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The value of software revenue may have finally stopped rising
Startups are raising record sums around the world, thanks to several contributing factors. As The Exchange explored yesterday, historically low interest rates have helped venture capitalists raise more capital than ever, to pick an example.
Low rates have helped startups in another manner: As yields fell for certain assets, investors chased returns by betting on growth. And in recent years, the investing classes turned their attention to public software companies, bidding up the value of their revenue to record highs.
This raised the worth of startups in general terms, and private tech companies’ comps enjoyed a steady, upward climb in the value of their revenues. If the value of a dollar of SaaS revenue was worth $1 one year and $2 the next, the repricing was good for private companies even if we were tracking the metrics from the perspective of public companies.
The free ride could be ending.
The Exchange explores startups, markets and money.
Read it every morning on Extra Crunch or get The Exchange newsletter every Saturday.
I’ve held back from covering the value of software (SaaS, largely) revenues for a few months after spending a bit too much time on it in preceding quarters — when VCs begin to point out that you could just swap out numbers quarter to quarter and write the same post, it’s time for a break. But the value of software revenues posted a simply incredible run, and I can’t say “no” to a chart.
The pace at which software revenues were repriced upwards in the last few years is simply astounding. Per the Bessemer Cloud Index, back in 2016, the median revenue multiple for public SaaS companies was around 5x. When 2018 began, median SaaS multiples had expanded to around 7x.
That’s a 40% climb in pricing, but it proved to be just a foretaste of the feast to come.
By the end of 2019, the median figure had appreciated to around the 9x mark. And today it has shot to just under 18x. That is why software companies have been able to raise so much money, earlier, and in larger chunks. Every dollar of recurring revenue they sold was worth $5 in market cap in mid-2016. At the end of 2019, that same dollar of revenue was worth $9. And today, for the median public software company, it’s valued at around $18.
There are nuances to the data, but we care less about exacting definitions than the directional change it describes: The median value of SaaS revenues more than tripled from 2016 to 2021. That’s an insane amount of growth.
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Perform a quality of earnings analysis to make the most of M&A
As a startup founder, there will be three scenarios in which you’ll need to understand how to properly do a quality of earnings (QofE) if you want to maximize value.
The first scenario will be when you decide to raise a Series A and subsequent VC rounds, followed by when you do a strategic acquisition, and lastly, when you sell your company.
This post is a framework for how to think and organize your QofE and go through the most common items that you’ll want to keep top of mind for every M&A and private equity transaction you may be part of.
Why perform a QofE?
The goal of a QofE is to adjust the reported EBITDA to calculate a restated EBITDA that best reflects the current state of the company on an ongoing basis. It also presents a historical adjusted EBITDA that is comparable throughout the last two or three years.
QofE can have a significant impact on a company valuation for three main reasons:
- The adjusted EBITDA will be used by a buyer/investor as the basis for valuation (for companies valued based on an EBITDA multiple).
- The adjusted revenue will be used to recalculate the effective growth rate.
- The adjusted revenue and EBITDA will form the basis of forecasts.
With that in mind, every entrepreneur must understand how to properly form a view of what is the proper adjusted EBITDA and adjusted revenue of your company. It is common for founders in an M&A process to be unfamiliar with the notion of QofE and leave value on the table.
When performed by a professional transaction service advisory team, the quality of earnings is a result of a thorough review of all the documents generally available in a data room.
This breakdown aims to ensure that you won’t be that founder and that you’ll be armed to negotiate your company valuation on equal ground with your investors. If you are in the seller’s shoes, you will get the advantage of understanding how an experienced investor or buyer thinks. If you’re in the buyer’s shoes, you’ll benefit from understanding and valuing your acquisitions better.
How is a QofE professionally performed?
When performed by a professional transaction service advisory team, the quality of earnings is a result of a thorough review of all the documents generally available in a data room. These include, but are not limited to: Legal documentation, financial statements (P&L, balance sheet, cash flow), audit reports, management presentation and contracts.
When doing a QofE analysis, it’s key to consistently ask yourself: “Can or should this information translate into an adjustment of revenue or EBITDA, net working capital (NWC) or net debt?”
Why did we include NWC and net debt? That is because they often have an indirect impact on adjusted EBITDA. Think of an adjustment to the historical level of inventory. Less inventory likely means fewer storage costs. So if you adjust historical inventory, you’ll want to also impact your adjusted EBITDA.
On top of reviewing all the aforementioned documents, your QofE analysis will heavily rely on interviewing management. No matter how long you look at the financials, if you can’t have management confirm information or explain trends, you won’t be able to draw proper conclusions and understand the numbers.
Principles for efficiently building your QofE
- Automatically link everything you read and hear to potential QofE adjustments. This has to become second nature during the engagement.
- Always think about all the ways an event or item that qualifies for an adjustment impacts the financial statements overall. For instance, if the event impacted revenue, did it impact costs in some way as well?
