How VCs Evaluate Web3 Startups
I was on a panel a few weeks ago with a large group of web3 startups. One of the questions we spent a bunch of time on was around how web3 startups are being considered and valued in today’s market. This was asked before the tech stocks got crunched in May, so I thought it was a good time to revisit and elaborate on this topic.
Let’s start with some basics. Whenever a VC is looking at a startup, there are a few big categories being considered. For me, it starts with the team. Have you got the right team members already onboard or at least identified to start after a capital raise is completed? Do you have the right mix of skills for the stage of your business? This needs to include product, dev, marketing, and whatever else is needed to win. For a web3 startup, I also want to see that the founders are imbedded in the web3 world. Are you active holders of similar NFTs? Have you experimented with related products? What is your experience level in Discord and on Twitter? Do you know other founders that are active in the space? When I see founders that haven’t red pilled into web3 trying to build in the space, it seems inauthentic and looks like a cash grab. I’m looking to end that call quickly. Lastly, does the founder understand that web3 is moving at a lightning pace? One year in Crypto can be like seven years in any other market. Do you have the right mindset to move fast and execute? Do you have the right people to do that? It’s going to be a hard, fast race to success.
Now that I like the team, the next thing I’m looking at is the size of the market. Are you going after something really niche with only a small group of potential customers? Or have you entered a market with a potentially massive audience? Who are the other competitors trying to hit up that market? How susceptible are they to losing market share, or can your product effectively increase the size of the market? Are you doing something that might have regulatory concerns or other reasons you can’t break into your chosen market? These are all standard startup questions. For web3 startups, I’m really trying to figure out if you’re going after people that are already Crypto native or if you need to bring in customers without that comfort level. If it’s the Crypto natives, why are they going to try your product? How will you break through the noise? If it’s newbies, then why will they go through the hassle of opening a wallet, buying Crypto, and interacting with your product? Or do you have a better go to market plan?
Just like any other startup, after I get comfortable with the team and market, I am going to breakdown the product. Is this something new or just a knockoff of a close competitor? Does your solution offer any competitive moat that will be difficult for someone else to follow? Are you building something that will have enduring network effects? If I get the right answers on this, then I want to be sure you have a team that can deliver on the solution and a roadmap to make it happen. When it’s a web3 startup, the product discussion goes further into the tokenomics or NFT supply/demand dynamics. Is this just a one-off sale opportunity? Do you have follow-on products to expand the market? Have you thought through the long-term supply/demand challenges to make sure there will be buyers for this project for a long time? If not, you might make some money on one sale, but you’ll never be able to build an effective business. One flop these days is enough to doom a web3 company.
The last big area of evaluation is around the financials and deal terms. I want to know how much cash you have in the bank and how quickly you are burning. I want to understand how this looks today and what it will look like after the capital raise closes. In today’s difficult funding environment, I am looking to see if you realize that assuming you’ll be able to raise again in 9–12 months is dangerous. I’m hoping you have a plan to make the cash last 18+ months unless the market environment improves. I want to know that you have a strong understanding of the levers you’ll pull to produce revenues and manage your expenses as the business grows. Not much difference between a web3 startup and one that isn’t on these financial points, other than maybe the revenue assumptions are more aggressive in web3.
When it comes to valuation, this is probably the biggest point of difference. Valuations for the other categories I invest in are definitely getting hit by the tech stock selloff. If you’re a consumer subscription app, there are plenty of market comps on value multiples to revenue to help set the market. If you’re a media company relying on ads for your revenue, the same applies. In the web3 space, things get difficult. We have seen companies like OpenSea, Dapper Labs, Sorare, Yuga Labs, Axie Infinity, and several others see extraordinary revenue growth. I’m not sure there are good comps for companies going from zero to hundreds of millions of dollars in revenue in less than a year. New markets are being created seemingly overnight, and the best companies are reaching one million paying customers at an incredible pace.
This is leading to pre-product companies still raising $10–20MM rounds at valuations approaching $100MM if they have the right team, market, and product. When I look at these types of companies, it comes down to belief that they have a product that can really change the market and pop fast. I’ll be honest, this is the hardest part of my job as a web3 VC, and I’m sure others would agree with me. On these types of companies, you either believe and live with the high valuation or you pass on the deal.
Will this end in the next month or two as even web3 VCs come to grips with the new tech pricing environment? I don’t think so. There are too many VCs that have raised dedicated Crypto funds, and there is still plenty of optimism that we will see dozens of breakout hits as the number of consumers in web3 grows exponentially. Time will tell if this was the correct investment strategy or a bubble waiting to burst.
I’m going to wrap this post here, hopefully this helped you get some insight into how VCs are looking at new web3 companies.
Follow me on Twitter for more frequent updates on web3.
*Thank you for reading this post. If you would like this directly to your Inbox twice a week, please subscribe. I would also really appreciate if you could share this post with someone who is interested in learning about Crypto and web3.*