888-983-1617 [email protected]

Can Your Startup Generate Venture Scale Returns? Check the Math.

My good friend Beezer Clarkson at Sapphire Ventures spots the best articles. This one, by a partner at JME Venture Capital, shows one way for company founders to see their businesses through investors’ eyes.

I’ve summarized the article here, so the post is longer than usual.

1. Remember the business that investors are in – getting their money back, plus a risk-adjusted return that makes sense measured against the size of their fund.

2. This is just math. The author highlights these rules of thumb:

  • An early-stage venture fund is going to invest in 20 companies.
  • To achieve a 2x cash-on-cash return and 15-25% IRR for limited partners, the fund aims to get a 3x gross return (before fees) across all its investments.
  • The expected distribution of outcomes is 1/3 losses (7 companies with 0x returns), 1/3 money-back (7 companies with 1x returns), 1/3 successes (6 companies with substantial returns). The expected distribution of the 6 successes is 1 home run and 5 “meaningful exits.”
  • Crunching these numbers, each “meaningful exit” must generate 1/3 of the original amount of the fund. In other words, if a $50M fund must generate $150M overall, each investment (averaging $2.5M) must have the potential to generate $17M in 5-7 years.

3. A founder/business owner can use the math to back into enterprise value targets that investors will be thinking about as they assess investments.

  • The author assumes that an investor is going to construct a 20% ownership in a successful company over time (not an easy task).
  • So, for a $50M fund, an investment must generate at least $17M in returns to be considered meaningful, with a 20% ownership position for the VC at the time of the exit, implying that the company has to be sold for at least $83M. If the VC had only 10% of the company instead of 20%, the company had to sell for $167M instead of $83M just to be meaningful.

4. The enterprise value target and valuation multiple at exit lead to a revenue target. Gross margin and growth rate are some of the most important factors to determine the valuation multiple.

– As examples, the author assumes (a) no debt, (b) the same growth rates and (c) these basic gross margin and valuation metrics:

  • A SaaS company with 75% gross margin can be sold for 5x ARR.
  • A marketplace company with 15% take rate can be sold for 1x the last 12 months (LTM) gross merchandise value (GMV).
  • An e-commerce company with 30% gross margin can be sold for 2x the LTM revenues.

– Now that we know the size of the exits we need (e.g. $83M for the $50M) and the expected revenue multiples for different business models (e.g. 5x ARR for SaaS), we can determine the revenue targets for the different combinations of them:

  • A SaaS company has to be able to generate $17M in ARR in 5–7 years.
  • A marketplace company, $83M in GMV.
  • An ecommerce business, $42M in revenue.

5. So, as a business owner, can you grow fast enough to become a meaningful exit for this kind of investor? Continuing the example of the $50M fund and the SaaS company:

  • Consider that some of the best SaaS companies have followed an annual growth rate of T2D3 (triple, triple, double, double, double). This means that, if current ARR is $200K ($17K MRR) and this revenue trajectory is achieved, the company reaches ~$14M ARR and might be a meaningful exit for the VC.
  • Then consider sales and marketing costs and other expenses required to achieve this goal, and assess whether the overall picture is achievable.

The takeaway: Different investors have different parameters. Make some assumptions and do the math to estimate exit requirements of investors you might want to target. Focus on those whose requirements you can achieve.

Read the whole article here.

3 Signs an M&A Deal Is in Trouble

Read the article in CFO.Spotting signs of trouble early is critical for CFOs to prevent a deal from derailing. Not every CFO will experience M&A firsthand during their career. But those who do typically find that their existing skillset makes them a crucial asset...

4 Tips for Pitching Investors in Today’s Economy

Read the article in CFO.Any company that intends to grow past a certain point eventually reaches the familiar milestone of pitching to private capital sources in hopes of securing additional funding. Those businesses that tend to be most successful are the ones that...

Resolving Conflicts in a Family Business

Read the article in Small Business Current.When family members run a business together, the experience often draws them closer, but there are inherent risks as well. Having years of personal history with one’s co-workers can sometimes lead to non-work disputes...

Oaklyn Consulting Congratulates Proof of the Pudding on Acquisition by Bruin Capital

Oaklyn Consulting congratulates Atlanta-based catering, food service and event company Proof of the Pudding on its recent acquisition by Bruin Capital. Oaklyn Consulting assisted Proof of the Pudding in evaluating potential partners and negotiating the transaction....

Analyzing Broad vs. Narrow M&A Deal Processes

We respect the unique M&A market insights that Sutton Place Strategies, an affiliate of Bain & Company, creates from its business development work with PE firms. SPS Founder and CEO Nadim Malik gave a presentation at ACG Boston's M&A Outlook forum in...

How To Work Through Conflicts In a Family Business

Creating a family business comes with a lot of positives, as well as a lot of challenges. Here’s how to handle those conflicts as they arise. Thanks to The American Genius for having me! Read the article in PDF.Anyone who’s managed a business with other family members...

Takeaways from Axial’s Recent ‘Dead Deals’ Analysis

Those of us who negotiate M&A transactions for, and with, small- to mid-sized businesses know a few hallmarks of the process: For any company, there is a limited universe of buyers. Each buyer's interest is unique, so average valuations are not reliable indicators...

Who We Helped in 2022

At the start of every year, we at Oaklyn Consulting like to look back at the past 12 months to reflect on projects accomplished and lessons learned from our clients. Building on our achievements from 2021, Oaklyn Consulting worked with 34 organizations in 2022 on...

Monty Bruell Interview with Business Radio X

Our Monty Bruell sat down with Business Radio X to discuss succession planning in minority and women-owned businesses. Listen on Spotify or Amazon Music or read the transcript below!INTRO: Broadcasting live from the business RadioX Studios in Atlanta, Georgia, it's...

Succession Planning for Minority and Female Business Owners

For the founders of minority and women-owned business enterprises (MWBEs), succession planning takes on a deeper significance. Our Monty Bruell explains in a guest column for Memphis Business Journal. Read the article in PDF.Any entrepreneur approaching retirement has...