was 11.9.
This means that companies raising equity crowdfunding are doing so at valuations around 12x their annual revenue. The average revenue multiple over the last decade was 9.2, which means investors have been pricing significant revenue growth into their investments.
Notice in the chart above how revenue multiples were contained in the 5-10x range between 2008 and 2019 before breaking through 10x in 2020. We expect this upward expansion trend to continue into 2021 and beyond as long as the global markets remain stable.
Of course, not every company or industry will raise funding at 5, 10, or even 12 times revenue. Industry often plays a big part in the funding multiple because each industry differs in business models and subsequent profit margin.
Operating profit margins tend to be wider in industries like software and media, for example, as compared to industrials and manufacturing, which explains the spread in revenue multiples investors are willing to pay.
VC Revenue Multiples Correlated to S&P 500 PE Ratios
One interesting comparison to look at is how our valuation to revenue multiples compare with historic price-to-earnings ratios among companies in the S&P 500 index. Interestingly, there is a clear correlation between these two metrics, despite 2009 being an outlier year.
After the housing market collapse of 2007-2008, earnings were down significantly but by 2009, investor optimism returned to stock prices, which inflated P/E ratios significantly.
All things considered, the correlation between private and public markets showcases that a price (or valuation) to earnings (or revenue) follows a similar curve. Most often, the growth (or decline) of public market valuations can be a good indicator of private market valuations.
This analysis also highlights the benefit of investing in early-stage companies with the potential for an IPO exit. Investors who are able to buy a spot on the cap-table of these high-growth and IPO-bound companies will stand to profit from this discount, and likely much more.
Valuation vs. Funding: Pre-Money Valuations Diverge From Stable Funding Goals
Another interesting trend we uncovered during this study is that while pre-money valuations have increased between 2007 and 2020, the funding goals of crowdfunding campaigns have remained relatively unchanged.
This signals to us that $2 million is the sweet spot for equity crowdfunding campaign goals, despite rises in perceived pre-money valuations. The average funding goal between 2007 and 2020 was $2,018,245.
You might stop and ask, “wouldn’t inflation cause companies to require more funding?”
In fact, $2,000,000 raised in 2020 would have the equivalent buying power of only $1,554,212.70 in 2007. So raising $2 million today is almost 25% less impactful dollar for dollar than it was in 2007.
One hypothesis for why inflation didn’t significantly impact funding goals is that the amount needed to build a company is inversely correlated (i.e. startup costs decline overtime). Let’s use the software industry as an example.
In 2007, cloud computing wasn’t as ubiquitous as it is today, meaning many software companies chose to host products on their own servers, increasing the startup costs significantly. Today, however, scalable cloud computing allows companies to get quickly up and running and only pay for what they need.
Expectation vs. Reality: Valuations by Industry
It’s clear who has the negotiating power in deals: investors.
The entrepreneurs and teams behind the companies bring forth their desired pre-money valuation into the deal, and investors will negotiate for a post-money valuation they are comfortable with.
On average, investors on EquityNet got valuations worth $1.3 million less than the valuations entrepreneurs sought.
The industry with the largest disconnect between the amount of funding sought and the amount raised on average is the energy and utilities sector. These companies sought valuations around $14.5 million and were able to raise at valuations closer to $12.1 million, a $2.4 million difference.
The electronics industry, on the other hand, saw an average difference between the valuation asked and the closed deal valuation by less than $120K.
Investing at Valuation Multiples You’re Comfortable With
As the data shows, investors have the upper hand in negotiating deals and will ultimately only invest in deals they believe can deliver value to themselves or their LPs. In hot deals, it can be tempting to stray from your investment thesis and philosophy, paying more in the way of a valuation multiple than you initially intended.
One of the benefits of using EquityNet is the access to multiple deals in the industries that align with your investment focus. Another benefit is that you can negotiate the terms of each deal based on your investment plan’s target valuation multiple. Unlike other platforms that essentially operate on drag-along terms, giving the investors little or no say in what price is paid in terms of valuation and more.