Private Equity and Venture Capital are often used synonymously. Both invest in private companies whose shares are not publicly traded on exchanges. However, VCs generally invest earlier in a company's lifecycle than PE.

If we go one level deeper, we can categorize private market investors into general stages:

Each stage comes with a different set of investment criteria and return expectations.

Note: There IS OVERLAP. Many of the firms listed below play in multiple arenas. Someone in the Angel camp may follow on in a Growth stage deal; someone in the Cross Over bucket may preempt a company at the Growth stage. The buckets are not mutually exclusive.

For example, Sequoia, a prolific Seed stage investor, worked its way through to the opposite side of the spectrum, now participating in Cross Over and even select Public Market opportunities. Shooters gunna shoot.

With that, let’s break down the game within the startup game.

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**Angel

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Angels give support to start-ups at the initial moments and when (most) institutional investors are not prepared to back them. They may be families, friends, or former colleagues of the founders. They usually invest when a company is trying to go from PowerPoint to reality.

💸Check Size: $10K to $250K

⌛️Holding Period: 8 to 10 years

💰Target Return: >75% IRR or +10x

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Seed-stage investors are usually the first institutional check into a company. Capital is typically used for market research, product development and business expansion. At this stage the R&D team gets a makeover and the first full-time sales and marketing people might be hired.

💸Check Size: $250K to $2M

⌛️Holding Period: 6 to 8 years

💰Target Return: >60% IRR or +10x

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**Growth

**

Growth investors typically participate in Series A, B, and C rounds. They pour fuel on the fire once product-market fit is established. This is when a company is scaling its go-to-market engine for exponential growth. Investors are more accepting of cash burn at this stage, encouraging the company to spend ahead of profits to capture a market opportunity.

💸Check Size: $10M to $50M

⌛️Holding Period: 5 to 7 years

💰Target Return: >40% IRR or +7x

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At this stage in the startup lifecycle, investors look for companies that demonstrate efficient growth and are marching towards a sustainable long term financial profile. Proceeds may be used to transform from a single to a multi product company, and maybe even expand sales internationally. Investors often use this stage to build starter positions so they can double down at IPO.

💸Check Size: $50M - $150M

⌛️Holding Period: <5 years

💰Target Return: ~25 to 35% IRR or +5x

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This is when investors buy the entire shebang, usually incorporating a heavy dose of debt. Their goal is to make the company more efficient, mark it up, and flip it for a multiple down the road. Buyout flavors include LBOs (leveraged buyouts), Take Privates, Rollups, Platform plays and HoldCos. Free cash flow is required to pay down any debt the company takes on, calling for a very different financial profile than companies burning red at the Growth stage.

💸Check Size: Depends on strategy, but could be hundreds of thousands to billions (see: Anaplan, Sailpoint)

⌛️Holding Period: 3 to 5 years

💰Target Return: >18% IRR or +3x

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The price-to-earnings (P/E) ratio relates a company's share price to its earnings per share. A high P/E ratio could mean a company's stock is overvalued, or that investors are expecting high growth in the future.

However, GAAP accounting forces companies to mark up “other income” when their holdings increase in value, and down when their stocks fall.

Other income may include interest, rent, and gains resulting from the sale of fixed assets.

The delta can get especially large when there’s a ton of cash on the balance sheet accruing interest or they sell off something valuable. As a result, you can get false signals as to the health of the underlying core operations of a company.

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Most businesses have maintenance capex. If they don’t spend that capex, the business' earning power will go down each year.

There’s Growth CapEx and Maintenance CapEx. Think of it in this way - when a company such as Walmart refurbishes an existing store – laying new flooring, painting the walls, replacing cash registers, etc. – it is engaging in maintenance CapEx. Likewise, if Walmart opens a new store, this would be considered growth CapEx.

If you want the business to stay alive, what’s actually available to service debt is either:

Your businesses needs oxygen. Don't suffocate it.

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Many ignore working capital when calculating of ROIC. Working capital includes all the capital wrapped up in current assets and current liabilities (like accounts payable, and accounts receivables).

Depending on the business model there can be a lot of money somewhere in the cash conversion cycle.

To avoid overstating returns you should calculate ROIC as:

`ROIC = (Net Operating Profit After Tax) / (Working Capital + Property Plant and Equipment)`

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Most investors and operators have a core set of KPIs they track. But many are doing it wrong. Here are 6 common mistakes with metrics that can kill a company over time.

