Venture capital is getting more difficult to obtain in today’s market. So how do SaaS founders know when they should tighten their belts and be more efficient with capital? This is a really important question and one we get asked a lot at Kruze Consulting, so let’s look at the best indicator to use and why you need to stay up to date with the changes it presents.
How Capital-Efficient Your Startup Should Be Has Changed
When you look back on 2021, you will remember that venture capital was flowing and everyone felt confident. A large number of venture investments were happening and everything felt very positive.
However, in 2022, everything started to slow down from February and into March. Then in mid-October (when we recorded the accompanying video), while there were still a lot of deals happening at the early stage, money going in to late-stage startups really slowed down. This slow-down of cash injections has had a lot of ramifications on how capital-efficient a startup needs to be.
You will hear the mantra “you should always have 12-18 months worth of cash in the bank” and, if you don’t, then you need to be a lot more capital-efficient. Right now, this means that you can’t burn as much cash as perhaps you were in 2021.
But these factors do change over time, and sometimes founders come to us looking for an accurate pulse on the market.
One Market Indicator
One measure we use to gauge the need for capital efficiency is the Bessemer Cloud Index. The Bessemer Cloud Index is made up of a group of publicly traded, high-growth SaaS companie. That makes this index a good indicator for a venture capital-backed SaaS startup, meaning you can look at the forward revenue multiple over time and see what the market is doing. When you look at the forward multiples there’s a handy chart there which allows you to figure out how capital-efficient your SaaS should be.
The Bessemer Cloud Index in 2021 Versus 2022
In 2021, the top 25% of all publicly traded SaaS companies were trading at 20 times revenue on a forward basis. That is a huge number since, historically, it usually ranges from 5 to 10 times revenue. But in 2021 it was anywhere from double to four times historical levels. At the time, this indicated:
1. Money is readily available.
2. Deal activity is at a peak.
And in a climate like that, you don’t need to be as capital-efficient.
Fast forward to now (circa mid-October, 2022) and the top quartile is trading at eight times forward revenue. This means the stock market public investors, who normally look forward at least one to three years, are now saying that they will pay eight times revenue. Obviously, this is a big jump down, given that it is a 60% decrease from where it was in 2021, around the same time of year.
So, in this circumstance, the market is telling you:
1. You need to be a lot more capital-efficient.
2. You can’t spend as much money (reduce your burn rate).
3. You need to be really smart about the investments you are making.
This is because 2023 has got the potential to be even tougher than 2022 for startups to fundraise. We don’t know that for certain, however, as this stuff changes really rapidly and that is important to remember.
The Stock Market is Volatile
The stock market is very volatile, especially in high-growth companies such as publicly traded SaaS companies, and venture capital backed startups are even more so. No matter what they say, VCs will always take their cues from the public market. The public market determines what IPO prices are in public M&As and late-stage VCs look at the public market intently.
Since they are constantly looking at the public market to see what they should be paying for late-stage startups, this then filters back into the early-stage ecosystem and affects capital efficiency in all startups.
Keep An Eye on the Market
As you can see from the differences between 2021 and 2022, the market has a strong effect on venture capital funding. And if funding is tighter, your SaaS startup needs to be more careful about how you’re using your cash. So check out the Bessemer Cloud Index regularly and look at the forward revenue multiples. That will give you a good sense of how efficient you need to be with your cash. If you have any questions on the Bessemer Cloud Index, startup investing, startup accounting, taxes or venture capital please contact us.