The Most Important Fed Meeting in Recent History
The Most Important Fed Meeting in Recent History
8/4/24 Benchmarks for Operators
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The Most Important Fed Meeting in Recent History
The image above blew my mind - there are 725 private tech companies with “unicorn” valuations of $1 billion or more. This compares to about 550 public tech companies trading at over $1 billion today.
Reader Diego O. shared some compelling insights about the potential thawing of the IPO market:
“I was doing some digging on the IPO market and what it would take to thaw it for sub-500m companies, and my conclusion (and bias/hope) is that this upcoming FED meeting might tilt this curve even further and open the floodgates. And would be curious to see if it takes us all the way back to 2018-2019 financial profile, or somewhere in between.”
As he points out, many of the private companies waiting in the wings for the IPO market to improve are in the sub $500 million revenue range. And, according to SVB’s report, perhaps a quarter will need to raise capital within the next 12 months or face running out of cash. And the recent jobs data below may have been the push the fed needed to cut rates more drastically, making the IPO market a more hospitable place.
Why the potential change in rates (and investor sentiment)?
The TL;DR is July jobs data didn’t score well - unemployment grew and the number of new jobs created was half of what was targeted. It usually takes 6 months for Fed changes to reverberate through the economy, and they are now getting signal that they didn’t cut rates aggressively enough.
Mark Zandi, chief economist at Moody’s, voiced a sentiment shared by many:
“They made a mistake. They should have been cutting rates months ago. It feels like a quarter-point cut in September isn’t going to be enough. It’s got to be a half-point with a clear signal that they are going to be much more aggressive in normalizing rates than they have been indicating.”
With the benchmark interest rate at a 23-year high, there's growing anticipation that the Fed will now cut rates by 50 basis points in the coming months, twice as much as the 25 basis point scalpel usually employed. In fact, they may make a larger cut twice before year end to move their rate down by a full percentage point. That would be a game changer in the DCF models of investors.
Taking a step back - Lower interest rates typically lead to higher tech multiples because they reduce the cost of borrowing and increase the present value of future cash flows. In a low-rate environment, investors are more willing to pay higher prices for growth stocks, like tech companies, as the discounted value of their expected future earnings increases. This, in turn, drives up valuation multiples, making it an attractive time for companies to go public or raise additional capital. Additionally, lower rates can stimulate economic activity, which benefits tech companies with scalable business models that thrive in expanding markets.
That’s why this next Fed meeting is so important - it could be the straw that breaks the camels back, triggering a wave of IPOs and allowing LPs to finally receive distributions.
TL;DR: Multiples are DOWN week-over-week.
Top 10 Medians:
EV / NTM Revenue = 12.1x (-1.5x w/w)
CAC Payback = 15 months
Rule of 40 = 50%
Revenue per Employee = $541K
Figures for each index are measured at the Median
Median and Top 10 Median are measured across the entire data set, where n = 109
Population Sizes:
Security: 17
Database and Infra: 14
Backoffice: 15
Marcom: 16
Marketplace: 15
Fintech: 16
Vertical SaaS: 16
If you’d like the company level metrics used in these reports, upgrade to paid and you can download the excel sheet at the bottom of this post
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
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)
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 %
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 most common buckets companies put their operating costs into are:
Cost of Goods Sold: Customer Support employees, infrastructure to host your business online, API tolls, and banking fees if you are a FinTech.
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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