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The funding timeline followed by most startups is hardly intuitive.

The “textbook” version goes like this: first, the founders pay for everything themselves; then come investments from friends and family, followed by angel investors and venture capitalists. At the end of all this, one hopes, comes some kind of exit. (For an in-depth look at the funding timeline, click here.)

Each time a startup progresses from one funding stage to the next, it also grows in valuation. It makes sense – why would investors want to throw in more money unless the business is bigger and better than it was the last time?

Still, the leaps in value can seem a little bit arbitrary… and sometimes even extreme.

So how does a startup go from a million-dollar valuation to a $50 million valuation in such a short amount of time?

The first thing to keep in mind is that a startup’s value isn’t simply a measure of what it’s worth today – rather, it’s a projection of what the business will be worth someday. To learn more about startup valuations, click here.

In the earliest rounds of fundraising, a company will typically make more modest leaps in valuation – maybe a few hundred thousand to a few million dollars at a time.

Later in the game, though, you’ll often see private companies’ valuations shoot skyward by hundreds of millions of dollars every few months!

It may seem crazy, but there’s a good explanation for this:

As a company matures, it needs to prove that it can do more than just grow in size. It also needs to accelerate the rate at which that growth occurs.

Why? Because investors want to know that, no matter what stage they get in on, they still have a pretty good shot at a larger return.

Imagine you’re approached by a startup founder seeking an investment. The idea behind the business looks promising, but when you take a closer look at the numbers… you notice that the company’s growth is slowing down.

Why would you write that check? You basically have evidence right in front of you saying that your shot at a big return is getting smaller by the minute. Wouldn’t you rather back a business that’s just ramping up for a huge growth spurt?

Accelerating growth is a tall order. Just like working a 9 to 5 grind, running a marathon, or eating an entire pizza… the first half is easy. It’s that last bit that really gets you.

It’s a lot easier to scale a business from a $1 million valuation to $10 million than it is to turn a medium-sized operation into a billion-dollar one. And so, given the enormous scale of the task at hand, it makes sense that a later-stage cash raise comes with a bigger ask than the round before.

Still, to get the best deal for your dollar, make sure you’re familiar with the basics of pricing a round. Click here to learn more.

Until next time,

Neil Patel


Comments

5 responses to “Understand the “Snowball Effect” to Maximize Your Payout”

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  2. I love this. I have been looking for things to be explained. Start up is probably what i have been looking foe (angel). I have bn wanting to invest..learn & participate. Thank u

  3. Mr. Patel
    I want to THANK SO MUCH FOR YOUR ADVICE ON ANGEL INVESTING.
    I am an Entrepreneur & Inventor plus a Start Up company. Therefore I used your advice from the outside inward approach & took beaucoup notes for later review. The knowledge to gave me was priceless & FREE!!!
    Free stuff is my favorite subject!!! Thanks for giving the little guy a leg up & a FREE Education at No Charge. But first I saw the value of using your
    outside/inside strategy & adapted it for my purpose. Please inform me of similar subjects.

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