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Not all metrics are meant for all companies. For example, if you sell to Small Businesses and plan to land and expand over time, you probably shouldn't be copying Oracle's Enterprise sales KPIs just because it's Oracle.

Wish I could put that on a billboard somewhere.

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As your company grows it should see operational leverage - that means the ability to do more with less. The best way to check if you are getting leverage is simply (# of employees / revenue )

In particular, this metric is great for evaluating unprofitable high-growth tech firms. You're drilling down to the core economics - you can't drill down any further.

Most SaaS firms in the high-growth stage have a rev per employee between $250k and $350k.

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Customer Acquisition Cost measures how much it costs to land a net new customer.

Ideally you want to get it as low as possible by using efficient sales and marketing channels.

CAC can create a money-losing flywheel that starts at acquisition. If CAC is too high, each new customer extends losses rather than growing profits. Without sufficient cash, accelerating losses aren't sustainable. To make things worse, adding more customers creates more admin costs.

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“TOO MUCH VALUE?!” you say! Bear with me! A massive LTV to CAC ratio may actually mean you're not spending ENOUGH on S&M. It could indicate you’re actually leaving growth on the table.

Since valuation is often tied to growth, you may be restraining shareholder value. And from a competitive standpoint, you might be making life too easy for your competitors by not more aggressively chasing new customers.

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This one really grinds my gears...

GMV is commonly used for marketplaces (Etsy) and payment gateways (Stripe) that charge a fee or take rate. GMV is not a true reflection of a company's revenues, but rather its through-put, as most of the revenue goes to the original seller.

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Growth is great. Growth at all costs is not. Using one of these metrics without the other can lead to a skewed view of company performance. Making choices purely based on topline can lead to poor investment decisions.

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I asked my investment professional friends on twitter:

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Contrary to popular belief, you don't need to sell big deals to Fortune 500 enterprises to be successful.

@investianalyst points out how ACV is really a vanity metric that’s a byproduct of your business model, not a driver of it.

In fact, the world’s biggest and best software companies tend to have smaller ACV’s.

Remember: Increases in ACV aren’t free. Usually to increase ACV, it means some other metric of importance gets worse, like CAC.

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The price-to-earnings (P/E) ratio relates a company's share price to its earnings per share. A high P/E ratio could mean a company's stock is overvalued, or that investors are expecting high growth in the future.

However, @brianferoldi points out how GAAP accounting forces companies to mark up “other income” when their holdings increase in value, and down when their stocks fall. This throws off false signals as to the health of the underlying core operations of the company

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Most businesses have maintenance capex. If they don’t spend that capex, the business’s earning power will go down each year.

Per @10kdiver if you want the business to stay alive, what’s actually available to service debt is either:

The businesses needs oxygen. Don't suffocate it.

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Many software businesses maniacally focus on ARPU (Average Revenue Per User) and how it grows over time. But overemphasizing growth in ARPU without digging into account retention masks a potentially leaky bucket

From talking with @alithecfo, if ARPU increases, but you’re losing users at a rapid rate, that’s not healthy or sustainable growth.

You’re really on a treadmill and will need to keep spending to acquire new users.

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Contrary to popular belief, not all "revenue" is created equal. Multi-year contracts with deep first-year discounting or volume ramps over time drive deltas between the first and last year's ARR.

Many companies will claim the larger, exit year Contracted ARR (CARR) as ARR. But CARR will not track to current period GAAP revenue or billings.

@lukesophinos says using a non-standard definition of ARR can lead to unexpected mark downs by investors during financing events.

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Many ignore working capital in calculations of ROIC (Return on invested capital). Working capital includes all the capital in current assets and current liabilities (like accounts payable, and accounts receivables).

Depending on the business model there can be a lot of money tied up in the cash conversion cycle.

According to @mt_capital1 to avoid overstating returns you should calculate as:

`(Net Operating Profit After Tax) / (Working Capital + Property Plant and Equipment)`

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CAC (Customer Acquisition Cost) is what you spend in S&M (sales and marketing) to land a net new customer. And CAC Payback Period is the number of months it takes to break even on that new customer.

Per myself lol @cjgustafson222, S&M costs should be lagged by the average sales cycle of the sales engine you’re measuring. And Customer Support costs should match the current period.

The goal is to align the dollars you spent in the past to generate the sales (ARR) you are seeing today.

