This week we’re super excited about the successful IPO of the sweet and fizzy, Lemonade Insurance! This is a big deal for the global Insurtech community. A fruitful liquidity event promotes Insurtech as an attractive vertical for VCs, and now Hippo is daring to be next.
Lemonade built a full-stack insurance company from the ground up, using first principles in its design, user experience and a customer-first business model. “It was mind-boggling that an industry that is performing such an important societal role is perceived so negatively” – CEO & Co-founder Daniel Schreiber. Daniel attributed a perceived ‘conflict of interest’ as a major contributor to the negativity, i.e. customers buy insurance to access claim benefits but the less an insurer pays in claims, the more profit they achieve.
Lemonade was created with a simple but effective counter-argument to this conflict – a company mission to “delight customers”.
In practice, this means fast service and fast claims (driven by user experience and AI), and fixing Lemonade income at a flat 25%, with any residual profit being offered to a charity of the insured’s choice.
Lemonade is now live in 25 US states, Germany and the Netherlands and has successfully created a paradigm shift among consumers, attracting 730k insureds, most of which are new, young customers (70% new to renters insurance).
In 2019, Lemonade provided $631,540 in funding to charities. This funding may be in-part lip service, but the company’s net promoter score, customer satisfaction and growth trajectory speak volumes for the effectiveness of this strategy (explained in depth in the video below).
Now, Lemonade is driving a paradigm shift in the Insurtech investment market.
The company reported $67m USD in revenue in 2019, with a loss of $108.5m and is yet to become profitable. But on 1 July, 2020, Lemonade (NYSE: LMND) completed an IPO at $29 per share. The company’s stock traded up 139% from the IPO price on day 1. After a week, it was trading over $81 per share with a market cap. >$4bn USD.
In this piece, we explore the polarising question on Lemonade’s valuation.
Lemonade’s IPO consolidates its valuation at a remarkably high level, relative to their current state.
In the past five years, Lemonade has raised $480m USD in funding as a private company, the latest of which placed their valuation at $2.1bn post-money (April 2019)². 2 years on its estimated value has doubled.
I often get asked how a loss-making start-up can be worth more than an established insurance company with 10x the profitability and 10x the revenue?
To make a case for Lemonade’s valuation is to make a case for start-up valuations in general.
This may sound surprising to some, but start-ups and their valuations are not immune from the principles of economics and finance. If you ask your Corporate Finance professor, the discounted-cash-flow valuation method applies well to no-less-than every asset under the sun.
Discounted Cash Flow (DCF) Valuation attempts to figure out the value of an investment today, based on projections of how much money it will generate in the future. (Investopedia)
What DCF gets right is consideration for future performance. Alternative valuation methods such as EBIT multiples or price-to-earnings are of no use when EBIT and earnings are in the red. More importantly, these valuation methods do not account for the unique characteristics of each company in a fast-changing environment, and they offer little insight into what drives valuation³.
How are start-ups valued differently to traditional businesses?
The elements that inform a valuation are similar, from a traditional business to start-ups, though weighted differently. Valuations of traditional businesses are generally focussed on past performance, with consideration to market conditions, current market share and return on capital.
Valuations of Start-ups are generally focussed on future performance.
McKinsey & Co offer a palatable explanation of the methodology – Start by thinking about what the industry and company might look like as the company evolves from its current hyper-growth, uncertain condition, to a sustainable, moderate-growth state in the future. Consider operating performance, such as customer-penetration rates, average revenue per customer, sustainable margins, and return on invested capital. Then it’s time to reconnect the long-term forecast to current performance and capability. Do this by assessing the speed of transition from current performance to future long-term performance. Estimates must be consistent with economic principles and industry characteristics.
We can see why comparing a start-ups’ valuation to that of traditional business in a moment in time is problematic. Traditional businesses are generally in a moderate growth phase, whereas a start-up is generally in a hyper-growth phase. A moment in time does not capture velocity. Its where the velocity eases and plateaus into a profile more consistent with that of a traditional business that is the focus of the forecasting and thus valuation.
Start-ups by definition are businesses designed to grow fast.
From Pre-Seed to Series C, founders will generally acquire a capitalisation table full of industry legends, strategic thinkers and door openers. Founders also generally give up most of their company’s equity for the purpose of fuelling their velocity, from launch to scale-up with the key focus being speed and market share.
Lemonade is valued higher than other insurance carriers who have far greater revenue and are consistently profitable. Based on the above theory, it’s where Lemonade is predicted to plateau into a sustainable, moderate-growth state that in-part drives its value.
Likely a controversial parallel, Tesla, has not yet reported a full year of profit but has an extremely high valuation due to its future trajectory.
Through 2019, Telsa sold 367,200 vehicles, the same year Toyota sold 10,460,000 vehicles and recorded revenues 10 x that of Tesla. Yet as at 30 July 2020, Tesla has a higher valuation than Toyota.
Looking at this theory from a different angle, the higher the discrepancy between a start-up’s current profile and valuation, the greater the forecast of velocity, or time spent in hyper-growth mode.
As noted, there are also considerations for market size and conditions. With the globe at the beginning of a shift to renewables, with consumer’s forecasted to spend billions annually on electric vehicles, home batteries, solar panels, at what point will Tesla plateau into a sustainable moderate-growth state? Likely not until it takes a solid chunk of impending market share.
At what point will Insurtechs like Lemonade reach a sustainable model of growth?
Some would say that being a low-cost digital product and service, it will be much sooner than a manufacturing market like cars or batteries. Which might explain why funding volumes for Insurtech are up and the investment market has already returned to a pre-COVID trajectory.
Dr. Andrew Johnston of Willis has again produced the April – June Quarterly Insurtech Briefing with the high points as follows:
– 71% increase from the previous quarter, which sustained the brunt of the COVID-19 impact.
– 10% increase on previous year’s April – June quarter
– The bulk of the money went to later-stage rounds, with early-stage seeing a drop of 43% in volume from the previous quarter and 17% of the previous year’s corresponding quarter.
– MGAs continue to lose ground to SaaS/ B2B business models.
Source: Willis Towers Watson Quarterly Insurtech Briefing Q2 2020
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² Financial Technology Partners
³ McKinsey & Company