While stocks looked for a comeback on Friday after another torrid week of selloffs, it’s a fact that software valuations are testing new levels of price depression.
There’s widespread damage as a result of all of those red charts plummeting down and to the right: The decline in the value of public software companies has been a key leading indicator for the present slowdown in venture capital activity, for example, and the ability of startups to push their own valuations higher.
Day-to-day coverage, however, can provide snapshots instead of more complete images. So this fine Saturday, I want to slow down and take stock of where are regarding software (SaaS, effectively) valuations.
The smaller reality of SaaS valuations
There’s no need at this point to gloat about how much investors got things wrong last year. Markets have a way of teaching their own lessons; we don’t need to add to the lecture notes provided by public-market immiseration of recent tech IPOs or the panic that overpriced unicorns feel as they compare their revenue base to their sticker price.
Keeping to the numbers, a few key data points for our work:
- Despite a Friday bounce, the value of the Bessemer Cloud Index, a basket of cloud and software stocks that loosely tracks the value of SaaS companies, is off around 40% this year and more than 50% from all-time peaks.
- The same underlying dataset on Friday stated that the average public cloud company has a revenue multiple of 10.2x and is growing at 41.3%.
The 40% mark is a good number to keep in mind. Why? Because with the traditional Rule of 40 in place, startups that are looking to go public with 40% growth rates will need breakeven cash flows at IPO to be merely average — not underwater — on the key metric. That’s not a low bar.
But more to the point, the 40% to 50% decline in the value of public SaaS companies has effectively revalued software concerns that are good enough to go public and are still growing at 40% at just about 10x their revenues. That’s a figure that some startups won’t be able to manage, mind, as they won’t be able to reach the public markets with 40% growth. That means that for some companies, eventual IPOs are going to include single-digit revenue multiples if things don’t improve.
For many unicorns, this is a tragedy. Many such private companies were valued at 35x to 100x last year, to draw a wide lasso around the herd of horned ponies. A startup that sold stock last year at a 50x ARR multiple — a loose cognate for revenue multiples more generally, and one that is close enough for our directional math today — would need to double and then double again before it would have a multiple that is similar to the current public-market standard.
Now, a company doubling yearly would be able to command a greater revenue multiple than what we see among the slower-growing public company cohort. But at the same time, that unicorn likely doesn’t have the cash it needs to double for several consecutive years without refueling. This means that our 50x ARR startup that is on pace to double this year won’t be able to de-risk its valuation before it needs to raise more funds.
The future likely holds down rounds, flat rounds and what I expect will be some dramatic implosions.
It feels a little unfair to say it like this, but the startups best equipped to survive 2021 prices are those that raised way more than they needed and are sitting atop a personal bank — or those that simply don’t lose that much money. Or both. I suspect that most unicorns fail those tests given where spend was in startup land last year.
So here come single-digit SaaS multiples for lesser startups — and perhaps IPOs once the window cracks open once again.
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