How do investors evaluate startups in Europe? (Spoiler: It isn’t just about team and revenue)

By Oleksandr Melnyk, ex-PR writer at F1V

Venture capital funds may refuse to invest in a startup if its target market size is below €1 billion, said Michal Rokosz, partner of Poland-based Inovo Venture Partners.

Rokosz has been investing for over 7 years – his fund has backed 35 European startups, including Booksy, Preply, and Allset. When valuing a startup, apart from the team and company’s financial results, Rokosz pays attention to three other factors:

• market size;
• exponential growth;
• and retention rate.

He talked about them in detail at a webinar held by Flyer One Ventures in mid-June. F1V publishes an edited and condensed version of Rokosz's speech.

Market size

Startups must look for a bigger market when launching their business. Why? Because targeting a larger pool of potential buyers just gives a bigger chance to succeed, bigger scaling options, and hence higher value.

While having a market with a $1 billion revenue potential is good, targeting an even bigger audience – say, a $10 billion market – will mean that your company will be valued ten times higher because the end game is higher.

VCs typically look for companies that can fully return the investment. If a fund’s size is $50 million, it needs a market of at least $1 billion (or at least €1 billion).

When pitching, consider the size of a fund: the bigger the fund, the bigger it expects the startup’s market to be.

Exponential growth

Founders have two ways of building a company: bootstrapping or fundraising.

When bootstrapping, founders retain full ownership of their company, but quick growth depends on how much cash the founders can burn. When attracting money from VC funds, the founders cease to be fully independent and must be accountable for the pace of their growth, for their team, and their financials.

Investors evaluate how quickly they can return $1 million from the initial investment and then how quickly this number reaches $100 million. Typically, investors look at the startup’s ARR or accounting rate of return. The best of them can get their ARR to $100 million in 5 years. But achieving the same within 10 years is also considered a good result.

Source: Lenny Ratchitsky

When raising a round, a startup needs to have money that will help grow 3x in a year – at least. Being able to finance a 5x growth year over year will give startups a premium multiplier.

While growing, startups may be proud they are making it an organic way, not using paid marketing channels. For investors, although counterintuitive, it’s a bad sign – the company may not know how to scale a business through paid advertising.

Retention

Retention of the client base is a core metric to evaluate startups even at an early stage. It doesn't matter how many customers a startup acquires if none of them stick around. With a high retention rate, it’s more likely that a startup will show growth each month.

It isn’t always that sunny, though. When, after the launch, a company starts losing its userbase, it means the company will most likely go into the red. VCs consider this factor and can avoid the startups’ low retention rate – it’s more challenging to grow such companies.

Retention rate is important, because the cost of acquiring new clients is much higher than retaining existing customers. Besides, loyal clients help in marketing, as they can become brand ambassadors.

Last factor – where to register

“If I had to choose a location to register a startup, I’d do it in the United States – particularly in Delaware. The US is a huge market, and it will always be easier to raise investment, even during the startup’s latest stages. EU countries or the UK are also acceptable,” said Michal Rokosz.

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