Navigating Choppy Markets – Put Your Investors To Work!
By Scott Stuart & Petros Krommidas
As the world kicked off 2022, the only thing that was certain was the palpable uncertainty ahead. As inflation crept in then escalated, as rising rates loomed then became a reality, and as the geopolitical conflict began then worsened, public markets across the board saw initial volatility followed by extreme selling. Particularly hard-hit were publicly traded SaaS companies, which had, for the past twelve years, moved almost exclusively up and to the right. Most were buoyed even higher during COVID as the world turned virtual. However, this bull market stopped in late 2021, and the following six months proved to be a trying time for public SaaS companies.
The cumulative SaaS market capitalization has fallen nearly 50% from the last twelve-month highs, with specific market sectors hit even harder. Forward revenue multiples, the primary valuation methodology for public SaaS companies, have seen significant decreases, ranging on average from 40-70%. Despite an overall correction, a clear trend has become apparent during this sell-off: the fastest-growing companies have re-traded the most. In other words, currently, public market investors are not valuing growth at all costs; instead, growth and efficiency together are the most critical determinants of valuation.
Given this changing dynamic, private companies and investors alike have begun to evaluate the road ahead and think about the precautionary actions they should take, particularly focusing on “efficient growth.” During any large market pendulum swing, founders and companies need to identify tangible frameworks that they can execute to withstand uncertain times. It’s times like these when the investors you’ve chosen to partner with can be paramount in helping to identify and navigate the best course of action.
As growth investors in disruptive software and tech-enabled businesses, one of our primary focuses at Sageview is contending with this shifting market landscape. We understand that as active partners, regardless of market conditions, our job is to help our management teams, whether that’s weathering the storm or taking advantage of market tailwinds. Running a concentrated portfolio (~15 investments) helps us ensure that we have ample time and resources to leverage our decades of experience, operational expertise, and network to help each company. We are totally aligned (with 20%+ of Sageview’s capital coming from its employees) and maniacally focused on each company’s success. We don’t deprioritize a company when things go south or sideways.
As concerns around the market outlook grow, businesses are anticipating difficult times in the quarters ahead and facing tough decisions, not unlike the early days of the COVID-19. Although the circumstances are different, it’s helpful to look back at some of the work we did with our portfolio companies during the pandemic as a recent reference point for another period of great uncertainty. The pandemic offers insight into the guidance that helped our portfolio companies remain successful during a past period of volatility.
During the first few weeks of the pandemic, we worked closely with each of our companies to assess the key drivers of their businesses and focus and execute on the KPIs that would drive positive business outcomes. In every company, we employed a three-stage approach to helping manage the business:
- Phase 1: The Basics
- Freeze hiring
- Reduce discretionary spending
- Pull down lines of credit
- Phase 2: Focus on Revenue Impacts, Cost Measures, and Cash Management
- Revenue impacts:
- Carefully track drivers of revenue to anticipate any revenue shortfalls
- Identify additional revenue opportunities resulting from the environment
- Cost Measures: anchor cost work off latest quarter actuals, not budgets
- Tech Spend: continue to invest in tech for growth – R&D is the core of your business – don’t touch this at all, if possible
- Sales & Marketing: resize to reflect lower demand
- Think of sales & marketing spend like a Capex investment – you put a dollar in and expect a great return on that investment. When demand is softer, you should expect a lower return on your Sales & Marketing spend. Adjust it appropriately to hold your LTV/CAC flat, i.e., keep your return on spending constant. Each company will need to determine the right spending level
- G&A: right size
- It’s a great time to use technology and process to create leverage and scale
- Cash Management
- Goal: achieve 2+ years of runway
- Concerns: receivables
- Reminder: having ample cash is not a reason to avoid managing the business aggressively
- Revenue impacts:
- Phase 3: Continue to Monitor Your Revenue & Customize Your Approach to Reflect Company Performance
In summary, we offered our time and resources to all our businesses during the pandemic. Across our portfolio, S&M was reduced by 18%, G&A reduced by 15%, and R&D increased by 2%, totaling a 12% decrease in operating expenses on average and extending the runway materially.
The effect of current public market dynamics on venture markets will not be evident until data for the next few months arrives, and even then, most deals announced in the second quarter were likely priced in the first quarter of this year. Put differently, it can take half a year or more before the degradation of the public market negatively impacts private market access to fundraising initiatives and valuations. Public and private software businesses would be remiss not to rethink operating plans to gain leverage and efficiency. We are actively advising our businesses and prospective portfolio companies to have two years of runway by modifying hiring plans, trimming S&M and G&A spend, conserving cash, and all-in-all shifting from focusing on growth to focusing on efficiency. Indeed, there are challenges ahead, but it is imperative to remember that there are silver linings. Some of the most well-known and impactful technology companies were founded in recessions: Amazon, PayPal, Salesforce, Airbnb, Stripe, and Google. The pandemic catalyzed a work-from-home new normal that has expanded the appetite for global talent, potentially increasing applicant supply and team quality while reducing costs.
This is also an opportunity to shift focus from raising capital opportunistically to course-correcting and focusing on fundamentals. Here at Sageview, we have the firm conviction that the best days for SaaS and the broader technology market are in front of us. We always help on an as-needed but never-imposed basis. We never implement a cookie-cutter playbook or de-prioritize portfolio companies when things do not go to plan. Finally, as long-term investors, we evaluate companies on the ROI their products provide, the potential greenfield opportunities ahead, the unit economics, and the strength of their financial profile. Despite a market downturn, quality companies will remain in high demand for potential investors and will continue to command fair prices. With the dry powder available (i.e., the capital many investors need to deploy), founders will undoubtedly still be approached by many investors, but in this type of market environment, finding the right founder-investor fit becomes increasingly important.