Another day, another 52-week low for the value of modern software stocks.
Once a key indicator of the market’s effervescent enthusiasm for the value of cloud companies, the Bessemer Cloud Index has become a barometer of the opposite in recent months. After a dizzying ascent, the basket of public software companies has given back all its gains since May 2021, and is not that far from losing 50% of its value since it reached record highs in late 2021.
This is despite the companies in the index posting good growth during the pandemic, and hard evidence of the fact that even during periods of economic distress, tech companies don’t lose their footing as other industries might. However, that anti-fragility is proving less attractive as other sectors come back to life as the pandemic fades.
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New data from an investor clarifies the result of the repricing of software revenues. It sums to a simple question: What’s your startup worth with a single-digit revenue multiple? For startups building software in the last few years, the question may sound unnecessarily harsh. It’s not.
The question doesn’t apply evenly. Seed-stage startups busying accreting their first four, five, six figures of revenue aren’t really valued in revenue terms, so they are somewhat to the side of this conversation. But for Series A and beyond, the reality is not changing; it has changed.
Hearing about 40x, 50x even 100x startup revenue multiples last year wasn’t uncommon. The Exchange heard from a number of investors that they were seeing Series As getting done with low-six-figure revenues, with valuations set at multiples so high that the startup in question was essentially priced like the next Slack. Or Twilio.
What are those startups going to do if they are worth not 100x their recurring revenue, but, say, 8x?
Premium compression
There’s more bad news from the market for software startups looking to scale their valuation: The growth premium is compressing.
Last year, startups could expect richer and richer revenue multiples to come with faster growth rates. There was something of a compounding valuation effect to faster growth, as investors baked in exponentially growing future value to present-day share prices. But that, of course, was not sustainable. As the overall value of software revenue decreases, the software companies that saw the most rapid pandemic-era growth are now seeing the most compression, bringing their revenue multiples more in line with startups that saw less of a COVID bump.
This means that startups who got a material valuation premium for faster growth in 2021 could find themselves the most befuddled by the new market reality, while startups that struggled to achieve a similar premium for their corporate progress could find themselves less upside-down.
Not that this means much to the long-termers out there, content to discuss valuations a decade hence. But for those of us focused more on the near-term — say, the time interval required to see all current startups raise their next round, or exit — the rapid deflation of the value of software revenues, especially for the fastest-growing software companies, is something that we have to grapple with.
The bad news
Friend of The Exchange Jamin Ball of Altimeter published new data last week showing that the overall decline in the value of software revenue — the key output of startups, really — is hitting the most richly valued companies the hardest:
In early 2021, quickly growing startups could price their private rounds with public comps turning in 40x revenue multiples and have data to back up their value. Now those same comps are racing toward single-digit multiples. For startups in the middle-growth bucket, they have seen comps slip from more than 20x revenues roughly a year ago to single digits today.
So what is your startup worth at 8x, 9x, 10x next year’s revenue? It’s an interesting question, and one that we can noodle around with.
Let’s talk about Crunchbase, a company I know well as I worked there for a few years and still own shares in. Please note at this juncture that we are leaning into my conflict of interest as the example is illustrative. And it seems fairer to ask, “How does this all shake out in reality?” if we’re discussing something that we actually care about.
So, Crunchbase. It is expected to reach $38 million ARR by the end of 2021. Let’s presume that it did. PitchBook data pegs the company’s last round as a $30 million Series C at a post-money valuation of $150 million. We’re now around 2.5 years later on. I don’t know Crunchbase’s current growth rate, but let’s run some numbers on what the company might have been worth at the middle valuation range in the above chart:
- Crunchbase EoY value at January 2021 middle-growth multiples (~20x): $760 million
- Crunchbase EoY value at March 2022 middle-growth multiples (~8.7x): $331 million
Crunchbase goes from putting up more than 4x returns from its Series C price to a rough double over essentially a one-year time frame. That’s how much things have changed, which does impact Series C-stage startups, and I would say even Series B companies and, at times, their younger siblings in the Series A range.
For faster-growing, earlier-stage startups, the damage could be even more severe. If you raised at 40x $1 million ARR in early 2021, you are probably working on figuring out how to raise more capital in short order. Let’s say you tripled last year. So you are entering 2022 with $3 million in ARR. Which, at a 12x multiple that we source from the above chart, puts your value at around $36 million. You’ve gone backward while tripling revenues in a single year.
Naturally, we’re speaking generally, and every startup is unique, but I think that the question of what one’s startup is worth at a single-digit multiple is one that everyone should consider as they sort out their spending plan for the year. What’s better: Slightly faster growth or more cash conservation? The market is signaling the latter today, after years of the former taking precedence.
It’s going to be a fascinating year for observers, though perhaps a vexing one for startup founders.
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