Hockey Sticks

Most companies raising capital have revenue projections that look something like this chart (with funding occurring at the end of Year 2):

Although we see a lot of projections that resemble the one above (commonly referred to in VC/startup lingo as the “hockey stick”), we don’t require this type of optimism to get excited about a prospective investment.  Entrepreneurs often earn more credibility by showing more conservative projections, partly because we appreciate how difficult it is to grow revenue more than 50-100% per year in a capital efficient way, and partly because businesses can drive strong returns without hyper growth.

An entrepreneur can certainly raise a large round of capital and try to scale an early stage business quickly, but unless the entrepreneur has figured out a repeatable, scalable go to market strategy (and most early stage businesses have not), then that dilutive capital will likely be inefficiently spent.  We generally prefer businesses that raise modest amounts of capital ($5-10M or less of equity in total to reach breakeven) to drive steady growth.  For example, consider the following situation:

• An enterprise software startup has $1.5M of revenue at the end of Year 1 and raises a $2M Series A round at a 4x revenue multiple
• Using no additional capital, the startup drives revenue from $1.5M in Year 1 to $14M in Year 6
• The startup is acquired at the end of Year 6 at a 4x multiple of revenue

In this scenario, the exit would return $14M to the investor for a 7x cash on cash return.  Certainly returns can be reduced if the company requires additional capital or sees its revenue multiples decrease, but most entrepreneurs would consider these revenue projections to be a slam dunk – and in the above scenario a $5M Series A round would still return over 5x invested capital.  The point is that companies can drive very attractive returns with relatively modest revenue growth.

Here is a summary of the variables, along with a revenue chart… Hockey stick not included!

We are obviously not opposed to our portfolio companies growing revenue over 100% per year.  But we realize that this is the exception and that our investments can still generate attractive returns with capital efficient business models that generate more realistic growth rates.