Feb 10 2016

The Profit Imperative

With the markets crashing around us and the sky once again falling I thought it was time to revisit a few fundamentals and perhaps more importantly share some what what we’re now seeing in the private funding markets.  

Growing Profitably. Let’s start with what I labeled the Growth Imperative a few months ago in a post, where I pointed out 1) that investors were (over) valuing growth and 2) that when this changed it was going to change quickly (and in a separate post said: “when the growth imperative shifts to a profit focus, companies with high burn and weak operating metrics can get stuck in the lurch.”).  It always amazes me how quickly the markets can shift and how rapidly investors change their mind set. But they do, and they are right now. We’re seeing lots of market data points that suggest that the private markets have shifted dramatically to a Profit Imperative, overnight eschewing high growth/high burn with no line of site to profitability and favoring companies that are growing more slowly but doing so profitability or with a clear path to profitability. There’s an increased focus on key metrics – especially those core metrics that drive the spend/growth curve such as LTV/CAC and months to pay back CAC. 

Valuations are Down. As the public markets have fallen, so have the private markets. No surprise here, but the drop has been rapid and it’s been dramatic. In the public markets public SaaS valuations (EV/Revenue) are down 33% since January and 66% since their high in January 2014. This is true across other markets and has quickly worked its way down into the private markets (btw, the current EV/Rev multiple for public SaaS is 3.2x). Different sectors of the market have seen varying levels of decline, but overall the private markets are off similarly to the public markets. I’d point out that this is especially true for companies in the Series B stage.

Flight to Quality. Just as we’ve seen this in the public markets (with Google, Facebook and a few other giants suffering stock losses much less than their smaller peers), the private markets are quickly differentiating true market leaders from the rest of the pack. And while there are plenty of markets that aren’t necessarily winner take all, investors aren’t buying the story for why a 2nd or 3rd player can break out.

Product vs. Company. There seems to be a growing realization – especially in the B2B SaaS market, but also across others – that many of the companies that have been funded and have seen reasonable growth are really products, not companies. And that at some point their growth will flatten out as their product saturates the market. I think this is coming through in subtle ways as investors evaluate companies (I’m not hearing people talk about it explicitly) but behind some of the comments is clearly this question and all companies that are in the market to raise capital should recognize this bias.

There’s no silver lining with which to end this post (other than that I personally think the markets – public and private – are overreacting; but that doesn’t mean they’ll necessarily correct back any time soon). Hopefully you took the opportunity in the past few quarters to shore up your balance sheet. If you didn’t it’s time to be careful. Plenty of companies will continue to get funding, but beware of the market dynamics that I describe above.