How Far Will Early-Stage Valuations Fall?

Historically, whether a startup graduates to its next fundraising round could be considered a random event. To raise its next round, the company may need to hit key milestones pertaining to user growth, revenue growth, product development, etc., and the ability to do so is unique to each individual startup. As a result, up through 1Q20, if we plot the typical pre-money valuation against the overall markup rate of those deals, we see no correlation at all:

But the pandemic venture environment was anything but typical. Here’s what happened from 2Q20 through 4Q22:

The pandemic venture environment was a structural break in the relationship between pricing and markups. What was once an uncorrelated mess became a downward-sloping line: as deal prices increased, the markup rates of those deals twelve months later fell significantly.

When Will We Return to Normalcy?

The sooner early-stage venture can find a “bottom,” the sooner it can begin to recover. As such, we want to try and identify how far early-stage valuations will fall. At what point will valuations support historically normal levels of venture activity?

Of course, our data is historical, and there has been substantial inflation since the earliest quarters plotted on the above charts. Consequently, it seems most likely that prices will fall to the highest historical valuations consistent with the historically uncorrelated relationship between prices and markup rates. Based on the above charts, those appear to be typical pre-money valuations of:

• $12M for (priced equity) Seed rounds
• $35M for Series A rounds

Note that these values are consistent with the typical historical step-up in valuation from seed to Series A of just under 3x. This is auspicious for the forecast since it would be consistent with the existing structure of venture investing and fund returns (the most likely model for the future is for it to be the same as the past with different numbers).

Before proceeding, there’s a potentially strong contrarian position to address: startup valuations should be highly sensitive to interest rates. Higher interest rates reduce the value of future cashflows. Startups are priced based on (the chance of) enormous future cashflows. So startup valuations should be highly sensitive to interest rates even if the overall tenor of the venture market doesn't change (i.e., even if the probability of going Seed → A → B → C etc. stays the same).

Past prices were made in a near-zero interest rate environment that highly valued future cashflows. In a higher interest rate environment where those future cashflows are more discounted, prices may end up lower than we saw from 2015-2019. We don’t think this is correct, though, because real interest rates are still close to zero. Startups will need to raise more money at higher valuations than historical tendencies simply because the dollars themselves buy fewer hours of the same employees’ time.

Future Pricing

Typical pre-money valuations for Series A deals have fallen from $65M to $45M over the past 12 months. Linearly extrapolating, this suggests we will reach pre-money valuations of $35M around the end of this year. Overall, this timing would align well with our prior forecast of the venture market beginning to recover at the end of 2023 and early 2024.

Seed is a different story. The following chart shows the ratio between the median Series A pre-money valuation and the median seed pre-money valuation from one year prior. This ratio peaked in the first quarter of 2022 at more than 6x, a valuation step-up that appeared to justify a $20M valuation for seed rounds becoming “typical.” Now the ratio sits at just 2.25x, a historical low:

Our data suggests that seed round pricing is just beginning to fall. The typical priced equity seed round on AngelList is at about $16M pre-money, just a small drop from its $20M peak. That means right now successful seed investors are beginning to see valuation step-ups of 2x or less from seed to Series A (e.g., a post-money valuation at seed of $20M raising a Series A at a pre-money of $40M.) These smaller multiples may not be adequate compensation for the increased risk of failure of seed investments and the larger loss on failed seed investments. We believe that the feedback from the step-up compression at Series A will likely eventually result in pricing discipline from seed investors. We forecast that typical seed round prices will continue falling gradually for another year.

This adjustment in seed round pricing is the end of a long process that began with the public market drops in January and February of 2022. That public market change first affected growth investors, then Series B investors, and now Series A and seed investors. The sequentially linked and delayed feedback loop between fundraising rounds is, we believe, why our data suggests early-stage venture markets can lag public markets by up to two years. The primary reason we are making an explicit pricing forecast for seed and Series A is the hope that sharing our unmatched timely data on round pricing can help to expedite the venture market finding a bottom and beginning a recovery.