Executive Summary:
With Venture Capital restricting investment and SaaS-based business valuations plummeting, executives are refining their approach to valuing VC-backed growth-stage companies. Favored strategies include focusing on fundamentals such as revenue, burn rate, and cash management. Companies demonstrating strong performance in these areas are more likely to thrive and find access to capital.
Introduction
It’s no secret that 2022 has been rough for valuations of public and private SaaS companies. As recently as May, Meritech research indicated that combined market caps across the sector had fallen around 50% from highs set in 2021. Although not making news headlines, layoffs were abundant in May of this year, and have continued at a steady pace in the sector since.
However, the extent of those valuation shifts were not consistent across the entire SaaS landscape, with early-stage and seed companies continuing to hit new highs even as late-state valuations plummeted throughout the first quarter of the year depending on the vertical
All of which raises the question: to what extent are these valuation shifts trickling down to private companies? Earlier this year, Carpe Diem Partners spoke to 58 finance professionals across the SaaS B2C and FinTech landscape and asked how they were approaching valuation in a market increasingly spooked by issues related to Covid-19, inflation, and fears of a recession.
Across the professionals surveyed, revenue and burn rate emerged as common themes for maintaining realistic valuations in a tumultuous period. Several executives commented on the need to incorporate spend/burn rate elements to temper a trend of over-valuations based on ARR alone.
- “Valuations will continue to be based on revenue because of the transformative nature of tech […] Data within the corporation could also be additive to the revenue multiple. Good environment for strong valuations.”
- “Valuations will have to be backed by the true power of recurring revenue, not diluted by long contractual lead times driven by tech implementation and deployment.”
- “Valuations based on ARR but not looking at spend/burn rate have been crazy—I’m focused on a real valuation incorporating the burn rate elements.”
Not surprisingly, most of the executives surveyed expected valuations to continue to fall as elements such as inflationary pressures, tight labor markets and interest rate hikes drive up the cost of capital and potential burn rates.
- “Valuations are at the peak, lots of inflated multiples in the market not based on real values and fundamentals.”
- “I see these valuations going down. Valuations are propped up by excess cash, not core fundamentals. Current valuations assume that these firms are category-killers and they aren’t–the market is too crowded.”
- “Feel like there needs to be a correction as they are too high. Infinite growth in double digits seems unreasonable, but the SaaS model may be able to sustain high valuations, (just) not sure how this is sustainable.”
With such high levels of volatility, executives are looking to a business’ ability to survive without fresh infusions of capital as key to their valuation. While the volume of potential capital remains high, many VCs are waiting for markets to stabilize in the aftermath of covid, inflation, and ongoing geopolitical issues.
- “Valuations have dropped substantially for those firms needing more capital due to increasing cost of capital. Future earnings are being heavily discounted as attention on revenue is hard to maintain. Important to tell a story about high growth with a reasonable capital requirement as opposed to growth at all costs.”
- “Leverage may be a better vehicle than capital raise in the current environment […] the market is punishing where firms miss on key numbers especially COGS.”
- “18 months ago, it was sales and growth rates, now EBITDA is more important. Spending a lot of cash is hurting valuations. When funds get cheap again this will change.”
Conclusion
For most executives, it’s clearly time to head back to fundamentals. With higher capital costs, market disruptions and less certainty over the ability to monetize scale, the key to strong valuations in 2022 is cash management. Reducing burn rate and generating revenue are two areas where growth-stage companies can distinguish themselves from the pack. Should 2023 prove to be less volatile, capital inflows may emerge quickly—with companies who have proven their ability to stay afloat in this uncertain period likely to be at the head of the line.
These market insights from Carpe Diem Global Partners are gathered from the firm’s extensive client work leading Board, CEO, CXO, and CHRO executive search engagements for public and private multinational companies. For deeper, custom insights, contact Michael Whitehead at mwhitehead@carpediempartners.com.