Since the start of 2022, the startup fundraising space has substantially changed. The Russian invasion of Ukraine, the continued high levels of inflation across the world, and gathering fears of a coming global economic downturn have made investors a lot more cautious. Moreover, the Federal Reserve, European Central Bank, and others such as the Bank of England, have embarked on a cycle of monetary policy tightening, which has further driven the widespread startup investment pullback.
While these factors have combined to create a more difficult fundraising environment for startups, founders and their companies continue to have options. Investors still want to invest. They are simply more cautious about allocating capital because of market volatility. With this in mind, there are specific key financial metrics that investors will be considering over the next 12 months. By focusing on these metrics, startups can improve their fundraising campaign success.
What Are the Best Metrics for Valuing a Company
Company valuations have always been a complex topic. Many market observers have reacted in disbelief at some of the multi-billion-dollar valuations of some tech companies in recent years. In 2015 there were 80 companies valued at over $1 billion. This figure ballooned to some 900 companies valued at over $1 billion by January 2022. Much of this apparent valuation is tied directly to a company’s growth prospects. However, even the most famous of valuations examples indicate that putting an accurate figure on a company is much easier said than done. In 2019, SoftBank valued WeWork at $47 billion. Just two years later, its value plummeted to $9 billion.
There are so many calculations and seemingly endless types of valuation metrics for investors to consider when reviewing a company. Therefore, it’s very easy to get overwhelmed. In such situations, keeping it simple with time-tested metrics is generally a good rule of thumb. However, in this particularly investor-cautious market, startups must respond in kind to this sudden shift by focusing on what investors want to see.
- The magic number
Investors are more often asking for this company valuation metric - the so-called “magic number”. This metric defines the amount of money in annual revenue growth that every single dollar in marketing and sales investment produces. Investors are so keen to know this number because it enables them to get a more accurate view of return on investment that drives growth.
The investment era of readily available VC money is gone, or at least it is for the foreseeable future. With so many factors driving investment volatility - global geopolitical tensions, the Ukraine war, inflation, the climate crisis, and protectionism - it could be years or more before it comes back, if it ever does. As a result, due diligence has taken center stage again. Investors are taking their time to go through all major facets of due diligence before giving out any cash.
These include metrics such as company capitalization, price-to-earnings ratio, price-to-book ratio, price-to-sales ratio, and price-to-earnings growth.
- Company capitalization
The total value of your company’s shares.
- Price-to-earnings ratio (P/E ratio)
P/E, also known as price multiple, is the predominant starting-off point for valuing virtually all companies. As one of the most important financial ratios for investors, this valuation ratio provides insight into your company’s share price versus its annual earnings per share. As a result, you can see how many years it would take for the company to provide a full return on investment at the current earning rate.
- Price-to-book ratio (P/B)
P/E should always be calculated alongside P/B, rather than on its own. P/B can indicate if a company is undervalued by the market by revealing its book value. Likewise, it can also unearth whether your company is possibly overvalued by the market.
- Price-to-sales ratio (P/S)
P/S is calculated by dividing your company’s total capitalization by its total revenue over the last 12 months. This financial metric acts as a very insightful benchmark to determine the accuracy of a company’s valuation.
- Price-to-earnings growth (PEG)
To get the PEG ratio of your company, take your P/E and divide it by the rate of growth for your company over a given period of time, such as in the last 12 months. This metric provides investor insight into the cost of investment, its earnings per share, and the length of time that they may expect ROI based on the growth rate.
- Price-to-cash flow (P/CF)
This important financial metric measures your company’s capitalization versus its operating cash flow.
All of these seven metrics are going to be important for demonstrating your company’s appeal to investors. While they are all useful and insightful, the most important will be the magic number, as investors will be keen to learn immediately if your application for funding merits their attention. If it does, they will likely want to dig in further by employing a comprehensive due diligence stage, which will likely include the rest of the aforementioned metrics.
What is Value Investing?
There are two main types of investing: value and growth investment. Value investing refers to the identification and funding of companies that are viewed to be undervalued. Growth investment refers to companies with strong potential for high growth and to outperform the market. Value investment metrics include P/E, book value, sales figures, debt to equity and any others that can indicate if a company valuation is lower than it should be.
What is a Good Market Value Ratio?
As shown above, there are many ways to get an idea of your company’s market value. However, because no single ratio can be completely accurate, investors tend to use a number of them in conjunction. This enables them to view your company from different angles and understand it in greater detail. However, the use of the magic number is trending up. Its trajectory as the go-to reference point is only set to continue over the next 12 months. Generally, a magic number of one or thereabouts is considered strong. This is because it demonstrates that your sales and marketing efforts are driving consistent revenue.
Top Tips for Attracting Investors in Difficult Market Conditions
Many startups make the mistake of thinking that investors simply don’t want to invest when market volatility and uncertainty persist. This is not true. Most investors do still want to invest. They are simply more cautious about where they put their money. They tend to take extra precautions to assess your company before deciding. Here are some tips to put your company in a strong position to continue to receive funding during difficult market conditions.
Have a clear understanding of your financial position
Investors want to know key financial metrics. By having these ready to go, you will be able to provide prompt, informed communication and data to would-be investors. To do so, you must have a full and clear understanding of your company’s financial position.
Establish an efficient financial reporting process
Using the right financial automation technology can ensure that your company is able to keep track of its financials and update them in a timely manner. This can ensure that the data gathering, analysis, and interpretation steps are fast and comprehensive, and that the investor reporting process is highly detailed and precise.
Focus on your leadership team
Investors will focus on leadership teams whatever the state of the market is, but this will especially be the case during less predictable conditions. More than ever, they will want to invest in people they believe in as they are placing their trust in the form of funding in them. Typically, investors will want to see strong competence, market knowledge, and synergy between all the individuals that lead your company - the founders, executives, and department heads.
Drive Your Fundraising Campaign Success with the Right Approach and Support
By adopting an approach that adapts to changing investor preferences, you put your company in the best position for fundraising success. The alternative - of having your own defined way of showcasing your company and expecting investors to adapt to you - may place you at a disadvantage. For the rest of 2022 and in 2023, investors will be taking a far more cautious approach to startup investment than they have in previous years in response to greater market volatility and uncertainty. They will be eager to know your company’s magic number and also likely carry out a thorough due diligence process.
With this in mind, now is the time to get your company in as best shape as possible and have a crystal-clear understanding of its financial position. To do so, financial planning and analysis software that harnesses leading technological capabilities in automation, data management, and machine learning can accelerate your performance.
Abacum can empower your company to exceed investor expectations with unrivaled performance tracking, investor reporting, and detailed, data-driven forecasting to drive your business growth and enable precise measurement in real time.
If you are looking for a solution to help streamline your data into a centralized platform, Abacum is your cutting-edge, cloud-based platform. To see how Abacum equips your team to keep track of crucial KPIs and metrics, request a demo today.