A Divergence of Risk
9/1/24 Benchmarks for Operators
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A Divergence of Risk
Scott Galloway recently had Nate Silver (of election forecasting fame) on The Prof G. pod to talk about risk taking. In the course of the conversation, Scott’s experience with taking venture funding comes up:
“I've been an entrepreneur for most of my life and have raised a lot of money from VCs and where I thought there was a bit of a disconnect or dislocation between their interests and my interest is that they would always encourage me as the CEO or the founder of a company when it was going well to go bigger, harder, bolder because they're looking for billion dollar exits to pay for the 80% of their portfolio that doesn't even get its money back. And you know, half of them that go to zero and they need those big pops.
And I always thought, okay, I don't need to be a billionaire. I need to have economic security and this is where our interests diverge. Because I used to advocate for and usually would ultimately would win for selling the company.
I sold my first company for $33 million. Our investors were disappointed.
I sold my last company for $160 million despite my investors tripling their money in 27 months. They were disappointed because I didn't have a bunch of chips on the table, I had one big chip on one number.
And so it creates a divergence of risk.”
He’s right - founder’s only have, maybe, four swings in their careers to hit a home run. Investors have 10 to 12 swings per fund, and they raise a new fund every four or five years.
Now, I’m not saying that each venture partner gets the same economics as the founder of a company - it’s not like they’re personally clipping 25% stakes from Series B rounds.
And I’m also not saying that nibbling secondary off along the way is impossible for founders. It’s a tried and true path for getting rich (and de-risking).
But I am saying there’s a clear dislocation in risk when one side is playing multiple hands over multiple games. And if you believe in math, the VC should push the founder to shoot for a home run, and, statistically speaking, most likely not get past first base. And as a founder, that can suck, because a double (or even a walk) could be life changing.
A VC friend of mine drove the point home:
"We invested in Box pre IPO. Their founder Aaron Levie, at time of IPO had 4% equity. It was a $1 billion outcome. He made $40M for all that work.
Someone I know just sold his company for $40M and also made $40M. He never raised any money.
Same outcome for both owners."
There are multiple ways to get rich as a founder. Each comes with a different flavor of heartburn, odds, and risk adjusted outcomes. While there’s no “right” game to play, it’s on you to study the rules before saddling up to the table.
TL;DR: Multiples are UP week-over-week.
Top 10 Medians:
EV / NTM Revenue = 13.7x (+0.2x w/w)
CAC Payback = 15 months (-2 months w/w)
Rule of 40 = 50% (-4% w/w)
Revenue per Employee = $502K (-$25K w/w)
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 smooths 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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