- Make sure that the cost you are adjusting was not already offset by another accounting entry (i.e., had no impact on EBITDA).
- Make sure that the cost you adjust for was classified above EBITDA in the first place.
- Make sure that you can quantify each adjustment in the most objective and rational way. This is sometimes not possible and you may have to come up with a range.
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Investors’ thirst for growth could bode well for SentinelOne’s IPO
Turning the page from the early-stage venture capital market to the super late-stage exit market, this morning we’re talking about endpoint security company SentinelOne’s IPO in the context of Sprinklr’s own. We’ll have more on the public offering market later today when Doximity and Confluent price their respective IPOs after the close of trading.
The Exchange explores startups, markets and money. Read it every morning on Extra Crunch or get The Exchange newsletter every Saturday.
SentinelOne’s IPO, expected to price on June 29 and trade June 30, is a fascinating debut. Why? Because the company sports a combination of rapid growth and expanding losses that make it a good heat check for the IPO market. Its debut will allow us to answer whether public investors still value growth above all else. And this week, the company gave us an early dataset regarding its market value in the form of an IPO price range. This means we can do some unpacking and thinking.
A reminder regarding why we dwell on the exit market for unicorns: We care because the value of late-stage startups when they reach a liquidity point helps set valuation comps for myriad smaller startups. Furthermore, the level of public-market enthusiasm for loss-making, growth-focused companies will determine the scale of returns for many a venture capitalist, founder and early employee.
So, let’s talk about SentinelOne’s cybersecurity IPO price range; Sprinklr’s social-media software debut will play foil.
The price of growth
It can make good sense to pay up for a quickly growing company’s shares. This is why you may hear of a startup raising an early-stage round at a very high revenue multiple.
Why put a $50 million price tag on a startup that just crossed the $1 million annual recurring revenue (ARR) threshold? If it’s growing sufficiently quickly, the math can pencil out. If that startup was growing at 300% per year, say, the revenue multiple that you paid in the round valuing the startup at $50 million would fall sharply over the next year, at which point other investors would probably scramble to put more capital into the firm at a higher price.
Bingo! You just got a markup on your initial investment, and the company has found someone else to lead their next round at a higher price, giving it even more capital to keep its growth game going and make your early investment appear prescient. See? Venture capital is easy.1
The same general idea applies to companies going public. Growth matters, and the more rapidly a company is adding revenue, the more money it will be worth because investors can anticipate its future scale (within reason). Some companies that sport quick growth can have other issues that impact their value. Extensive debt, for example, a history of uneven growth, or deteriorating economics could come into play. Or simply very high losses.
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Twitter said to have held acquisition talks with Clubhouse on potential $4B deal
Twitter held talks with Clubhouse around a potential acquisition of the live drop-in audio networking platform, with a deal value somewhere around $4 billion, according to a report from Bloomberg. TechCrunch has also confirmed the discussions took place from a source familiar with the conversations.
While the talks occurred over the past several months, they’re no longer taking place, though the reason they ended isn’t known according to the report. It’s also worth noting that just a few days ago, Bloomberg reported that Clubhouse was seeking to raise a new round of funding at a valuation of around $4 billion, but the report detailing the potential acquisition talks indicate that the discussions with Twitter collapsed first, leading to a change in strategy to pursue securing additional capital in exchange for equity investment.
Twitter has its own product very similar to Clubhouse — Spaces, a drop-in audio chatroom feature that it has been rolling out gradually to its user base over the past few months. Clubhouse, meanwhile, just launched the first of its monetization efforts, Clubhouse Payments, which lets users send direct payments to other creators on the platform, provided that person has enabled receipt of said payments.
Interestingly, the monetization effort from Clubhouse actually doesn’t provide them with any money; instead, it’s monetization for recipient users who get 100% of the funds directed their way, minus a small cut for processing that goes directly to Stripe, the payment provider Clubhouse is using to enable the virtual tips.
While we aren’t privy to the specifics of these talks between Twitter and Clubhouse, it does seem like an awfully high price tag for the social network to pay for the audio app, especially given its own progress with Spaces. Clubhouse’s early traction has been undeniable, but there are a lot of questions still remaining about its longevity, and it’s also being cloned left and right by other platforms, begging the age-old startup question of whether it’s a feature or a product on its own.
Whatever went down, the timing of this revelation seems likely to prime the pump for Clubhouse’s conversation with potential investors at its target valuation for the round it’s looking to raise. Regardless, it’s exciting to have this kind of activity, buzz and attention paid to a consumer software play after many years of what one could argue has been a relatively lackluster period for the category.
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Fintech startup ClearGlass Analytics closes $3.6M for pension funds transparency platform
Fintech startup ClearGlass Analytics has closed a £2.6 million ($3.6 million) funding round for its platform, which aims to create greater transparency on fees in the long-term savings market, such as pensions and the wider asset management market.
