Which Balance Sheet Do I Back?
01/05/25 Benchmarks for Operators
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The circles I run in are awash with excitement as tech royalty is staffed to official (and unofficial) government positions.
Elon Musk is influencing public policy from X, making the $44B he paid for it a rounding error when you consider its influence on public discourse and actual decision making.
BTW - much of that decision making is linked to infrastructure proposals that impact the chips that go into his cars or the airspace he launches his rockets into.
X’s ROI can’t be simply measured in a DCF model or on a basis of ad revenue.
And apparently like half of a16z’s general partners will serve in the next president’s cabinet. I hear Marc Andreesen spent most of his fall in Washington campaigning for the firm’s interests, and is now logging significant time at Mar a Lago. I didn’t take him for a big YMCA guy, but the song does slap once you’ve had a few cold ones.
It’s only inevitable that we’re going to experience a heavy tech first policy and set of incentives. And that starts with unlocking the IPO market.
The easiest way to do so would be to CTRL ALT DELETE Sarbanes Oxley, which is admittedly overdue for an overhaul. This would make it easier for companies to go public (but hopefully not, like, SPAC easy) and stay public. The new tech and entrepreneurial minded cabinet members will also accelerate M&A activity by shoving any sort of DOJ monopoly standards in the closet.
And honestly I’m conflicted.
This is great for my wallet. As someone who holds a bunch of pre IPO stock and is employed by an industry that makes money when valuations go up and companies are sold, I’ll hopefully make a metric shit ton of money.
“Honey, you can go buy that steak you’ve been looking at!”
But at it’s core I don’t think the government is meant to be run like a tech company with weekly sales pipeline reviews, or mobilized like an investment committee seeking DPI.
The role of government isn’t to serve specific sectors or interests (tech, crypto, defense). And it’s not to seek the highest financial return on all initiatives. If that were the case, we’d never fund public schools, because the timeframe to build a smart, good natured citizen runs from K through 12, which would bust a fund’s timeline to return.
And this isn’t picking just on Silicon Valley. It’s anyone who thinks the government should lean towards being more like an entrepreneurial venture than a backstop or safety net.
President Obama hit on this back in October of 2016:
"Government will never run the way Silicon Valley runs because, by definition, democracy is messy.
This is a big, diverse country with a lot of interests and a lot of disparate points of view.
And part of government’s job is dealing with problems that nobody else wants to deal with."
An investment firm can scientifically hone in on which sectors it wants to invest in, and then be maniacally focused on finding special founders to fund.
Unfortunately, you can’t take that view with our country. You can’t just tell Florida to fuck off. Many of the country’s problems suck. And it’s the governments job to try to fix them.
Obama elaborated:
“But the reason I say this is sometimes we get in the scientific community, the tech community, the entrepreneurial community, the sense of we just have to blow up the system, or create this parallel society and culture because government is inherently wrecked.
No, it's not inherently wrecked; it's just government has to care for, for example, veterans who come home.
That's not on your balance sheet, that's on our collective balance sheet, because we have a sacred duty to take care of those veterans.
And that's hard and it's messy, and we're building up legacy systems that we can't just blow up.”
This perspective underscores the inherent differences between government and business operations, particularly in addressing the needs of all citizens and funding projects that may not attract juicy private investment, but serve the public good.
Or said another way, no VC is going to back mental health programs for veterans or unclog the shit pipes in Pittsburgh.
And to tie it back to investment terms - the government has a different balance sheet.
Now, should the government be funding studies on the effects of cocaine on Japanese quails or auto printing every document? Absolutely not.
Obama actually admitted the same:
“That's not, by the way, to say that there aren't huge efficiencies and improvements that have to be made.”
Note: he left out the part about the coked up quails.
Come to think of it, I’ve seen tech firms spend money on some stupid shit too. In fact, I have an entire section of my podcast dedicated to “the craziest thing you’ve ever had someone try to expense”:
A singing clown
A chainsaw
A breast reduction
The list goes on. And I’ve yet to have anyone from WeWork as a guest.
To be fair, there are a few areas where we should consider leveling up the talent, and maybe pulling someone in who’s actually from tech:
We spend billions of dollars each year to maintain space bases that are not actually, like, active.
The CHIPS act was a spray and pray, run by someone who knew nothing about computer chips.
The head of the FTC is a lifelong academic who’s never spent any time in the private sector, or negotiated a working capital peg.
And most importantly, there’s been a massive brain drain in government. I don’t think it’s controversial to say that public office is NOT where the smartest people are going after graduating college.
Public service used to be something that was venerated and respected. Up until perhaps the 1980’s some of the brightest minds leaving Harvard and Yale would go into government. Grover Cleveland never mulled an offer from Databricks vs running for office.
Instead, it’s become a backwater for people looking to collect a pension, Netflix and Chill, or scoop insider trading tips. So it’s refreshing to see smart people wanting to contribute to government again.
And yet…
Capitalism and Democracy are great friends, but they are not the same thing. One may enable the other, but they are not synonymous. If there was a spectrum, perhaps they should be closer to drinking buddies than business partners.
I’m torn because my personal balance sheet seems like it’s about to get a lot better. But at the same time, I’ll have to squint my eyes and try to block out the glaring hole in our collective balance sheet as a country.
Yes, we’re up to our eyeballs in debt. That’s on the balance sheet too. But we also have to remember that some of the government inefficiency or waste is a feature, not a bug. Let’s not measure against the wrong benchmarks.
TL;DR: Multiples are UP week-over-week.
Top 10 Medians:
EV / NTM Revenue = 17.0x (FLAT w/w)
CAC Payback = 27 months
Rule of 40 = 53%
Revenue per Employee = $403K
Figures for each index are measured at the Median
Median and Top 10 Median are measured across the entire data set, where n = 110
Population Sizes:
Security: 17
Database and Infra: 14
Backoffice: 16
Marcom: 16
Marketplace: 15
Fintech: 16
Vertical SaaS: 16
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 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.
Well done! Normally I don’t want to see anything political in my business feeds except for regulation monitoring. You found the perfect balance to express sentiment regarding government without being “political”. A great reminder to that we’re looking at two different things. I enjoy your content- high value!
You don't have to measure against financial returns. For example, improve incentives to boost students' test scores. There's a lot of regulatory capture (via lots of unnecessary complexity). If there's better garbage collection and simplification, that'll shed more light on wasted money/effort. As any system grows, there's growing conflicts of interest (corporate lobbying, etc.). And they form and persist with more diffusion of responsibility. Overall, bringing a zero-based budget mindset will bring more attention to where there's waste. I'm optimistic.