Hello and welcome back to our regular morning look at private companies, public markets and the gray space in between.
Today we need to talk about what we’re hearing from the private markets and the public markets, and how different their messages seem to be.
The public markets through yesterday were on the bounce, rising sharply from recent lows, driven by negative news concerning COVID-19 and its ensuing economic damage. As TechCrunch noted yesterday, major American indices had seen their value sharply recover from lows recorded earlier in the year. This was odd, as the news from COVID-19 is far from good — America is still the country with the highest rate of new, confirmed infections and related deaths by some margin — and the economic damage stemming from the nation’s belated efforts to stem the pandemic at home piles up.
You can easily read optimism in the stock market: that the COVID-19 infection footprint at home isn’t as bad as some models indicated, that social distancing is working, and that the economy will quickly rebound from this bother. Ask around the private markets, however, and you’ll hear a very different narrative.
Yesterday while kicking over the business-focused modern software market (enterprise SaaS, if you prefer) with Shasta Ventures‘ Jason Pressman, we discussed the state of affairs for private companies that he’s seeing from his perch inside the startup machine. Taking his notes into account, along with those of other investors that we’ve spoken to recently, it’s hard to understand the level of optimism that public markets are signaling.
Not that Pressman is a pessimist, it would be difficult to be a net-gloomy venture capitalist on the whole, given the risk profile of the investments they make. But some VCs who have invested through prior downturns are comfortable being candid about what they are seeing from private companies, those inside their portfolios and out.
This morning let’s explore the public-private optimism gap for the second time. The last time we undertook this particular theme, public investors were being pessimists and private investors appeared unseasonably bullish. It’s unlikely that there is room for both views to be correct.
Smiles, frowns
On the public side of the market, our job is somewhat easy. How can we show that stocks have turned a corner in terms of expectations? Observe the following tale from the ticker tape: Since recent 52-week lows, set in the COVID-19 era, the Dow Jones Industrial Average was up 31.5% at yesterday’s close, while the S&P 500 had recovered by 29.6% and the Nasdaq 28.4%.
Those gains are material and broad; the three indices include a goodly number of companies from around the domestic economy. It would be a different indicator if only one, or two, were improved. And as we noted yesterday in our reporting concerning the markets’ latest gains, driving investor sentiment as divined by the financial press is highlighting bullish notes like COVID-19 figures that may indicate a post-peak reality and early Q1 earnings that aren’t as bad as anticipated.
If that revs your engine, so be it.
The private markets are harder to understand as they are, by nature, more opaque and less liquid. News is harder to gather, facts and figures irksome to extract and trading volume (pricing events) are sufficiently infrequent as to be more directional guidance than market-driven clarifications of value. (If we’d like, I can write about how venture capitalists value their investments in a downturn, which is interesting. Let me know.)
But we can listen to folks who are plugged in in ways that we cannot be. In that vein, let’s turn to some. First, recall that investors have already informed TechCrunch about rising churn (revenue loss from existing customers) at startups, founders have told us that investors are slowing their activity and it appears that some startup revenue growth is slowing.
We need more, however, so we’ll begin with a note from GGV Capital’s Jeff Richards, an active Twitter user and someone who shares useful tidbits from time to time. In response to a thread on this morning’s topic, here’s what he said regarding startup (private market) growth yesterday evening:
I am focused on enterprise software. Most companies anticipating at 50-80% drop in new bookings in Q2 vs forecast. Renewals will be below forecast, esp if any correlation to headcount (seat license), but will be better than new.
— Jeff Richards (@jrichlive) April 14, 2020
Notably TechCrunch editor Jonathan Shieber was trying to argue that perhaps consumer-focused startups (B2C) will fare poorly in the newly changed economy that the stock market has hailed in recent weeks, but that business-focused startups (B2B) would do well. Richards, an investor in B2B startups, disagrees.
The forecast he is referring to is often referred to as “plan,” the expected pace of growth from a startup against which it has modeled its spend, burn and fundraising needs. Richards doesn’t merely expect a small “miss” against plan but a 50-80% drop. That’s a cratering from expectations.
Indeed, if a Series B SaaS startup, to pick an example, was hoping to grow 80% this year — a number that would be ok, but not great, and not awful, depending on its starting ARR — it would, under Richard’s notes, manage to grow somewhere between 0% and 30%. Startups convert external cash into growth; if they don’t grow, upstart companies are merely luminous money torches. Not growing is bad.
