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Compound Valuations (TFN #68)
This week, OPay announced a $400 million fundraise, valuing the company at $2 billion.
Some took to Twitter to ask how OPay could be worth that much, especially in comparison to the market caps of Nigerian banks. At a $2 billion valuation, OPay is valued higher than every single incumbent bank in the country.
Others challenged the valuation in the context of their growth model, where the acquisition of initial users was subsidized (though apparently that is no longer). Others still defended the valuation, citing significant growth metrics and trajectory. After all, a valuation is less of an indication of the company’s value today, as it is a bet on the sustained growth of the company and a discount on the future valuation.
The thing is, this discourse around valuations – and the inherent skepticism that comes with the numbers rising as fast as they do – has not been specific to OPay. And the reality is, we’re going to (continue to) see more early-stage startups growing at a comparable pace, with valuations that many of the same people will feel are too high.
So let’s talk about that.
I don’t know what OPay or any other comparable growth-stage company should be valued (though for a primer on valuing neobanks, I recommend this piece from the Frontier Fintech newsletter). But what I do know is there is an opportunity – and a need – to think about valuations differently.
A Controlled Bubble
Alex Danco thinks that startups aren’t economically sensible. He writes,
When you set out to build an important piece of the unknown future, you have two missing pieces of information. First, you do not know how much money you will make if you succeed. You can guess – a lot, hopefully – but you cannot know. Second, you do not know how much capital you will have to raise before you reach positive cash flow. You can guess, but even the best-laid plans go awry when you enter unknown territory.
The combination of these two unknowns means that even the best founders cannot know the true value of their own equity – even if you could somehow correctly discount for execution risk. This is a problem! When you’re starting out, your equity is the main thing you have to trade. If you can’t know what it’s worth, and investors can’t either, you can’t fund yourself across the gap and get to positive cash flow.
This is why funding is done in stages. Risk is re-rated at each stage, and investing in tranches ensures investors aren’t overcapitalizing a fledgling company.
But staged investments then creates a coordination problem between the present and the future. He asks, “When you write the first check, do you know that the next check will not only be there, but will be willing to pay a higher price? And will that second check have that same confidence in the third check? And the fourth?”
Alex argues that VC investing is both a bid and a signal –
“By signing this term sheet, we anticipate this company will grow into a 1.5M ARR business by next term sheet” or the like. It’s not a valuation; it’s a convention…
With their term sheet bid, early investors telegraph to both present and future investors: we believe that this $6M price reflects a discount to the price next round. Nowhere are they signalling, “this company is ‘worth’ 6 million dollars”; because the equity is still impossible to value. The signal is: “Now is your chance to get in at 6, because the next round will be higher.”
Venture capital is a sort of “controlled bubble”, in which inflated valuations continue to rise (and are sustained) until such a time as the valuations match reality.
Now, the arguments against a $2 billion valuation for OPay, for example, is that its valuation will not catch up with reality. While that may be true for OPay specifically (and I’m not saying that it is), the more important question is: is it true for African tech companies generally?
The 8th Wonder of the World
When I think about rising tech valuations, I can’t help but think about how far things have come. As VC Kanyi Maqubela recalls,
When I worked on my first startup, we raised a series A of three and a half on 12. This was in 2006. Today, a Series A of 20 on 90 is not out of balance. I’ve seen specific examples of companies that are literally at a hundred million dollar valuation and I distinctly remember that a lot of people, when Mark Zuckerberg was walking up and down Sand Hill to raise his Series A, his first equity financing after the seed round from Peter Thiel, were absolutely gobsmacked by the fact that he was asking for $100 million valuation and it was Facebook. Meanwhile, it’s almost blasé to see numbers that are approaching that today.
The question, of course, is if these numbers will keep going up forever. And if these numbers will keep going up forever in Africa.
Packy McCormack recently published a fantastic piece entitled Compounding Crazy, discussing this very topic. The discussion starts with a premise: that human progress is exponential.
It’s an idea in part evolved from Ray Kurzweil’s Law of Accelerating Returns:
The Law of Accelerating Returns states that the rate of change of progress accelerates because humans can use the technology at their disposal to progress faster than previous generations could without the technology.
Not only are more advanced societies progressing, but they’re able to progress at a much faster rate than less advanced societies. And this growth is exponential because of compounding returns on knowledge. As Packy writes, “previous generations’ hard work makes it easier to build new things.”
And in an environment like African markets, where so much of the current phase of its tech ecosystem has been building the infrastructure, it becomes not only easier for newer companies to build, but it becomes easier to build more cheaply, faster, and with less employees than ever before. And it becomes easier to build companies of significantly greater value than those that came before it.
As PiggyVest’s Odunayo Eweyini has shared, PiggyVest would not be possible if not for Paystack. Many other (billion-dollar) fintechs would not be possible if not for Plaid. It’s no wonder that Plaid-esque startups on the continent – Mono, Stitch, Okra – have all raised significantly within the past year. There will be unicorns built on top of today’s infrastructure.
So where are we on the curve?
Timing is indeed a huge question. The US venture capital ecosystem will invest more money this year than ever before – an estimated $300 billion, an 83% greater amount than the second highest year – but its year-over-year growth has been linear, despite the number of unicorn exits growing on a more exponential curve.
Meanwhile on the continent, we can still count the number of unicorns on one hand. And perhaps that’s the point – the African tech ecosystem’s flywheel, in which exits allow for increasing amounts of money and knowledge to get invested back into the ecosystem – is barely spinning.
But the rising valuations of the tech ecosystem is a clear indication that the work of the ecosystem’s vanguards has paid off, and that we are largely in the infrastructure phase indicates that we can expect (significant) growth thereafter. We will see exits and more money in the ecosystem, and at the same time, it will become increasingly easier to build companies of greater (and greater) value.
So, OPay’s the newest unicorn operating in African markets. And there will be many more to come.