Compound Annual Growth Rate (CAGR) is the average annual growth rate of an investment over a specified period longer than one year. Unlike simple returns, CAGR accounts for the effect of compounding—earning returns on your returns. If you invested $100,000 in a startup and it grew to $250,000 over five years, CAGR tells you the consistent annual percentage rate that created that growth, smoothing out yearly ups and downs.
How It Works
CAGR uses a mathematical formula that assumes profits are reinvested each year. The calculation takes your starting value, ending value, and the number of years, then determines what constant annual percentage would bridge the gap. A 20% CAGR means your investment increased by 20% per year on average, compounding annually. This differs from average annual return, which doesn't account for compounding or volatility. CAGR provides a single, comparable metric regardless of whether the investment experienced booms and busts along the way.
Why It Matters for Investors
As an angel or growth investor, CAGR lets you evaluate startup performance objectively and compare different investment opportunities fairly. Early-stage companies rarely grow at perfectly linear rates—some years spike 100%, others flatten. CAGR normalizes this volatility into one meaningful number. When evaluating portfolio companies or potential deals, you can benchmark their CAGR against industry standards and peer performance. Understanding CAGR also helps you set realistic expectations and distinguish between luck and sustainable business growth. It's a critical metric for due diligence and for communicating results to LPs or co-investors.
Example
Suppose you invested $500,000 in a SaaS startup in 2019. By 2024, it's worth $1.5 million. That's a 200% total return, but what's the annual rate? Using the CAGR formula, this investment grew at approximately 25% per year compounded annually. This 25% CAGR is far more useful than the raw 200% figure because it accounts for the five-year timeline and reveals the actual yearly growth momentum. If comparable startups in the sector average 18% CAGR, your investment outperformed significantly.
Key Takeaways
- CAGR smooths volatility into a single annual growth rate, making it ideal for multi-year investment comparisons
- Use CAGR to benchmark startup performance against peers and industry benchmarks
- CAGR is different from average annual return because it accounts for compounding effects
- Knowing your portfolio's CAGR helps you evaluate whether your ROI justifies the risk and time invested, and guides future allocation decisions