Goodwater Cap
Entrepreneurs always ask the question, “Is now a good time to raise money for my startup?” The reality is that nearly every early stage startup is less than 18 months away from its next fundraise. As a result, the state of the fundraising environment is top of mind for every entrepreneur because a CEO’s core responsibility includes keeping cash in the bank to fuel their team and vision.
Well-functioning Boards of Directors offer guidance on fundraising strategy via anecdotes from their portfolio, learnings from recent financings, and discussions with other VCs. They help an entrepreneur understand how long a funding round will take, expected terms, and diligence requirements. VCs keep their pulse on the market and translate that understanding into strategic advice for entrepreneurs who focus on building the business.
As we sat in board meeting after board meeting discussing the rapidly changing funding environment in 2016, we realized that there must be a better way to support entrepreneurs in this area. It was very hard to communicate how much the market had changed over the prior year. From 2009 to 2015, VC funding had mostly been an “up market” and startups were trained to raise ever-larger sums of capital on ever-higher valuations. But as the market hit turbulence, that reality shifted quickly. Quality companies struggled to raise money, requiring inside rounds led by existing investors, or even down rounds.
We heard many anecdotes and some data points. Unfortunately, there seemed to be no concrete way to systematically quantify the changes in the market environment and how it would impact fundraising. All the while entrepreneurs tended to think logically, “I’ve grown my business 4-6x since my last round, this should be an easy fundraise.” Ultimately, that kind of thinking turned out to be incorrect due to fundamental changes in the market.
To address this conundrum, we built a product that provides accurate data on the key drivers of the venture capital funding environment. The Goodwater Index helps entrepreneurs understand the overall health of the venture capital funding environment for consumer tech. The monthly score (41.9 in March 2017) is a simple assessment of fundraising prospects for consumer tech companies, offering perspective on how much the market has improved or worsened over the last few months or years. As a useful reference point, the Index value for March 2000, the peak of the dot-com bubble, has been normalized to 100. We also provide a specific recommendation on timing, terms, and expected diligence, the kind of tactical advice that you would hear from a good VC board member.
We calculate the Index by combining key industry data sources including dollars invested, VC funds raised, deal volume, M&A, and IPOs. The Index is a composition of key indicators that have correlated highly with the historic health of the US consumer tech VC funding environment. While our data set is focused on the US, we believe the overall curve is broadly indicative of global consumer tech funding activity (excluding China).
Our formula was backtested on 20 years of historical data and is based on the most statistically significant components. For historical context, we annotate key moments such as the Pets.com IPO, Facebook’s founding, major geopolitical events, and market commentary from industry thought leaders. We also show the top 10 US consumer tech companies of every year, which powerfully illustrates the rapid changes in our industry.
Goodwater’s mission is to empower exceptional entrepreneurs who are changing the world. We see this mission as a call to serve the entrepreneurs in the Goodwater family and also broadly serve entrepreneurs across the startup ecosystem. With Index, entrepreneurs will be empowered to understand and navigate rapid changes in the fundraising market. Of course, there are nuances with every company’s situation and there is no such thing as “one size fits all” fundraising advice. We hope that the Index simply provides an objective, data-driven starting point for entrepreneurs. We will update Index with new data on a monthly basis and continue to improve the data and add features that better serve the entrepreneurial community and bring transparency to an otherwise opaque market.
How We Did It
Correlation-based Approach
The answer to “What’s the fundraising environment like?” is based on many disparate factors. The challenge in synthesizing a useful index that answers this question is 1) identifying which factors are most relevant and 2) determining how to combine them into a single representative measure.
There are a couple approaches:
- Choose factors that are intuitively relevant and combine them using predetermined weights (e.g., in equal proportions). Although this approach is simple and intuitive, it’s not necessarily representative and may overweight some factors and underweight others.
- Correlate a set of factors against a target quantity and use a regression model to combine the relevant factors. While this approach is more complex, it allows us to be more rigorous about choosing relevant factors and determining proper weightings.
We used the second approach to develop the Goodwater Index. This naturally leads to the question “what’s the right target quantity to use?” Again there are a couple different approaches:
- Use a standard KPI like deal volume. While it would be interesting to develop a model that can forecast deal volume, deal volume by itself does not determine the health of the funding environment. We would still need to figure out how to combine it appropriately with other factors to fully capture overall health.
- Use an assessment of the historic health of the fundraising environment. With the benefit of hindsight, we can holistically assess how overall health has trended over the past 20 years, particularly the relative size and timing of peaks and valleys. We can then use this trendline to identify the underlying factors that have historically correlated most significantly with the overall health of the fundraising environment. The result is a more robust model for assessing overall health going forward.
We chose the second approach and formed the target quantity around the peaks in Q1 2000, 2007, 2014/15, as well as the troughs in 2002/2003 and 2008/2009.
Data Collection
We believe historical context is important when interpreting fundraising data, particularly the dot-com bubble of the late 90s through 2000, and so we looked for data sources that are both relevant and available for at least the past 20 years. The data we collect include venture investments, VC funds raised, IPOs, M&A transactions, and public market metrics.
To the extent possible, we curated data to focus on the space of US consumer tech. For IPOs and M&As, we selected listings and acquisitions of US consumer technology startups. For public market metrics, we went back in time and found the largest public US consumer technology companies every year from 1997 until now and used their performance in the public markets as an input to our model.
From the raw data, we produced dozens of derivative features. Based on these features, we fit a regression model against the target quantity. Care must be taken when selecting the features to include in the model, as many pairs of features are actually highly correlated, and therefore including both in the model would not add significant additional signal and tend to overfit the existing historical data. For example, the number of VC deals and the dollar value invested unsurprisingly have high positive correlation, as do the number of deals and the number of VC funds raised over the trailing 4 quarters, as shown in the plots below.
Taking these considerations into account, we arrived at the ultimate model that drives the Goodwater Index. It’s not a perfect predictor of the health of the funding environment because there are nuances that data cannot fully capture, but we hope that it serves as a useful reference point and context for understanding the funding landscape.
If you have ideas for how we can improve Index or if you are interested in helping us aggregate other relevant data sources, please email index@goodwatercap.com.