Weekly Update: SaaSocalypse Part II...YC Demo Day: "Hold My Beer"
A few highlights from the week of 9/19
It was a frigid week for public SaaS equities as the WCLD cloud index plunged another 8%, ending at $26.25. Friday’s WCLD low of $25.88 just missed the June low of $25.66.
The week was marked by the Fed’s 75 basis point hike & hawkish commentary on inflation. Mr. Market interpreted this as an admission that more rate hikes are coming and a recession is likely. Market watchers quickly ratcheted their expectations down, such as Goldman lowering their year-end S&P 500 target to 3600 (which is ~2.5% below Friday’s S&P close of 3693).
Meanwhile, the median forward public SaaS revenue multiple is a paltry 5.3x. Not only is that under the Covid low from March ‘20, it’s well below average pre-covid multiples - for example, the NTM revenue multiple at year-end 2019 was 7.49x.
Interestingly, the highest quality SaaS names still command “growthy” multiples - with Snowflake leading the pack at 20.6x NTM. Altimeter’s growth investor Jamin Ball provides a nice summary:
Despite the market fallout, the recent YC Demo Day of Sept 8/9 and subsequence YC funding blitz was very much a “hold my beer” moment. Many YC startups had already completed oversubscribed seed rounds before Demo Day at valuations well north of pre-Covid norms.
One experienced YC investor remarked that it was “business as usual” for YC startups with many raising their prices as their rounds filled out.
I have a hard time reconciling the public markets’ gloom with the YC Demo Day boom. Although I have anecdotally observed tight seed market conditions outside of YC - perhaps YC provides a “flight to safety” for seed investors with dry powder.
Podcast recommendation of the week:
Founders Podcast has another gem, reviewing one of my favorite business books, Cable Cowboy.
The cable industry offers a number of valuable lessons for tech founders. A few that don’t come up much in typical startup strategy sessions:
1). Tax efficiency provides free lunch: there’s a saying in economics that “there’s no such thing as a free lunch” and it’s generally true - if you think it’s “free,” you probably don’t realize how you are paying for it. Tax efficiency is an exception - it offers a free cornucopia of delights for those with the patience to understand the tax code.
Growing cable companies used massive depreciation “costs” to avoid paying taxes, despite positive cash flow. I say “costs” because depreciation is a non-cash charge, which provides a lot of room for, ahem, “optimization.” For the cable industry, tax efficiency dramatically boosted their long-term capital appreciation.
Of course, VC-backed tech companies are typically quite unprofitable, not paying income tax, and therefore have little to gain from tax efficiency. But for the profitable bootstrappers, tax efficiency offers enormous potential benefits - where can you invest in “free” depreciable assets today to boost growth tomorrow?
2). Power of scale: competition in the cable industry was dominated by scale. A small cable company might pay 10-20x the per subscriber fee to a cable channel vs what a large company would pay. Scale economics drove much of the cable industry’s highly profitable consolidation over the years - and is also arguably the largest driver of tech PE returns from M&A-driven roll-ups.
Tech startups should keep in mind their market power will grow dramatically as they scale, both helping them to raise prices over time and drive down (non-labor) costs. A free tier in SaaS seems a lot more sensible when one understands it as under-pricing in the short-term to build valuable market power in the long-term.
One more reading recommendation from this week:
David Sacks has a great tweet that highlights the remarkably long “time-till-revenue for Figma” - it was 5 years between Figma’s founding in 2012 and their first revenue in 2017!
Equally remarkable, once Figma began to monetize, their ascent was stunning. VCs paid huge revenue multiples to participate in Figma’s growth rounds, but they turned out to be spectacular investments.
