📕 Startup term you should know

Ever heard of Revenue multiple?

The value of the equity relative to the revenue the business generates. Revenue multiples are often used to value startups that are not yet profitable.

My insider scoop: Today it’s much easier to get to $1M ARR compared to 10 years ago, but companies can even get to $1M ARR and still NOT have product-market fit because distribution channels are so good. For this reason, Series A benchmarks have gone up — you need to be well above $2M run rate in most cases. Hustle Fund GP Shiyan Koh adds a caveat for early checks: seed companies have so little revenue that applying multiples to them “doesn’t make any sense.” Multiples earn their keep at later stages, where there’s enough revenue to compare against public companies.

📰 Today's topic: Are the private markets going to tank?

Is there any correlation between the public markets and early-stage VC? Startup investing oftentimes feels like its own little world, with its own prices and its own bull and bear cycles that don’t necessarily reflect the reality of the broader market. However, there is indeed a correlation.

Eric Bahn, GP at Hustle Fund, calls it the rule of six months. The rule is pretty straightforward: when you see a real, sustained move in public stocks, you’ll often see the same move hit early-stage private companies about six months later.

We can stress-test this idea by looking at historical changes in the market and how they’ve trickled down to early-stage prices.

How the rule of six months plays out in the market

Starting in the spring of 2022, public tech stocks fell off a cliff, with lots of companies trading far below their all-time highs. In the private markets, the pain showed up later. Eric observed the downturn wasn’t really felt in early-stage deals until around the second quarter of 2023.

In the fall of 2021, shares of late-stage private companies on the secondary market were trading at about a 20% premium to their last round price. Public stocks started selling off in the spring of 2022, and it took another 6-12 months for private prices to really give in. By May of 2023, those secondary shares were trading at an average ~60% discount to their previous priced round.

By this time, public stocks had already started bouncing back. For a while, you could buy some late-stage private companies at a discount to similar public companies.

If you know the indexes to pay attention to, you can come upon great buying opportunities.

Why the private market lag happens

Private markets are opaque, hard to access, and often inefficiently priced compared with public markets, so prices tend to adjust more slowly.

There’s also a human aspect to the lag: many of the people who invest in startups and venture funds have a lot of their own wealth in public stocks. When the market is up, they’re more willing to deploy capital, and when it’s down, they’re more risk-averse. It’s natural human psychology, but that behavior takes time to trickle down to pre-seed and seed rounds.

Applying the rule of six months as an angel investor

The rule of six months is a crude signal in a market that doesn’t have many of them. So we advise not treating it as a hard and fast rule. However, a crude signal is better than no signal, so here’s how to think about it in relation to your own investing:

• Watch for sustained moves in the public market vs. one bad week. If public markets have been sliding for months, expect founders to have a harder time raising soon, even if your deal flow is still robust today.

• Treat a downturn as a buying window. If you can invest at a lower valuation than you believe a company to be worth, you should.

• Expect the rebound to show up in prices. When public markets recover, valuations in early-stage deals tend to follow 6-12 months later, so the buying window won’t stay open forever.

Don’t change your whole strategy every time the market turns

VCs invest with a 7-10 year time horizon. You know what else tends to happen every 7-10 years? A recession. Every VC should plan on having to deal with one.

Dramatically changing your approach every time the market turns is probably not sustainable long term. If you believe in your investment approach, it should be able to withstand both bull and bear cycles. The six-month rule is about timing and pricing, not about discarding your thesis at the first sign of trouble.

And remember, early-stage companies depend on you when times are hard. These businesses are primarily underwritten by angels. These are the people willing to take a risk on a team they believe in, and who don’t have to manage LPs or fund timelines. When everyone else is scared, angels have a distinct advantage, and those founders won’t forget who showed up for them in their hour of need.

– Brian from Angel Squad

Overheard in SF…probably

“I told the investor we’re at a $12M valuation and he said ‘based on what’ and I said ‘conviction.’”