Kingsley Amis was right to note that the metaphysical hangover that comes after too much drink is often worse than the physical shock of waking up and realizing that your head has been filled with angry wasps and your bones and organs are on strike.
You can fix physical ailments with water, time, food and a tuft of fur from your household pet. But it often takes longer, and more work, to rectify one’s spirit after a real session at the bottle.
Thus, today’s venture capital market. I won’t argue that the slowdown in venture capital spending has been easy on startups (accustomed to easy capital access through 2021) or their backers (accustomed to easy and frequent paper mark-ups on their investments through 2021), but at some point we have to acknowledge that the worst is behind us, and any remaining malaise is potentially psychosomatic.
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This column made an argument along those lines just a few weeks back, in fact.
New data from Bessemer and Forbes underscores just how far startups have progressed since the venture market and tech economy hit turbulence in late 2021.
As you’ll recall, startups were forced to change their posture after interest rates began to rise. All of a sudden, tech companies accustomed to double- or triple-digit multiples on their revenues were looking at a future where their price-sales multiples would land in the single digits.
Suddenly, profitability and general business sustainability became hot topics, inspiring a thousand venture tweets and blog posts.
The best startups listened. Anu Hariharan, a former Y Combinator and a16z investor, wrote earlier this week that many later-stage startups run by “great” founders “are on track to hit positive free cash flows and net income [positivity] without having to raise a single penny from external investors.” He added that quite a few of the unicorns in question have already achieved the feat.
Hariharan wasn’t merely talking about her book — she’s on the boards of several startups valued at $1 billion or more. She was accurately describing the new reality of the best cut of late-stage startups.
Each year, Bessemer and Forbes compile a list that they dub the Cloud 100. As all software is hosted on the cloud these days, it’s a list of tech startups that write and sell managed code, mostly. And the latest iteration that dropped this week had some fascinating data points. Bessemer’s cloud index is related, but different as it deals with public tech companies.
Consolidating the data that I consider the most salient, observe the following:
Falling valuations
The average company listed in the 2023 Cloud 100 is worth $6.6 billion. That figure is off 10% from 2022 ($7.4 billion), but 27% above the 2021 average of $5.2 billion. For perspective, the 2020 figure was $2.7 billion, and an even smaller $1.7 billion in 2019.
We don’t need to cheer declining valuations; you could argue that it would be gauche to do so. But a decline in the average worth of the Cloud 100 points to some progress in harmonizing late-stage startup valuations with today’s public market norms.
Of course, raw valuation figures are nothing without context.
Compressing revenue multiples
Trailing 12-month annual recurring revenue (ARR) multiples for Cloud 100 companies in the year ended July came to 26x in 2023, down from 30x in 2022, and 34x in 2021. The 2023 figure is still double what we saw in 2019 (13x) and more than in 2020 (23x).
Not all the valuation declines we’ve seen are due to compressing multiples, but the two data points do move in tandem. Seeing late-stage startups inch closer to public-market norms implies that we’re seeing the best-known IPO candidates get ready for an eventual debut, albeit slower than some might have hoped.
But what about lowering burn and working to build more self-supporting unicorns? That’s underway as well.
Cash flow breakeven is the new “elite” status
Twenty-three Cloud 100 companies are “already cash flow positive,” per Bessemer. Another five companies expect to be profitable by the end of this year, and 34% expect to be generating instead of burning cash by the end of next year — 62% of the Cloud 100 in the next five and a half quarters.
Sure, but how much have those numbers changed in recent quarters? An excellent question. We have data.
Less burn is possible, at least if your startup is exceptional
About 58% of this year’s Cloud 100 reported that they are “burning meaningfully less” this year than in prior years. Just 7% are burning more, with the rest around flat.
And these declining burn rates are having a tangible impact: Only 13 of the 2022 Cloud 100 were cash-flow positive, far less than the 23 we noted above. Others are making progress: While 43% of the Cloud 100 burned between $50 million and $100 million in 2022, only 33% did in 2023.
Nothing comes without a cost, however, and a partial result of lower spending, limited burn, and higher cash profitability has been a decline in growth rates.
Maybe double-digit growth is enough
From 2019 through 2021, the average Cloud 100 growth rate wavered between 80% and 100%, while the top 10 companies in the group scooted from 100% to 120% over the same time frame. Then, in 2023, the average growth rate fell to 55%, while the leading ten companies slipped to 70%.
Can leading startup unicorns go public at those growth rates? Of course. The question is at what price. Companies have to hope that improved profitability outweighs slowing growth when they do list. It just might.
There are signs that growth could pick back up later in the year and in 2024. Twilio is one such example. Any re-acceleration of growth from the Cloud 100 set (and what we could call the Cloud 1,000, to invent a new group) would help skim away a good portion of the remaining froth in the private market.
Hariharan agrees, though, that the pricing question for startups has not yet been resolved, even in the later stages. From the same tweet thread:
The big question is price / re-price. Founders would rather wait as they don’t need the cash, investors hesitant to reprice (some don’t even want to price) and offering converts.
The good news — there will be quite a few tech startups that hit the public markets over the next few years with significant cash flows and these CEOs will never forget their toughest days (2020 to 2023 has been a period of significant volatility). Therefore these companies will be much better run and more durable in public markets.
Do hard times yield great founders? That’s what we’re hearing, and the data is so far backing up that point.
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