How bad is coming in under plan? According to Shasta’s Pressman (recall that Shasta is now all-in on B2B startups and recently launched an educational program of sorts to help software founders scale their businesses from $1 million in recurring revenue to $10 million), pretty fucking bad.
TechCrunch asked him during our discussion of expected B2B startup growth deterioration how he would have felt about, say, his portfolio companies missing plan by 15% in Q4 2019, before COVID-19 changed the game. “It depends on the stage of the company,” Pressman responded, “but for most companies that are over $10 million or $20 million of ARR, that would be very concerning.” Especially if, he went on, that same miss was coming up at a number of companies at the same time, precisely what he told TechCrunch he’s seeing now.
Discussing what he’s seeing in “pipeline” for Q2 2020 (the current period), Pressman said that “you can see the deterioration happening,” adding that his “prediction is [that] we’re going to see much much worse numbers in Q2 for most companies than I think people” currently expect.
The damage is piling up. According to the investor, business software startups (enterprise SaaS) in his portfolio that had their quarter end in March saw missed growth expectations by between 15% and 30%. Startups of the same sort whose quarters end in April look “like they’re going to miss by 30 to 40%,” Pressman said.
Private worries
Looking ahead, Pressman sees a difficult fundraising market for startups, telling TechCrunch that “fundraising for all companies, for almost all companies at all stages, is [now] much harder and will deteriorate and decline dramatically when we start to see the post-COVID numbers” for the second quarter.
(Here I’ll note that Richards from GGV and Pressman from Shasta are both stated long-term optimists. Richards summarized this by saying yesterday that he’s “as bullish as anyone on long-term prospects for cloud/saas” yesterday, and Pressman said during our conversation that his firm will continue to write the a similar number of checks as it does every year, this year.)
When asked about possible value destruction in the private markets as growth rates slow, harming startup valuations predicated on continued, rapid growth, Pressman said that he “absolutely agree[s] with the premise that there’s going to be a lot of value deterioration.”
How does that square with the public markets? Pressman is not, if you will pardon the phrasing, impressed by the recent rally. “I think it’s a dead cat bounce,” he said about the gains, adding that he thinks that “we’re going to see the markets deteriorate again [and] very significantly.”
Previous declines
Public markets are down from 52-week highs, even with their recent gains factored in. As Redpoint’s Astasia Myers wrote earlier this week on Twitter, we’ve seen revenue multiple compression (the decline in the value of each dollar of revenue) amongst cloud and SaaS companies:
☁️SaaS / Cloud NTM Multiples medians by growth (defined as NTM rev. growth; % relative to LTM highs):
High growth (>30%) at 11.9x, ⬇️21%
Medium growth (15-30%) at 7.8x, ⬇️25%
Low growth (<15%) at 3.2x, ⬇️44%Slower growers the most negatively impacted. @redpointvc @SaiVC_
— Astasia Myers (@AstasiaMyers) April 13, 2020
Those numbers are a little dated today, but not enough to be material. So things are now a bit cheaper in light of a far worse economy, but stocks are trying to tell the world that things just aren’t that bad.
Wrapping
Moving us to a close as we’ve gone a bit long, here’s where things stand as far as I can tell: When COVID-19 forced a shuttering of the U.S. economy, startups that were impacted made staffing cuts that were loud; startups laying off staff after a years-long talent war was notable and was amply covered by the news media, this publication included. Stocks fell as well, as the rolling quarantines began to bite into employment rolls and consumer spending. But the stock market, accustomed to always going up for about a decade, began to cling on to any bit of good news it could find, some Fed action here, a better COVID-19 number there. Mix in some optimism about a faster recovery timeline for the economy and public investors got their footing back.
We’ll know more when Q2 earnings and Q3 forecasts are out. Private investors have not yet stopped ringing the alarm bells about the economy. The private and public markets cannot both be right as we only have one economy. Sure, big companies have more cash and Amazon is doing well in the current panic, but the stock market rebound has hardly been constrained to a few BigCo pandemic winners.
And that’s the public-private optimism gap today, the inverse of what we saw in late 2018, a little under 1.5 years ago. How quickly the world changes.
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