Rise Of The “Fastest Unicorn” - Discover The Unspoken Truth About Startup Valuations
There is a collective attempt to make Startup valuations sound like something rational. We throw around business jargon like MBA fundamentals, Product-Market Fit, ROI, SaaS metrics, market dynamics. But the “market dynamics” that underpin capitalism are at the mercy of the most irrational forces, as demonstrated by the zoo we call the stock market. In startup valuations, these irrational forces include investors’ biases and FOMO.
Of course, investors are nowhere near dumb: they want to make big money and often succeed. But they do so by hedging their bets across a diverse portfolio, because they fundamentally don’t know if any single one of their valuations is correct. They think of ROI at portfolio level. But startup leaders like you don’t give a toss about portfolios, you want to know how to value -your- company.
UK startup Cazoo just crossed the $1 Billion valuation threshold a mere 18 months after its funding, prompting the press to dub it the “fastest-ever British Unicorn”.
This article dissects why its valuation grew at such neck-breaking speed - the rational reasons, the irrational reasons, and what you can learn in order to boost your own company’s valuation.
MBA Fundamentals for Valuations
Business schools teach several methods to estimate the intrinsic value of companies, such as Discounted Cash Flow (DCF), the First Chicago method, the Book Value, the Liquidation Value, etc.
Another popular rational method is to value startups looking at “Comparable Transactions”. Basically you look at the price that other similar companies have fetched in previous M&A transactions. Then you work out the ratio between the transaction values and the respective companies’ EBITDA. Finally, you apply this “EBITDA multiple” to the company you’re considering. You can see a hypothetical example in the graphic below:
By the Comparable Transactions method, online marketplaces typically have a 3-5x EBITDA multiple, while deep tech companies have a 8-10x EBITDA multiple, for example.
Easy-peasy, right? This method is very popular thanks to its simplicity. But it’s impractical for early stage companies (in the first 3 years+ from funding) because their EBITDA is going to be erratic and most probably negative. So early stage investors will instead multiply Revenue by a “multiple” that is HIGHER than the industry EBITDA multiple, as there is larger potential upside for early stage investors. So in Series A and before, it’s common to value a company at 5-10x of Revenue (much more generous than EBITDA-based valuations).
“Fastest Unicorn” Cazoo is an early stage company. So how much did its Revenue drive the $1 Billion valuation? Spoiler alert: likely not much at all.
Cazoo hasn’t filed its accounts yet, so we can’t know for sure its Revenue. But we can estimate it.
According to a Sifted article, the company “says it has sold and delivered thousands of cars to date”. With most cars listed for £10,000 to £30,000 on their platform, and assuming that Cazoo doesn’t pocket the full amount but rather a % commission, their annual net Revenue is probably around £10-20 Million and their EBITDA is negative. To reach a Unicorn valuation, Cazoo would require a Revenue multiple of ~50-100x, which can’t possibly be based on average Comparable Transactions.
It’s not shocking to see a Unicorn with relatively low Revenue and negative EBITDA - even Uber and Amazon were money-losing Unicorns for the longest time. But this goes to show that MBA fundamentals are most likely NOT what drove Cazoo’s $1 Billion valuation. Which brings us to another classic rational criterion…
When a company has demonstrated its ability to deliver game-changing technology, its valuation soars. Even when a clear route to massive monetisation is unclear, some technological advancements can’t be ignored by investors, who can’t resist the urge to bet on such companies.
A good example is Google’s acquisition of London-based artificial intelligence company Deepmind in 2014 for $625 Million. Deepmind EBITDA or DCF-based calculations couldn’t justify this sum, but Google took a bet on the AI that the company was successfully developing.
As a technologist myself, I believe that betting on such game-changing tech is a winning investment strategy. High-tech accelerates way faster and is more defensible than low-tech businesses.
What’s apparent is that this criterion still doesn’t justify Cazoo’s Unicorn valuation, as the company isn’t building any revolutionary technology. So we need to move onto our next criterion...
