According to the "Venture Capital Market Study 2020" by PricewaterhouseCoopers (PwC), most investors rely primarily on experience when evaluating early-stage startups. Most of the VCs surveyed stated that they rely on their experience when evaluating early-stage startups. For later-stage startups, however, fact-based decisions dominate: Significantly fewer of the VCs surveyed are guided by their experience. However, a very high level of experience is available. 72 percent of respondents have more than 10 years of experience in evaluating startups. 34 percent even have more than 20 years of experience.
But of course, experience isn't everything: Multiple approaches and the VC method are also used. Discounted cash flow (DCF) methods, on the other hand, only become more important in the later stages. The evaluation of comparable financing rounds is also a popular tool.
What is important for the evaluation?
The experts pay particular attention to well-known factors in their assessments: The motivation of the founders is the most important component (73.2 percent of respondents consider it very important), followed by personality and social skills (61 percent) and the overall competence and vision of the CEO (58.5 percent). In contrast, only 14.6 percent of VCs pay attention to founding experience.
Other important evaluation criteria besides the founders themselves include the startup's growth potential (87.2 percent), scalability or internationalization potential (80 percent), and profit potential (62.5 percent). In contrast, only 10.3 percent consider a threat from existing competitors to be important.
What goals do VCs pursue?
"One of the many insightful study findings is that investors' target stakes typically range between 10 and 24.9 percent. However, 80 percent of investors plan for follow-on investments in subsequent financing rounds to maintain their stakes. This is good news for startups,"
explained Enrico Reiche, VC expert from PwC Germany. Almost a third of investors adapt business plans of Startups and uses lower discount rates. The expected internal rate of return (IRR) for the portfolio ranges from 32 percent annually for early-stage startups to 21 percent annually for later-stage companies. The expected multiple ranges from 5.9 for early-stage to 3.2 for later-stage companies.
Strengthening the financial ecosystem
"Startups are an important engine for innovation and growth. Venture capital is the fuel that drives startups forward and gives founders the space they need to develop their performance and passion. The financial ecosystem decisively shapes the development of young companies,"
says Dirk Honold, Professor of Corporate Finance and Business Administration at the Nuremberg Technical University and co-author of the study. He adds:
"The study shows that only one in four investors invests more than €15 million in a portfolio company. The currently discussed future fund can significantly contribute to more large-volume rounds and new, large VC investors in Germany."
The study also reveals that in almost 50 percent of early-stage deals, non-creditable liquidation preferences are agreed upon, which serve to compensate for higher company valuations in around one-third of the companies.
COVID-19 and its consequences
In 2020, a factor influencing contract drafting emerged that had never been seen before: the coronavirus pandemic. This led to adjustments to the company valuation or other contract components after signing and before closing in almost 50 percent of the financing rounds completed by the investors surveyed so far in 2020. Patrick Hümmer, Managing Director of Ventury Analytics, explains:
"More than 75 percent of investors expect COVID-19 to lead to declining valuations. Respondents also see an increased need for financing among 75 percent of startups, with 55 percent of investors favoring co-financing with government funds. However, the majority of this investor group does not want to wait for government aid."
About the study
The study was conducted by the auditing and consulting firm PwC, Dirk Honold, Professor of Corporate Finance and Business Administration at the Nuremberg Technical University, and Nuremberg-based Ventury Analytics GmbH. A total of 74 investors were surveyed on 113 details of their investment levels, valuation practices, and financing agreements. All respondents (also) have a focus on Germany and invest a total of more than two billion euros in venture capital annually.
