In the face of a turbulent economic landscape, today’s SaaS business leaders focused on driving revenue growth and profitability for their companies must pay close attention to the rapidly changing demands of their respective markets.
It goes without saying that the economic environment that business leaders are dealing with today in 2022 is a long way from those they experienced in 2021. Navigating through the “new normal” in 2023 will require CEOs and founders to revisit their current expectations, growth models and spending plans, and take essential actions to weather potential economic tumult on the horizon. While we all want to invest in what we believe will help our organizations thrive and excel, for the time being executives must prioritize those investments that will ensure they can ride out market instability.
This is why Akmazo Capital hosted its fourth CEO roundtable in early November, entitled “SaaS Valuations in a Changing Economic Climate.” Moderated by Gary Phillips, Partner with Akmazo Capital, this event brought together experts from the banking and investment markets; Ron Eliasek, Chairman of Global TMT Investment Banking at Bank of America; Peter Falvey, Managing Director at Shea & Company; and Chase Sanders, Managing Director at Baird; along with Akmazo’s Chairman and Managing Partner Jaime Ellertson to discuss the key considerations that SaaS businesses should keep in mind in your planning and operational execution to drive the most value through a healthy balance of growth and profitability.
We were thrilled by the turnout and by the enthusiastic participation of attendees during the Q&A our panel discussion. For those who were unable to attend, we’re excited to present you with some of the key insights from the event, so you too can ensure the ongoing success of your business, no matter the economic changes to come.
Changing valuation standards are forcing mid-market SaaS companies to make difficult decisions
Many mid-market SaaS companies that have been operating in a “revenue first” investment model to drive a premium in the valuation based on double-digit sales growth now find themselves in a position where difficult decisions regarding spending priorities. This drive to maximize revenue growth over profitability often comes with a high cash burn level and therefore necessitates the need to raise more capital. Their path to a high valuation is to scale as quickly as they can by retaining and building their customer base. While this strategy may have been the right course in the last few years, the economic changes might now force these organizations to consider the need for an increased emphasis on profitability.
Public valuations in 2022 are down 50-70% from 2021, and the prospect of a “mild” recession in 2023—as suggested by Ron Eliasek—means that the old approach to achieving an ideal valuation, simply won’t work like it used to for these enterprises.
Profitability is increasingly important
While prioritizing revenue growth over profitability has been a fine way to attract investors and buyers in the past, the prospect of recession—no matter how minor—naturally makes such parties wary. As laid out by Chase Sanders, while the market viewed revenue growth as 4 times more important than profitability just 18 months ago, that multiplier has now been cut in half.
Why is that? Because, while revenue growth is still a dynamic marker of future success, it suggests greater credit demands from investors and buyers which isn’t especially enticing in a time of potential market tumult.
Put simply, if your business makes growth the chief metric of its success rather than profitability, you’re making an implicit commitment to your investors that the capital they commit to your organization will ultimately pay off. Current market conditions are driving investors to place a greater value on their companies ability to get cash flow positive and move closer to profitability. Similarly, buyers might be more hesitant than in previous years to purchase an enterprise that has yet to truly make any money, lowering your ultimate valuation.
What can your business do about this?
So, what can your SaaS organization do to weather any challenges from a potential recession, to ensure the continued support of investors and prevent the derailment of any predicted acquisition opportunities?
How can you reshape your current strategy to fortify your business for the best possible valuation?
According to our panelists:
- Continue to aim for profitable bookings growth: Revenue growth is still valued over profitability, even if the difference has shrunk. New bookings are still seen as a positive, and can demonstrate the scalability and growth potential of your organization.
- Retain every renewal dollar: While investment might have been the priority in the past, the prospect of economic upheaval means that executive’s must shift focus to the easiest and cheapest ways to achieve both growth and profitability. That means prioritizing customer renewals and customer retention. Renewals represent the value that your customers are realizing from your solution. The more “sticky” the product is then the more value you create the more likely that customer will be to grow and expand their investment. While courting new customers and new investors can put substantial strain on marketing and sales budgets, retaining existing customers does not—while still growing your revenue. In terms of ROI, this is what demands your attention at this time.
- Utilize gates to manage growth in expenses: It can be all too easy to overspend at the beginning of the fiscal year—to implement all your big plans for hiring, expanding solutions and purchasing tools in the first quarter. Unfortunately, if you have a down quarter—which is more likely given the chances of an upcoming recession—then your valuation could be defined by your massive expenses rather than your growing revenue. Spending gates counter this by only “releasing” spending money as you hit certain booking numbers or revenue milestones, ensuring that you never overreach and suffer the consequences.
- If you save money, you can invest in talent: One of the greatest benefits of leveraging a gated expense strategy is that, rather than spending on what you think you’ll need in advance, your organization will be able to spend on what will actually benefit you when the opportunities present themselves. As Peter Falvey noted during his presentation, the recent economic climate has led to industry leaders like Microsoft shedding valuable talent that is now available to mid-market organizations whose revenue streams have given them the opportunity to snatch top talent. For those who are strategic with their spending—whether it be on new product, new customer acquisition or hiring—this newly available talent pool could help drive genuinely transformative growth in advance of valuation.
What do mid-market SaaS executives want to know?
One of the most exciting parts of Akmazo’s CEO roundtables is the opportunity to interact with our attendees, to know what’s important to them and their companies and what they hope to achieve in the wake of these discussions. As such, we wanted to share with our readers some of the topics on the minds of mid-market SaaS executives when it comes to valuations. While we cannot share all of the great questions we received, these are a few we think will benefit you.
In the wake of layoffs in SaaS, will engineering talent be cheaper?
Engineering salaries seem to just be going up, at the moment. That said, Mexico has seen an expansion for cheaper engineering talent in 2022—similar to India and the Philippines in the past. As many software-oriented private equity firms shy away from leveraging costly Bay Area engineering talent at all, emerging pockets of more cost effective talent—both international and stateside—could provide opportunities for SaaS companies looking to hire more engineers.
The advent of these emerging pockets combined with the aforementioned layoffs coming from big companies like Microsoft or Google, elucidate another trend. While on the whole, talent may not be becoming cheaper, it’s certainly becoming more widely available, something that executives looking for new engineers should keep in mind.
Will investors give businesses a “pass” (grade on a curve) in the case of a market downturn impacting company performance or will SaaS companies take a valuation hit?
The simple answer is that nobody knows how this will necessarily play out. When looking at recent periods of economic turbulence—be it the Financial Crisis or COVID—tech has fared better than other industries with IT spending holding relatively stable. That said, because we can’t predict a definite outcome, it’s worth taking a more cautious approach to your spending, aligned with revenue growth. There might be areas for you to make adjustments that could benefit your ultimate valuation. That said, while it’s unlikely investors will give companies a “pass,” they are aware of market conditions and tailor their expectations accordingly.
By understanding what lies ahead, you can leverage the full potential and value of your business
The Akmazo team would like to thank Ron, Peter and Chase, as well as all of our guests for their participation in our Roundtable. Everyone in attendance brought a unique perspective to this discussion, which helped provide the fullest picture of what might lie ahead for SaaS business valuations. We hope these takeaways from our session prove beneficial for all those who could not attend as well as those who wanted to revisit the topics discussed.
For those who attended “SaaS Valuations in a Changing Economic Climate,” we thank you for joining us and for your questions. For those who were unable to join, we hope you’ll sit down with us at our next roundtable. Akmazo is invested in providing organizations with the knowledge, the tools, and the support to succeed. Nothing helps us do that better, than getting together with experts and participants to tackle the questions on all of our minds.