Founder Track Record
It sounds rational to invest in a founder who has had Exits with large valuations before, right? Well yes, and the numbers agree. Leading BI company Mode Analytics published a study titled “Are Experienced Founders Better?” The study leveraged Crunchbase data and API to conclude that:
Older startup founders have higher chances to have large, successful Exits
These odds are even better when the startup is the founder’s second, third, or fourth startup, showing that the “lessons learned” from previous startups have material impact
The aforementioned study also highlights potential biases in the Crunchbase source data, but these conclusions ring true, especially as the track record of entrepreneurs has been known to influence fundraising and valuations.
And Cazoo’s founder Alex Chesterman has an insane track record, having built household names like LoveFilm and Zoopla and having sold the former to Amazon for £200 Million and the latter to a PE firm for £2.2 Billion!
With all of that said though, it’s rare for valuations to swell so much solely due to the track record of the Founder. It is evident to me that Chesterman played his impressive cards in order to leverage another, less-than-rational element of startup valuations…
Alex Chesterman has raised more than £200 Million for his new startup Cazoo, but he didn’t need to raise a penny. He’s very wealthy, he could’ve funded the company himself.
But he knew he could raise money easily at a huge valuation. All he needed to do was to tell investors that there was the opportunity to buy a stake in a company he was founding.
Investors inevitably wanted in. Not because of the numbers, not because of the technology - according to both of those criteria, Cazoo isn’t special. But because if you pass on an investment in Alex Chesterman and his new company makes it big, you will kick yourself.
That’s plain and simple FOMO. Compounded investor FOMO bridged the several multiples that separated a more realistic valuation of Cazoo from the prized $1 Billion threshold.
To Alex Chesterman, one of the world’s most successful serial entrepreneurs, we can only say a resounding, “Bravo!”
Now let’s draw the sums of what you can learn from him...
How -You- Can Boost Your Company Valuation
Know your numbers: What’s the typical multiple in your industry? Can you boost your EBITDA or Revenue now or show a believable path to a very appealing projected growth? If you’re an earlier stage company, valuation won’t be based heavily on this but you should demonstrate that you know this inside out. If you’re a later stage company, hire a finance professional experienced in DCF-based methods.
Show off your technology: don’t talk about your features, talk about your impact and ability to disrupt sectors. Are you building a faster gaming engine or are you setting the new standard that all Gaming companies will have no choice but adopt by 2025? Sell them your technology’s VISION.
Flaunt your track record: you may not be an Alex Chesterman (yet!) but don’t underestimate the impact that you and your cofounders as people have on your company’s valuation. So learn how to sell your unique background and bolster your credibility. Read more details in my article about what Investors want.
Play with investor FOMO: investors in your area / sector probably all know and talk to each other, so you should think about deliberately creating some buzz. I’m not suggesting to imitate Erlich Bachman from HBO’s hit “Silicon Valley” and stand up during a fundraising pitch to place your erm… privates on the table. But a much toned down version of that will indeed help.
BONUS - A higher valuation isn’t always good for you: valuations are a double-edged sword. At each funding stage, you’ll want to increase your valuation progressively. As a rule of thumb, you’ll want to 3-5x your valuation from Seed to Series A, then 3-5x again from Series A to Series B, and then double in Series C/D/E/etc. So for example if you’ve raised funds at a whopping $1 Billion valuation, then you’ll have to walk the talk and justify that valuation before you fundraise again. The key thing to keep in mind is that startup valuations, particularly at earlier stages, aren’t current valuations. Rather, they are a blend of current and belief in a future valuation at the next funding round -- i.e. you’re selling forward. Therefore, this period to “prove yourself” is typically half of your runway, because that’s when you’ll start fundraising or having M&A conversations. So the pressure is on! If you believe the market opportunity and/or Exit opportunity aren’t big enough to be valued $2-5 Billion within the next half runway, then you shouldn’t be raising at that high valuation. Ask for a lower one.
Basically, think about how you can play your cards right at your next fundraising! And if you want my advice on how you can do that in your specific situation, just grab a 30-minute slot and let’s jump on a call.