How have startup valuations increased over time?

Entrepreneurs frequently assign a value to their startup (startup valuation) when they seek startup funding or when they distribute shares to their staff, advisory board, and advisors. It is crucial to accurately assess a startup because if it is overvalued, investors cannot decide on a precise decision. However, there is not a simple formula to use when determining a startup's value. Thus, the qualities of the good or service, business expectations, and the total available market are all taken into account in startup valuations.

The valuation is crucial for venture capitalists because it affects their relationship with their fund providers, the percentage of shares they will receive in return for their investments, and the overall profitability of their fund. The valuation is also crucial for the entrepreneur as well since it determines his motivation and assigns a value to the time and money he invests in his new business. Additionally, according to studies, the valuation is crucial because it harmonizes the goals of the entrepreneur and investor, aids in structuring and ensuring fair treatment (https://experts.umn.edu/en/publications/an-entrepreneurs-guide-to-the-venture-capital-galaxy), and lessens the likelihood of future conflicts between the two parties (https://www.tandfonline.com/doi/abs/10.1080/13691061003771663).  

The year 2021 set new benchmarks for the worldwide startup landscape. Many entrepreneurs raised huge sums of cash at spectacular valuations that occasionally reached $1 billion or more. Crunchbase reports a 92% growth year over year in worldwide VC investments to $643 billion from $335 billion in 2020 (https://news.crunchbase.com/business/global-vc-funding-unicorns-2021-monthly-recap/). Between 2020 and 2021, startup investments in Europe more than doubled and by the end of June 2021, it was estimated that they will surpass €49 billion.

So, how have the valuations increased since the year 2010? 

The eras of startup valuation will aid in understanding the increase in startup valuation over time. 

When considering the era of multiples, in the mid-2010s, public market pricing strategies crept into venture lingo, around the same time as the Patagonia vest—another Wall Street sin—appeared in Start upland. The early startup prices used a forward-revenue multiple. Add the anticipated revenue for the subsequent twelve months, add the forward multiple of the published comps, and multiply. Furthermore, the forward ARR multiples replaced forward revenue multiples. The ARR estimates are still aggressive (https://tomtunguz.com/publi-arr-multiples/ ). They have not recognized revenue; rather, they are the business's run rate. However, these startups expanded more quickly than publicly traded corporations, therefore the market viewed them favorably. Furthermore, the venture asset class expanded from $30 billion to $300 billion+, and as a result, forward ARR multiples outgrew their double-digit roots and increased by an order of magnitude. Thus, companies were priced in the market at 10x forward ARR.

The third era (Discount-to-future value) began with that 10x increase because values based on forwarding multiples in the hundreds were no longer credible. The market has instead changed to discount the final value. Furthermore, CRM startups were considered unicorns if they were able to take 1% of Salesforce's $200 billion market. Following a record year for venture capital investment in 2017, and continuing at a record pace in 2018, VC valuations have risen across all stages. The most notable gain was at the late stage, where median pre-money valuations as of the first quarter of 2018 rose to $75 million, up 19% from the previous year (https://files.pitchbook.com/website/files/pdf/PitchBook_1Q_2018_VC_Valuations_Report.pdf). The accumulation of dry powder and the general availability of financing to high-growth companies, which has given these businesses pricing leverage in discussions with investors, is believed to have contributed significantly to this valuation expansion.

In reality, over the past ten years, European venture capital investments have increased from €7.6 billion in 2011 to €42.8 billion, representing an average annual growth rate of about 20%. The European VC industry has undoubtedly grown more developed, and there are now more significant VC deals than ever before. According to a Pitchbook Data analysis, this capital inflow had a particularly positive impact on the valuations of VC rounds that were in their final stages. Of course, round size and valuations are correlated; the larger the round, the higher the valuation.

It is also important to note that over the past ten years, investors in transactions have continuously taken a 20% ownership interest as valuations and deal sizes at the angel & seed stages have constantly increased. However, the median proportion acquired thus far in 2018 has increased to a decade high of 26.7%. This is an intriguing development because huge seed financings now require significant equity surrender, which is a trade-off. Furthermore, the market expectations for 2021 boosted post-money valuations, but the valuation model's internal workings also contributed to this inflation. However, PitchBook verifies that unicorn public exits all but vanished in the first half of 2022, and early-stage VC valuations suffered a steep decrease in the second quarter. Yet, the venture capital industry is not dormant, and some paradoxical evidence points to favorable economic outcomes for some startups. The market capitalizations and share values of publicly traded tech businesses fall precipitously in 2022 as a result of rising interest rates, geopolitical developments, and normalized technological conditions. Once-inflated values can become a grave issue in a market that is normalizing, especially for founders, workers, and early investors.

In most cases, the higher the startup's valuation the better it is for all parties involved. High valuations signal a company's success and future; they draw in new clients and employees, and they enhance its reputation. Furthermore, as long as a company's value keeps rising, everyone will gain. As a result, investors have always been encouraged to think highly of a company's potential. 

In conclusion, it is crucial to keep in mind that a startup or early-stage firm's value is based less on the present (or future, given how unlikely it is that the company will succeed) and more on immaterial considerations like the quality of the idea, the team's skills, and the sector it serves. Thus, investors must avoid becoming hooked on lofty startup valuations, which may be difficult to maintain.