If you check the Bessemer Cloud Index, it’s down 40% over the last six months, while the Nasdaq is only down 15%.
SaaS companies had a humongous run right after COVID-19, which turbocharged SaaS stocks. During Q2, Q3 and Q4 2021, SaaS stocks were up 10x, which is basically a 1,000% performance improvement on their stock.
It was really a wild time to be investing in SaaS startups because the multiples were going crazy and the dollars of capital were going crazy. Many late stage SaaS startups were able to go public.
Many of the early stage SaaS startups were getting funded at those big valuations. So the good news is they have a lot of cash and they can ride this rocky period.
In investing everything always eventually returns to the fundamentals. It just happens. And, it will happen in the public markets first because that is where you have sophisticated investors and huge pools of capital. Money moves very quickly because everything’s liquid, which is why we saw a huge correction in publicly traded SaaS stocks.
That correction then worked its way to the newly IPO’d companies that are all now trading below IPO value. Mind you, they did go public at very high inflated valuations – so don’t feel too bad for them.
3 tips for riding out a correction
Tip #1: If you have a big enough cash balance, ride it out
For those startups that are early to mid-stage that didn’t go public and that have raised 18 to 24 months of cash, you’re in good shape. There’s no need to worry about the correction. You can let this play forward another six months, perhaps 12 months.
It’s always a good idea to raise cash when you have nine to 12 months of cash in the bank. Any later than that and investors will start delaying things to see what happens. Startups lose their leverage if they don’t have a decent amount of cash on the balance sheet.
But startups that have that cash stockpile are in good shape and should be less stressed. They can actually focus on building their company.
Tip #2: Tighten the burn rate
During a turbocharged growth period, similar to what we saw in 2021, some startups become a little less disciplined and stop paying attention to financial models. They will often start over-hiring or hiring forward.
It keeps communication clear to the financial team, so they are aware of the current state of business. It will also make any kind of adjustments in burn or headcount much easier to handle.
Now is the time for startup CEOs to get really locked in on true financials every month.
Tip #3: Talk to your board
This is sometimes a tough step for some startups. But, they need to ask their board members if they are fundable right now.
Board members have a vested interest in the success of the company, but they are not going to sugarcoat it.
Knowing where they stand gives startups an idea of whether the board will be willing to write a bridge check down the road, if they aren’t able to get outside capital.
If a startup valuation is too high to raise off, they will need to work to grow into that valuation. Getting direct feedback from the board will be crucial to planning.
There are still investors out there
Even though the market has corrected all the way down, forward looking revenue multiples for the top quartile on the Bessemer Cloud Index are still at 10x. That means for every dollar of revenue, you’re getting 10x the value.
Startups can raise a lot of capital on a 10x valuation. And that capital can be used to build a great company.
The good news is investors are still doing a lot of deals. The velocity of fundraising is still way up. We’re just seeing people are getting a little more convervative on the actual valuations.
Dealing with a new fundraising and valuation reality
Things have clearly changed from the 2021 high, and startups need to understand that and incorporate that into how they’re running their business.
Startups that are focused on tightening their burn rate, keeping track of actuals, and staying in constant communication with their investors are in better shape than those who aren’t willing to adjust to the new (current) reality.
Just remember, it’s still a great time to build a company. In the grand scheme of things a 10x valuation isn’t so bad.
In the SaaS stock world, things can get wacky. According to the Bessemer Cloud Index, things get interesting every three years or so.
Those times when the valuations get high are pretty fun. They’re a great time for entrepreneurs. There is often a lot of innovation and a lot of companies going public.
If you have any questions on SaaS companies, VC funding, or financial modeling, please contact us.