Size Matters
6/30/24 Benchmarks for Operators
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This is my all time favorite scene from Succession. Cousin Greg learns that his billionaire grandfather is cutting him out of the will. But, lucky for him, his back channels tell him he’ll still get a small taste - $5 million - when the old man kicks the can.
Tom and Connor proceed to explain why $5 million is actually the worst place to be:
“You can’t do anything with $5, Greg.
$5’s a nightmare.
You can’t retire… Not worth it to work. $5 will drive you un poco loco, my fine feathered friend.
Poorest rich person in America. The world’s tallest dwarf. The weakest strong man at the circus.”
-Tom and Connor
The same could be said about companies trading at a $5 billion market cap.
$5’s a nightmare.
Companies in this range (some would even argue sub $10 billion) get caught between a rock and a hard place.
Why? Well, it has nothing to do with underlying business fundamentals.
Let’s say you’re a hedge fund manager with a $15 billion dollar fund. You can’t have 100 positions in the fund. So in order to move the needle, you need to have a position that’s at least $500m in each company.
And you also need the ability to get out of a stock relatively quickly (and quietly), if shit hits the fan.
As a litmus test, investors ask how many days of daily volume it would take for them to bounce.
A quick example:
The float on a $2 billion company is 20% to 40%, meaning there’s between $400M and $800M in actual tradeable equity at any given point.
And the daily trading volume on that float is $50M.
Finally, you want to stay under 10% of daily trading volume so you don’t crush the price.
Conclusion: it will take a long time to get out of a $500M position at $5M increments.
Plus, to build a meaningful stake, you’d need to own a significant chunk of ownership, triggering a threshold that requires reporting whenever you move in or out. That’s a pain and comes with a whole set of competitive considerations.
And from a coverage standpoint, researching and keeping up with these stocks will take about the same amount of time, effort, and resources as covering a stock with a $40 billion market cap. So the juice isn’t worth the squeeze.
Aside from the trading mechanics, from the perspective of the company, it’s really hard to get research coverage below a certain threshold. The Goldmans and Morgan Stanleys of the world won’t cover you at $4 billion, which makes it hard to generate awareness and visibility.
So you float in this zone that’s neither interest nor disinterest - but, rather, irrelevance…which is actually the worst place to be.
All these considerations, which are squarely outside the task of “building a great business”, are reasons why it doesn’t make sense for most companies to go public unless they’re going to trade in the mid to high teens of billions.
I used to think you could just build a good company that grows nicely, with solid unit economics, and you can go public at $100M or $200M in revenue. You can. But you’re fighting an up hill battle to thrive in the public markets, which partially trades on attention.
Yes the public markets bring liquidity, access to capital, and enterprise sales credibility. But if you aren’t pushing double digit billions in market cap, you’d hate to fall out of a favor in a way that’s hard to come back from (see: Jfrog, Pager Duty).
As my good friend, a crossover investor in the technology space told me:
“Sure - you are technically allowed to take a 125cc motorbike on a German Autobahn that has no speed limits. It’s just not going to be all that fun or safe with all the fast cars and big trucks around you.
One hiccup, somebody overlooks you, and you get severely injured, if not end up dead.
You can make it, but you better drive real careful and stay in your lane (and hope you don’t get side swiped at some point). Or you go as fast as you can and pray to God you reach the exit before shit goes sideways.”
Couldn’t have said it better myself.
So yea, size still matters.
TL;DR: Multiples are UP week-over-week.
Top 10 Medians:
EV / NTM Revenue = 13.6x (+ 0.9x w/w)
CAC Payback = 16 months
Rule of 40 = 42%
Revenue per Employee = $496K
Figures for each index are measured at the Median unless otherwise stated
Average, Median, and Top 10 Median are measured across the entire data set, where n = 102
Population Sizes:
Security: 17
Database and IT Mgmt: 14
Backoffice: 18
Marcom: 17
Marketplace: 16
Vertical SaaS: 20
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Revenue Multiples
Revenue multiples are a shortcut to compare valuations across the technology landscape, where companies may not yet be profitable. The most standard timeframe for revenue multiple comparison is on a “Next Twelve Months” (NTM Revenue) basis.
