When presenting their business to investors, startup founders will naturally typically seek to present their startup in the most flattering and promising light. They will have spent hours on their pitch deck, and it will be crafted to spin a narrative that results in their business delivering a respectable ROI for lucky investors.
As an investor, new business ventures and innovations are exciting. You want to see startups succeed, but you also want to avoid getting too swept up in the narrative without looking for the real, full picture. This type of assessment takes practice and knowing what to look for.
Here, we will show you a simple calculation that you can use to standardize startup growth rates to make comparison easier when selecting potential investment opportunities.
Why standardize startup growth rates?
When seeking to assess the numbers put forth by a startup, it’s helpful to understand how numbers can be manipulated to present a startup in the best way possible. This includes not only the numbers themselves but those that aren’t included.
Startup growth rates, especially, can often be dressed up by founders to present the business’ best side. An example of this could be presenting the company’s monthly growth rate instead of the annual growth rate. Naturally, founders will select the metric that looks the best.
For investors, a helpful tool to deploy when assessing metrics such as these is standardization. This makes it easy to distill these numbers down and compare them against other potential investment opportunities. This is especially handy when looking at top-line growth rates, which is a metric that can be commonly overstated by startups.
A note on top-line growth
Before we dive into that, it’s important to understand what top-line growth means. The top line refers to a company’s revenues or gross sales. Top-line growth occurs when a company’s revenues or gross sales are increasing. There are multiple ways a company could increase its top line, including increasing prices, increasing marketing efforts, increasing production, increasing service offerings, or improving upon the existing product offering. When used as a measurement, top-line growth is generally used to assess sales generation and revenue.
Top-line growth can be expressed in a few different ways. The most common you’ll see are growth per month or growth per year, and either may be presented as a percentage or a multiple.
Standardizing growth rates with multiples
A company that is experiencing 1.1x annual growth may seem more promising than one that is experiencing 1% month-over-month growth; however, the growth is roughly the same if we’re using ballpark estimates (with 1.1x being equal to 10% annual growth).
Imagine that a startup claims to be growing revenue by 1% month-over-month. How would we translate this to an annual growth rate? The best way to do this is by using exponents.
When revenue is growing at 1% each month (or each period) you would multiply the prior month’s revenue by 1.01 to account for that 1% growth as it compounds over time. Compounding is what happens when you take a number and increase it over and over again, which is why we can’t simply multiply 1% by 12 to arrive at our annual growth rate. Instead, we would take that 1.01 to the twelfth power (since there are 12 months in a year) to account for compounding growth:
(1.0112) – 1 = .1268 * 100 = 12.68% annual growth rate, growing at 1% per month
To make this calculation easier in the future, here is a cheat sheet you can use to compare monthly growth rates to annual multiples:
|Monthly Growth Rate||Annual Growth Multiple|
It doesn’t really matter which way a startup chooses to express growth rates; however, as an investor, it’s critical to be able to compare growth rates that are expressed in different ways to make the most informed decision possible when assessing an investment opportunity.
Interested in learning more about analyzing startup investment opportunities? Check out this blog on startup metrics next.
The information presented here is for general informational purposes only and is not intended to be, nor should it be construed or used as, comprehensive offering documentation for any security, investment, tax or legal advice, a recommendation, or an offer to sell, or a solicitation of an offer to buy, an interest, directly or indirectly, in any company. Investing in both early-stage and later-stage companies carries a high degree of risk. A loss of an investor’s entire investment is possible, and no profit may be realized. Investors should be aware that these types of investments are illiquid and should anticipate holding until an exit occurs.