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LTV (Lifetime Value) to CAC (Customer Acquisition Cost) measures the efficiency of your go-to-market engine. It shows you how many times over the average customer pays for itself. However, it leaves out R&D and G&A spend.

From talking to @thealexbanks consider using Burn Multiple for a more holistic view.

It determines how much the entire company is burning to generate each incremental dollar of ARR And takes into account functions across the entire company, not just sales and marketing.

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Accrual Revenue isn't actually cash. It's a GAAP based accounting view of the world, looking at when revenue should be recognized for services delivered.

Accrual Revenue will almost always lag cash received from new business. It will lag both ARR and Billings.

From talking to @kurtishanni if you make hiring and spending decisions based on it, you can cap growth and leave money on the table.

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@iamclintmurphy frequently sees companies:

For eCommerce and DTC businesses @joe_portsmouth says common errors include:

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Contrary to popular belief, not all "revenue" is created equal.

Not to throw anyone under the bus specifically, but it’s the Wild West these days on FinTwit (that’s finance twitter, for all the normies out there).

Pop in and you’ll see online marketplaces calling GMV Revenue and service based businesses calling one time Revenue ARR.

So let’s set the record straight:

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Commonly used for marketplaces (Etsy) and payment gateways (Stripe) that charge a fee or take rate. GMV is not a true reflection of a company's revenues, but rather its through-put, as most of the revenue goes to the original seller.

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This is an accounting-based view of topline (or a "GAAP" view). Revenue is spread out, or accrued, to match the delivery of the product or service. In SaaS, total Revenue will usually trail total ARR or total Billings as it is accrued over time.

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This is the opposite of accrued revenue and is a balance sheet item. It accounts for money prepaid for goods or services that have yet to be delivered. For example, in a 12-month SaaS contract, in month 4 there would be 8 months of deferred revenue left as a liability on the BS.

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RPO is all unrecognized contracted revenue. Deferred revenue goes out at most 12 months, so RPO extends further and includes both Deferred revenue and any unbilled portion of a multi year contract.

For a 3 year contract you’d have 12 months in deferred revenue and 36 months in RPO. Of the 36 months, 12 would be current RPO and 24 months would be non current.

This metric is increasingly used by companies with large multi-year commitments, especially consumption based businesses.

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This is when the deal closes and the customer signs. It represents the commitment of a customer to spend money with your company. It's based on the execution of the contract, even if they haven't used the service or paid you yet.

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This is when the accounting department actually "bills"' the customer for the "booking" that the sales team closed so you can get paid. The "booking" may be for a three year contract that you "bill" for annually. Therefore you would bill one third of it each year.

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ARR represents the annualized revenue run rate of all committed subscription contracts as of the measurement date. It assumes all contracts that expire during the next 12 month's are renewed with existing terms 1x purchases or services are NOT ARR.

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This is simply ARR / 12.

Said another way, MRR x 12 = ARR.

Once again, key word is "recurring"

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This is the summation of the annual values within a multi year contract.

Year 1: $200 ARR

Year 2: $300 ARR

Year 3: $400 ARR

TCV = $900 ARR

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This is:

TCV / # of years

In the example above this would be

Avg. ARR = $900 / 3 = $300

This is important for contracts with upfront discounting or a ramp period in the number of licenses under contract.

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Software is eating the world. This much is true. But not every company is a Software company.

More specifically, not every company is a High Tech company.

There are two categories of technology companies in my simple mind: High Tech and Tech Enabled.

And sometimes it can be hard to tell the difference between the two.

At the most basic level, High Tech companies literally wouldn’t exist without their underlying technology - they need to invent something net new.

On the other hand, Tech Enabled companies use existing technology to improve an existing market.

Neither type of business is inherently better. Both solve problems and deliver value to shareholders.

This post is NOT about valuation. We get it - High Tech (usually) trades at high multiples.

I want to compare operating models to see where money is spent and how durable revenue growth is accelerated.

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I’ve chosen a sample of 15 Tech Enabled and 15 High Tech companies from the Russell 1,000, which covers +90% of equity market cap value in the US.

So you know, I’ve excluded:

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(Data as of end of May 2022)

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To put a bow and a ribbon on this jam session, although the market risks and general time to market associated with each business model, they are both in fierce competition for talent. And that talent makes up the bulk of expenses.

By my estimation, costs that walk on two feet make up +75% of expenses at High Tech firms and +60% at Tech Enabled companies. Therefore, it seems to be more about how each type of company organizes people within the P&L rather than actually growing faster, spending less or having radically different bottom line outcomes.

