If you are an angel investor and are keen to participate in Africa’s boom in the Startups space, you must wonder how startups are valued. Based on data from Africa: The Big Deal, it has taken just 7 weeks for African startups to raise their first USD 1bln in 2022, and in some instances, with valuations, …
If you are an angel investor and are keen to participate in Africa’s boom in the Startups space, you must wonder how startups are valued. Based on data from Africa: The Big Deal, it has taken just 7 weeks for African startups to raise their first USD 1bln in 2022, and in some instances, with valuations, we have not seen before! For context, the total funding raised by the ecosystem in 2019, just 3 years ago, was USD 1.3bln!
Assuming you are already convinced that there is something here, the next question is which startup should you invest in and under what terms. The key term you are probably wondering about is the ‘V’ -word, Valuation! One of the questions I am asked most often is how do you value a startup? How can you tell that the valuation is correct? My answer, I really do not know and am not even sure it’s a question that can be answered. There are several methods used to value startups; if this is what you are looking for, unfortunately, this blog will not answer your question. However, this piece will help you decide if the deal at hand makes sense from an expected return perspective.
Public companies are valued. Private companies are priced! I did not coin this phrase. I do not know who did, but credit to one of the leading early-stage investors in the African ecosystem Eghosa of Echo VC, for bringing it to my attention. Once this statement sinks in, you will see the valuation of startups in a different light. For me, it boils down to a few points:
What then is the right question to ask? I think the question should be, should I invest with the terms on the table and with my return expectations/target? The VCs have thought about the problem and have developed systematic ways to answer this question.
The good part is that luckily for you, we have developed a tool that will help you to use this method to find out if you should be investing based on the terms provided to you by a startup. The bad part is that it will require some heavy lifting. The tool helps you think about the startup’s pricing the deal terms and ask what kind of returns you should expect under different scenarios. One of the key due diligence (DD) aspects every investor should carry out, assuming everything else checks out, is the deal terms DD! Here you ask, is this good business a good investment?
Let us make this tangible ; in 2020, amidst the chaos and suffering Covid caused, one story that made me smile was Paystacks acquisition by Stripe for USD 200 million (mio). At the time, we had not seen all the billions currently getting raised and this acquisition had the same impact as Flutterwave’s USD 3bln valuation.
Let us assume that you were an angel in this deal and that you invested USD 10,000 at a valuation of USD 1,000,000. From various case studies, we know that the company did not raise many rounds of funding, but let us assume that your exit happens at Series B for our illustration. Let us also assume that they had raised a Pre-seed, Seed, Series A, and finally, you exited at Series B by this time. That would mean you invested in the first round and there were two other rounds before your exit Let us also assume that you did not participate in subsequent rounds of investing as a new angel, which means that after your initial USD 10k investment, you did not invest in any of the other rounds. This means you were diluted in each of these subsequent rounds but thank God at higher valuations as the exit would show.
For ease in calculations, let us assume that Paystack took the following path to exit (which is achievable, a pricing lift of 5 – 10x between different rounds). Let us also assume that each round happened after 12 months with 10 – 15% dilutions per round.
With this in mind, we can determine the kind of returns you would have gotten at the exit, but that is not the fun part. The interesting part is asking yourself what kind of returns you would have posted had the entry valuation been different. We assume a pre-seed post-money valuation range for this blog starting from USD 1 mio – USD 25 mio.
The table below summarizes the return scenarios.
A few key takeout’s from these return numbers:
Conclusion: valuation, pricing or whatever you want to call it matters. Amid this frothy valuations market, do your analysis, not only on the company but most importantly, on the deal!