1/ Why in God's name would you expect your investment can exit for >$200M?
A thread:
A thread:
2/ The recurring joke about VCs is that they're bad investors. VCs invest at high valuations, follow trends like 13 year old girls on TikTok, and frequently don't do enough due diligence.
But is this actually true?
But is this actually true?
3/ We as VCs expect M&A exits on our early stage bets. I have discovered that within application software, it is incredibly unwise to pay >$20M pre-money valuation if you expect a 10x on an early-stage bet.
4/ Take this graph for example. Using application software M&A data from 1/2022 - Present, acquirers are showing that at a acquisition price point >$200M, they're meaningfully less willing to buy companies. 
5/ Shown another way, there are only 94 unique acquirers (PE + strategic) that have purchased an application software company >=$200M.
6/ When only accounting for this buyer universe (>=$200M), you're leaving a whopping 57% of strategic buyers off the table.
7/ Why such a sudden drop off? A few hypotheses:
- Some companies just aren't capitalized enough to write $200M+ checks
- If a small M&A deal fails, the internal champion won't get fired. The same isn't true for larger deals
- 2022-Present has been a tough time for software
- Some companies just aren't capitalized enough to write $200M+ checks
- If a small M&A deal fails, the internal champion won't get fired. The same isn't true for larger deals
- 2022-Present has been a tough time for software
8/ So what's the takeaway for investors?
If you're investing early, think thoroughly about your entry and exit points on an absolute (EV) basis, not only on a relative (multiple) basis.
If you're investing early, think thoroughly about your entry and exit points on an absolute (EV) basis, not only on a relative (multiple) basis.
9/ It doesn't matter if the deal is only 4x ARR at exit if the EV is $4B; only Thoma Bravo and Amazon can afford that.
Your buyer universe is small.
Your buyer universe is small.
10/ If you're investing early, many of your portfolio companies will fail, so you should aim for a 10x+. When aiming for a 10x, think about what a buyer's willingness / ability to pay is.
11/ If you're investing in a round with a pre-money valuation of $50M, know that a 4x is likely your max outcome, not a 10x.
12/ Assuming they're both opting for a 10x, it would seem to me that in app software that the seed investors (left picture; 2023 at $11M median pre) are sane and the series A investors (right picture; 2023 at $43M median) aren't.
13/ In an ideal world, get in at sub $10M pre.
14/ What's the takeaway if you're a founder?
Consider taking a seed or series A deal at a lower valuation. Sure, you'll take some dilution, but you're also setting a much lower bar for success.
Consider taking a seed or series A deal at a lower valuation. Sure, you'll take some dilution, but you're also setting a much lower bar for success.
15/ $10M+ is life changing money for anyone. If you raise your seed at $2M pre, $3M post, you can exit at $20M and make your investors super happy + take home $13M for yourself. Building a $20M EV business is way easier than $200M.
16/ Furthermore, in the $5M-$100M range, there is a huge buyer universe within the $10M-$53M range and $60M-$100M range.
17/ A few caveats:
- This doesn't apply to IPO exits
- This analysis only has data from application software deals
- M&A buyers will buy based on hot categories
- You might be underwriting to 3-5x not 10x
- This doesn't apply to IPO exits
- This analysis only has data from application software deals
- M&A buyers will buy based on hot categories
- You might be underwriting to 3-5x not 10x
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