Oooh that hurt. Not even the 6 billion Panadol tablets manufactured annually in Dungarvan are going to ease the valuation pounding of the first 6 months of 2022. And you thought the Nasdaq or crypto was bad? The 29% decline of the tech-heavy Nasdaq index might compare favourably with a 58% Bitcoin implosion but spare a thought for smaller publicly listed companies who rarely attract the headlines. Yardeni Research have just published a note showing valuations of US smaller caps have effectively halved over the past 18 months to now trade at price/earnings (P/E) multiples of 11.2x. For the additional valuation wince, note the “E” bit in P/E is probably falling too. That’s the stuff of 2008 nightmares but founders and fundraising teams need not freeze in fear. Keep going and keep sensible. The following thoughts might help:
- Valuations: Yes, valuations have moved but they will keep moving. They are always moving. Equity markets in an average year experience ‘volatility’ of somewhere between 18% and 20%. However, understand the difference between price and valuation multiples. Investment decks and proposals must reflect the fact that valuation multiples have ‘compressed’ in recent months. For example, in the previously ‘hot’ sector of SaaS – software-as-a-service – publicly quoted companies (a sample of 123 companies followed by Blossom Street Ventures) have reverted to revenue multiples(EV/Revs) last seen in 2016. Average sector multiples of 24x have cratered to just 8.5x. E-commerce companies have gone from 2.5x to 0.8x but gaming companies have been more resilient shrinking from 6x to 5.3x. Know what multiples are realistic for your sector or story.
- Public v Private Markets: Price discovery and valuations are instantaneous when looking at publicly listed companies trading every milli-second. Private markets are less liquid(don’t trade) and allow for more flexibility and much longer time horizons. Indeed, the mention of time horizons might conjure up wise sayings from Warren Buffett but our message is more blunt. Deal with ‘grown ups’(credible sources of capital) and avoid time wasters or those looking to run the clock down and perhaps force a founder into a last minute valuation crunch as a startup’s cash position becomes more stressed. Choose your funding conversations carefully.
- Cost of Capital: The biggest driver of capital markets by far is the cost of funds/interest rates. Again, investment proposals should reflect the reality of higher costs of capital. Not only does this affect valuations, in certain sectors it changes the risk profile of the proposition significantly. Note the recent fundraising conducted by Klarna whose business is financial services or, more specifically, lending to/funding consumers when they purchase goods online. A year ago Klarna raised money with a $45.6 billion valuation. Last week, not so much. The new valuation was $6.5 billion or a whopping 85% lower than 12 months ago. We have written endlessly about the risks of franchises dependent on “other people’s money”. So, the reality of rising interest rates is that lots of vulnerable business models have been hiding behind capital/money being almost “free”. That era is now over and startups exposed to “other people’s money” need to demonstrate a very robust business model. Be able to tell and sell your business model well.
- Sectors: We have mentioned SaaS, gaming and financial services in earlier valuation comments. While a bear market can sometimes feel like everything is falling in unison (correlations very strong) the more discerning investors will be looking for specific sector opportunities. The opportunities in food(agtech) and energy(renewables) are already receiving substantial VC interest. In Q1 alone the agtech sector(per Pitchbook) attracted $3.3 billion globally across 222 deals. Also, spare a thought for the business climate as margins are squeezed by inflation, higher debt costs, rising labour costs etc. Good old fashioned cost-saving solutions and services will attract serious investor interest too. Show real money examples.
- Revenue vs Cash Flow: Not too long ago it was all about growth. Every pitch, every deck was decorated with fabulous growth trajectories. Revenues were king. They still are but there’s a new queen in town. Guggenheim has published a fascinating analysis of the factors that drive the valuations of software companies, the ultimate growth bunnies. The most striking factor relationship of all was that between revenues and free cash flow(FCF). A year ago revenues as a factor were 4.9x more impactful than FCF on valuation. Now the impact gap has more than halved to just 2x. The big message here is that cash flow(or burn) is becoming a much more significant focus for investors. Note to fundraising teams – make sure founder slide decks address cash flow/burn.
- Storytelling: We can bang on about prices, equity shares, valuations, sectors and macroeconomics but ultimately the exit or funding achieved is what can be achieved on the day of the deal. Don’t underestimate emotion, chemistry and engagement as drivers of that deal. The story is critical to engagement and a shared vision of the future with investors. It is remarkable to see how many fundraisings have lawyers and accountants lined up but have sought zero professional input on how a company story is told. For example, in the current environment trying to be a solution to too many problems (‘Swiss Army knife” syndrome) can be a good ‘platform’ story but might struggle given multiple anecdotes coming from the pitching coalface. That’s the market right now. Focus your story professionally.
So, don’t be paralysed by the mainstream financial media headlines. There are lots of deals being done. Would you be surprised to know that there were 239 ‘unicorns’ or $1 billion valuations achieved in the first 6 months of 2022? That’s not far off the 267 achieved a year ago. Sounds like a lot of stories being told well.
What’s your story?