NTM is a generous cut, as it gives a company “credit” for a full “rolling” future year. It also puts all companies on equal footing, regardless of their fiscal year end and quarterly seasonality.
However, not all technology sectors or monetization strategies receive the same “credit” on their forward revenue, which operators should be aware of when they create comp sets for their own companies. That is why I break them out as separate “indexes”.
Reasons may include:
Recurring mix of revenue
Stickiness of revenue
Average contract size
Cost of revenue delivery
Criticality of solution
Total Addressable Market potential
From a macro perspective, multiples trend higher in low interest environments, and vice versa.
Multiples shown are calculated by taking the Enterprise Value / NTM revenue.
Enterprise Value is calculated as: Market Capitalization + Total Debt - Cash
Market Cap fluctuates with share price day to day, while Total Debt and Cash are taken from the most recent quarterly financial statements available. That’s why we share this report each week - to keep up with changes in the stock market, and to update for quarterly earnings reports when they drop.
Historically, a 10x NTM Revenue multiple has been viewed as a “premium” valuation reserved for the best of the best companies.
Efficiency Benchmarks
Companies that can do more with less tend to earn higher valuations.
Three of the most common and consistently publicly available metrics to measure efficiency include:
CAC Payback Period: How many months does it take to recoup the cost of acquiring a customer?
CAC Payback Period is measured as Sales and Marketing costs divided by Revenue Additions, and adjusted by Gross Margin.
Here’s how I do it:
Sales and Marketing costs are measured on a TTM basis, but lagged by one quarter (so you skip a quarter, then sum the trailing four quarters of costs). This timeframe smoothes for seasonality and recognizes the lead time required to generate pipeline.
Revenue is measured as the year-on-year change in the most recent quarter’s sales (so for Q2 of 2024 you’d subtract out Q2 of 2023’s revenue to get the increase), and then multiplied by four to arrive at an annualized revenue increase (e.g., ARR Additions).
Gross margin is taken as a % from the most recent quarter (e.g., 82%) to represent the current cost to serve a customer
Rule of 40: How does a company balance topline growth with bottom line efficiency? It’s the sum of the company’s revenue growth rate and EBITDA Margin. Netting the two should get you above 40 to pass the test.
Rule of 40 is calculated as: TTM Revenue Growth % + TTM Adjusted EBITDA Margin %
Revenue per Employee: On a per head basis, how much in sales does the company generate each year? The rule of thumb is public companies should be doing north of $450k per employee at scale. This is simple division. And I believe it cuts through all the noise - there’s nowhere to hide.
Revenue per Employee is calculated as: (TTM Revenue / Total Current Employees)
A few other notes on efficiency metrics:
Net Dollar Retention is another great measure of efficiency, but many companies have stopped quoting it as an exact number, choosing instead to disclose if it’s above or below a threshold once a year. It’s also uncommon for some types of companies, like marketplaces, to report it at all.
Most public companies don’t report net new ARR, and not all revenue is “recurring”, so I’m doing my best to approximate using changes in reported GAAP revenue. I admit this is a “stricter” view, as it is measuring change in net revenue.
Operating Expenditures
Decreasing your OPEX relative to revenue demonstrates Operating Leverage, and leaves more dollars to drop to the bottom line, as companies strive to achieve +25% profitability at scale.
The three most common buckets companies put their operating costs into are:
Sales & Marketing: Sales and Marketing employees, advertising spend, demand gen spend, events, conferences, tools
Research & Development: Product and Engineering employees, development expenses, tools
General & Administrative: Finance, HR, and IT employees… and everything else. Or as I like to call myself “Strategic Backoffice Overhead”
All of these are taken on a Gaap basis and therefore INCLUDE stock based comp, a non cash expense.
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