What’s a fair price premium for startup shares?

What is a fair price premium for a quickly growing startup? The answer is constantly changing, but recent history teaches us that it’s probably not more than 200% over public-market comps. It may even be closer to 100%.

It’s not an academic question. Where the startup price premium benchmark settles this year could help determine if a host of Series B and C checks are written at valuations that are miserable, palatable or even exciting.

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Pulling from a Redpoint Ventures report, this morning we’re examining how middle-stage startup valuations scaled to incredible levels in 2021, and how those price points have reacted to comparable companies’ projected revenue multiples contracting sharply. This will involve some numbers, some charts and a tiny bit of math, but I hope that when we finish, we will better understand how startup valuations managed to leave the atmosphere during the last tech boom and how close to earth they have returned in 2023.

Startup founders looking to fundraise later this year, this one is for you.

The ascent to madness

The venture capital market is responsive to the stock market. As the value of tech stocks rise, so do the value of startups, and vice versa. This is reasonable, because most startups are building toward an eventual IPO, so their value today should reflect their potential value in the future when they exit, which is partially set by recent stock market performance.

Redpoint’s new data makes the above plain and details how different slices of the startup-venture fundraising market can be stickier to price points than you’d expect. As with everything, let’s start from the beginning.

In the following table, we can see how prices for fast-growing public software companies ballooned over time, and how Series B and C startups saw their values scale even more rapidly:

A few notes on this data. First, the companies represented in the Series B and C line are a mix of companies that Redpoint would “want to look at,” according to Logan Bartlett, a managing director at the venture firm. That includes companies in the United States, Canada and Europe. This is a geographically constrained dataset instead of a global one, but given the chunk of the venture market that North America and Europe loosely represent, it’s not a bad sample to chew on.

Second, the premium calculations. In that line, a 100% premium is “flat” or in line with public market prices, and a 200% premium implies that the value of Series B and C startup revenues are double their public-market peers. You can easily check this math yourself, but just in case you are still drinking your first coffee, I wanted to make our methodology clear. In the following work, we’re amending the slide figures down by 100% so we’re only looking at the premium atop public market prices, demarcated with a ‘+’ in front of our numbers so that you don’t get the two mixed up.

Now, what can we see in the numbers? Here are the key bits:

• The value of software revenue on the public markets effectively tripled between 2017 (8.2x) and 2021 (32.4x). This is the “engine” that helped private-market companies command ever higher multiples.
• Initially, middle-stage startups got cheaper compared to their comparable companies as public-market multiples expanded: The private-market premium for Series B and C startups fell from +146% in 2017 to +57%, +60% and +72% in 2018, 2019 and 2020, respectively.
• In 2021, Series B and Series C prices went bonkers, shooting from ARR multiples of 39.7x to 105.4x in just a year. You can blame this on a host of things: ever larger venture capital funds, startups raising multiples times in a single year, Tiger and similar entities flinging bricks of cash at anything that moved … You get the picture.
• The result of the somewhat incredible inflation in valuations at middle-stage startups was that their price premium — after a period of relative moderation — expanded to +225% over public-market peers in 2021. This was a pretty “hot” figure because it is a departure from earlier trends. Put another way, either Series B and C companies were being priced erroneously between 2018 and 2020, or VCs were wrong about pricing in 2021.
• It turns out that almost everyone missed the mark in 2021.
• Then things got super sticky: In 2022, revenue multiples for high-growth software companies on the public market contracted sharply. In contrast, things didn’t change that much for middle-stage startups. The result was that the Series B and C premium expanded as the market got worse, to +460%.

The result of that, Redpoint points out later in its deck, was that the value of Series B and C rounds at companies fell sharply in 2022. Consequently, it has taken longer for startups to raise their subsequent rounds: After bottoming out at a median nine months to reach the Series B or C stage in the second half of 2021, it took startups 18 months to reach those rounds in the first quarter of 2023.

The good news is that it looks like private-market valuations are working their way back to being in line with their public-market peers.

Here’s another chart for us to ingest. It looks at the same data points, but broken down by quarter:

How did the price premium for startup shares get so whacky in 2022? Middle-stage startup prices kept rising in the first half of the year while public market valuations tanked. This led to a simply staggering +687% premium in the second quarter of last year.

(Note: Naturally, if we expanded this dataset to include more companies and more stages, the numbers would shift around. What matters is the general trend in the difference between public and private software revenue multiples.)

But reality smacked the Series B and C software startup market in the face in Q3 2022, and ARR multiples were halved. Why did the effective middle-stage startup premium increase in Q4 2022 from Q3? Because private-market prices take longer to deflate at Series B and C software companies than they do for their public counterparts. To pick a contrasting example, Redpoint noted that early-stage valuations “were [more] quick to correct” in light of changing market norms.

This brings us to 2023.

So where are we today?

Why does a startup deserve to be valued at a premium to its public peers? The latter are very liquid and thus should enjoy some sort of liquidity premium, so why do the numbers shake out the other way?

The answer is: growth, more or less. Series B and C startups should, in both mean and median terms, grow a lot faster than even the upper quartile of public software companies. This is because they have smaller revenue bases from which growth is measured and the fact that they can run at sharply negative operating margins thanks to venture capital.

So when such a startup isn’t growing faster, it looks more like a wildly inefficient public company instead of looking like a company that could become, say, the next Google.

In short, a hot Series B or C startup should be able to command a higher revenue multiple than its public comparables because investors expect its future cash flows to be, as we might say in the Bay, “hella valuable” thanks to the potential for exponential growth. Thus, the VC in question will overpay, in a sense, for startup stock today to reap the supposedly exponential benefits a few years down the line. This is pretty reasonable, provided that the premium paid is not insane.

This is where I leave you with some bad news: From 2018 to 2020, startup revenue multiples were never more than double the multiples of their public-market comps. We can see in the second chart that in 2023, the figure is +285%, which means it’s probably still way too damn high, at least compared to 2021.

You could argue that startup prices were too low between 2018 and 2020, or that the public markets are too depressed today for startups to fully match up with stock market metrics as we measure them. Maybe. But given the Redpoint data, middle-stage startups today still look rather expensive. Either the stock market needs to recover some of its juice, or startup prices need to fall more for things to get back to “normal.”

Which will happen first? We cannot say, but there needs to be some resolution to this market dislocation.