I’m just gonna be straight with you… there’s a TON of bad business advice flying around right now…
“Companies are only hiring AI engineers”…
“You need VC money to scale”…
“This economy is bad for starting a business”…
If you’ve fallen for any of these oft-repeated assumptions, you need to read Mercury’s data report, The New Economics of Starting Up. Mercury surveyed 1,500 leaders of early-stage companies across topics ranging from funding, AI adoption, hiring, and more, to set the record straight.
What they discovered is equal parts surprising and encouraging:
79% of companies surveyed, who have adopted AI, said they’re hiring more because of it.
Self-funding is the number one avenue for accessing capital — even for tech companies, with half likely to bootstrap.
87% of founders are more optimistic about their financial future than they were last year, despite prevailing uncertainties.
To uncover everything they learned in the report, click the link below.
*Mercury is a financial technology company, not a bank. Banking services provided through Choice Financial Group, Column N.A., and Evolve Bank & Trust; Members FDIC.
Walter meeting our new production intern, Grant.
The following is a guest post from my other newsletter, Looking for Leverage, written for finance leaders at Private Equity backed companies.
CFOs from portco’s backed by Thoma Bravo, Vista Equity, TA, and Carlyle read each week.
Recent topics include:
What’s a Stalking Horse in M&A?
“Well, since then, I've had a lot of time to just sit and think, and slowly, it dawned...
If I lost, someone else must've gained. So I ran a thousand simulations a day in my head. And over and over again, Bobby, it came back the same.
I was your stalking horse.”
Damn, Bobby Axelrod did him raw!
The origin of the term “stalking horse” comes from hunting, where in the 16th century hunters realized that fowl (birds) were spooked by humans, but you could get much closer if you hid your head and torso behind a horse. It became a clever way to sneak up on your prey (Source: Docket).
The term is used most commonly in bankruptcy proceedings. It’s the opening bid to set a reasonable floor and prevent a “naked” auction from occurring where someone walks away with a total steal. Ideally it gets the auction process moving and attracts other qualified buyers.
In return for throwing the first number out there, the stocking horse bidder gets extra incentives, like a promise of breakup fees and deal expenses paid back if it doesn’t go through.
“For example, a topping fee (which needs to be paid when the stalking horse is outbid) or breakup fee that is disproportionately high relative to the total asset value could force other bidders to exceed the stalking horse bid by an amount so large that the deal becomes uneconomical to the next bidder.”
To make that more real, imagine a debtor selling a used car where the stalking horse bidder offers $3,000 below the blue book market value, but requests a $4,000 breakup fee. Pretty good business if you win or lose.
While the whole idea is to encourage competition, it doesn’t always result in the intended outcome. One example that comes to mind is the sale of Bed Bath and Beyond. To kick off the bankruptcy proceedings, Overstock.com threw a bid in… but no on else showed up. As a result, they won the auction with their low ball offer. Woops.
While the term is traditionally used in bankruptcy proceedings, the same concept can be applied in non bankruptcy M&A situations.
It’s used all the time in the context of trying to leverage one party’s interest to get a better deal from someone else.
The term is being throw around right now with the Warner Brothers - Netflix acquisition, with some analysts calling Paramount’s takeover bid merely a stalking offer. While I don’t fully buy it, as Parmount’s bid seems like a true hostile takeover attempt, it forces Netflix to reach deeper into their pockets to ensure they win the deal.
If we tie this back to middle market private equity deals, when a company decides to run a process (or the always believable “non-process process”) bankers will try to get someone to throw a non binding offer (IOI) in, even if the company never intends to end up with that party. On one hand, yes, the number they write down is important, but past a certain threshold, it’s secondary. The real value is the FOMO it generates, and the forward momentum it unlocks.
This usually takes the form of bankers quietly floating the idea to friendly biz dev teams they know are hungry to spend some money and look busy.
Once they have an IOI in hand, they’ll take it to companies whom they want to jolt into action, framing it as if the target wasn’t even in market, but received a compelling offer that will, in the interest of shareholders, necessitate the need to kick off a more formal process.
To put it in banker speak, they may communicate something like:
“The Company has received a high-confidence, non-binding indication of interest from a sophisticated financial sponsor with significant sector expertise. The valuation range of this expression of interest is consistent with our expectations and is being used as a benchmark for evaluating additional parties.”
Even better if the stalking horse is a well known competitor.
There are some real risks of running this playbook, of course. The biggest is burning a good partner (like Axe did in Billions). If you go to someone in your ecosystem who currently helps you make money, and they find out they were essentially used to drum up interest, there could be bad blood. And that could hurt your revenue potential down the line for when you do actually line up a qualified buyer.
The other risk is simply appearing like you are in market too much. You don’t want to be doing this every six months. It will come across as less of an opportunistic situation for real buyers, and more the desperate boy who cried wolf.
Be careful which narratives you promote, and which horse you hide behind.
TL;DR: Multiples are UP week over week. There was a significant drop in tech stocks, with the top ten median falling from over 17x forward revenues into the 14x’s. The overall median is teetering on 4x.
Top 10 Medians:
EV / NTM Revenue = 15.6x (UP 0.3x w/w)
CAC Payback = 25 months
Rule of 40 = 51%
Revenue per Employee = $463k
Figures for each index are measured at the Median
Median and Top 10 Median are measured across the entire data set, where n = 147
Recent changes
Added: Navan, Bullish, Figure, Gemini, Stubhub, Klarna
Removed: Olo, Couchbase
Population Sizes:
Security & Identity = 17
Data Infrastructure & Dev Tools = 13
Cloud Platforms & Infra = 15
Horizontal SaaS & Back office = 20
GTM (MarTech & SalesTech) = 19
Marketplaces & Consumer Platforms = 18
FinTech & Payments = 28
Vertical SaaS = 17
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
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.
OPEX
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 in the cloud, 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.
Please check out our data partner, Koyfin. It’s dope.
Wishing you a CAC Payback period that cooperates with the laws of physics,
CJ