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I worked as a valuation associate at a private equity firm for 2 years. During that time I learned the art and the science of valuing public and private companies.

As you may have noticed, multiples across the board are down.

What I’d like to do is discuss mechanically why this is the case. In this post we’ll de-mystify the 3 most common ways companies are valued. And we’ll do it in plain English.

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There are 3 popular ways to value a company:

#1 falls into the Intrinsic Valuation bucket. You look at what the company is valued at on it’s own. This requires the most detailed analysis of the bunch.

#2 and #3 fall into the Relative Valuation bucket. They rely on what other companies have done, and are based on publicly available information.

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Analogy: When someone wins the lottery they have two payout options:

-Annuity: Get paid a fixed dollar amount every year, similar to a business owner taking a salary from the company’s profits

-Lump Sum: Take it all now in one big slug, equal to the sum of those future Annuities discounted back to a smaller present value

Now imagine the discount rate applied to the lump sum payout goes up. This is exactly what’s happening in DCF models, due to rising interest rates, and pushing present valuations down.

DCF models use a Weighted Average Cost of Capital (WACC) to discount future cash flows. When interest rates go up, the Risk Free Rate, a component of the WACC, goes up. Applying a higher WACC to your forecast decreases the company’s terminal value.

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Analogy: A rising tide tends to lift all ships, but you find out whose swimming naked when the tide goes out.

Why It Matters: As addressed above, models are getting more heavily discounted. When it comes to Comps, we’re looking outside a single company and comparing models to one another to get to a median valuation.

Other than rate hikes producing higher WACCs and lower forecasts, companies in a peer cohort may also suffer from macro events that drag forecasts and valuations down: labor costs, longer deal cycles, employee attrition, supply chain...

And when you smash a bunch of lower-ish models together, you usually get a lower-ish implied valuation. It’s contagious.

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Analogy: When you check your home’s estimated value on Zillow, it’s based on what similar homes in your neighborhood recently sold for.

Why It Matters: In today’s market, company’s aren’t raising as much cash. This means they have less to spend on M&A, which means companies end up selling for less. The price of debt financing went up too.

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Not an investment post, per say, but these are lessons I've learned from working in the investment world for investment companies.

Your company just doesn't want to carry your vacation on their balance sheet,

and they know you won't abuse it due to social pressures.

You don't need to pack both.

It's the ceiling for how they'll treat you someday.

4/ Learn the excel shortcuts and use them live in a meeting with someone over 50.

They'll think you know sorcery.

That excuse has been overplayed.

Ask them what's the best concert they've ever been to...

There's a Grateful Dead or Britney Spears fan in there somewhere.

Also pay for private jets.

It's 10x cooler.

You just don't know it in the moment.

A hedgefund manager's #1 job is sales.

A Big 4 Accounting partner's #1 job is sales.

But you will remember the wedding.

It will be the longest, most embarrassing 28 minutes at baggage claim of your life.

If you wait for 90%, the opportunity will have passed.

But remember -

Billy Beane never won a World Series.

It will never work out long term.

Unless your boss drives 2004 Toyota Corolla.

Then that's his problem.

Shift their thinking from

"What is wrong with one option" to

"Which option is better for me"

Know when to shut up and stop selling.

Say yes.

There are seasons in life when you should say no to almost everything..

Know which season you're in.

In fact, you SHOULD copy the good ones.

There's no grown-up in charge at the top of the financial system.

There's no wizard of oz behind the curtain.

like working for a startup

or investing in a bear market

Otherwise there wouldn't be the potential for outsized rewards.

Don't fool yourself with distractions when there's a project you need to finish.

Even if you stopped working on the presentation for tomorrow at 7:15PM.

This eliminates the opportunity for more corrections tonight.

Everyone's literally making it up as they go.

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Would you rather...

a company growing 70% Y/Y with -30% free cash flow margins....

or a company growing at 15% Y/Y with 30% ...

Both in same sector

Which do you take and why?

It's official - the current market reset is the 10th worst since 1929.

It's hard to decode what's going on with so many factors at play.

What's the most insightful soundbite you've heard to help explain what's going on?

Here are 10 quotes I've collected from talking to +50 sell side analysts and hedge fund managers in and around finance and tech over the last month.

Curious to what others are hearing...

If you like this type of content, 1x per week I send out a short email on business metrics and what makes startups tick.

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