The £2.6 million seed round includes European VC Lakestar and Outward VC, the venture arm of Investec, as well as several angels from both the asset management and pension fund worlds. These include Ruston Smith, a pension trustee; Richard Butcher, chair of the PLSA (U.K. pension trade body); Chris Wilcox, former Global Head of JP Morgan Asset Management; and Rob O’Rahilly, Sikander Ilyas and Alex Large, also former JP Morgan employees.
ClearGlass is targeting the £1.5 trillion mature “Defined Benefit” pension schemes market and claims to now work with more than 500 DB pension funds. It will use the funding to expand into the U.K. Defined Contribution pension market, and consolidate its early footprint in Europe and Africa.
How ClearGlass works is that it acts as a data interface between asset managers and their clients. Pension funds then use the platform to see all of their investment costs in one place, thus getting more data than usual from more asset managers and other suppliers. This helps the funds see the “true cost” of what they are paying for the management of their investments. ClearGlass claims to be able to uncover the kinds of costs of asset management that, in some instances, can be more than double those expected.
The startup recently did an analysis of the cost and performance of more than 400 asset managers. It found that while most U.K. asset managers were meeting minimum standards for data delivery, quality and accuracy, 30 (including some powerful players) did not pass their tests.
The company was founded by Dr. Christopher Sier, a World Bank and FCA expert who previously developed the cost transparency standard at the request of the FCA, and co-founders Ritesh Singhania and Kunal Varma.
Sier, founder and CEO, said: “Finding your costs are so much larger is shocking, but also something to be celebrated. These incremental costs were always there, they just weren’t exposed, and now you can identify those and bring about change. You can’t manage what you don’t measure.”
In an interview with TechCrunch, Ritesh Singhania, COO, said getting the data about pension funds is normally “super challenging and complicated. And second of all, even when you got the data, you couldn’t make head nor tail of it because you can’t compare it across funds. What we have done is that we have been the line of communication between the manager and the pension fund. So we have built a piece of technology that helps with the communication between the asset managers, and the pension funds to be able to collect that data, check that data. And finally, give them something that doesn’t require them to spend 20 hours to understand it.”
ClearGlass was incubated by the Founders Factory accelerator.
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Roblox raises at $29.5 billion valuation, readies for direct listing
Roblox is now one of the world’s most valuable private companies in the world after a monster Series H raise brings the social gaming platform a stratospheric $29.5 billion valuation. The company won’t be private for long, though.
The $520 million raise led by Altimeter Capital and Dragoneer Investment Group is a significant cash influx for Roblox, which had previously raised just over $335 million from investors according to Crunchbase. The Investment Group of Santa Barbara, Warner Music Group, and a number of current investors, also participated in this round.
In February of 2020, the company closed a $150 million Series G led by Andreessen Horowitz which valued the company at $4 billion.
The gaming startup had initially planned an IPO in 2020, but after the major first-day pops of DoorDash and Airbnb, the company leadership reconsidered their timeline, according to a report in Axios. Those major day-one share price pops left significant money on the table for the companies selling those shares, an outcome Roblox is likely looking to avoid. Today, the company also announced that it plans to enter the public markets via a direct listing.
Roblox’s 7x valuation multiple signals just how feverish public and private markets are for tech stocks. The valuation also highlights how investors foresee the company benefiting from pandemic trends which pushed more users online and toward social gaming platforms. In a 2019 prospectus, the company shared that it had 17.6 million users, now Roblox claims to have 31 million daily active users on its platform.
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Monzo confirms £60M down round, with a new pre-money valuation of £1.24B
Monzo, the U.K. challenger bank with more than 4 million customers, has confirmed it has closed £60 million in top-up funding.
Backing the round are existing investors Y Combinator, General Catalyst, Accel, Stripe, Goodwater, Orange, Thrive and Passion Capital, along with new investors Reference Capital and Vanderbilt University.
One of fintech’s worst-kept secrets, the down round sees the bank take a 40% hit in its paper pre-money valuation compared to its previous round, now priced at £1.24 billion.
That’s likely a reflection of the current funding climate amidst the coronavirus crisis, with Monzo having to raise a bridge round at quite possibly the worst time.
I also understand from sources that a number of Monzo’s later-stage investors played hardball, in a bid to force down the challenger bank’s ticket price, perhaps after investing at the height of the funding market pre-COVID-19. What is also interesting about the new round is that the share price is the same as the bank’s last equity crowdfund, meaning that the most recent armchair investors haven’t seen a paper loss.
Monzo is also disclosing that its business banking product has now reached 25,000 signups. Launched officially in March, the business bank account is aimed at sold traders and SMEs, with both free and premium paid-for versions available, offering various feature sets.
Meanwhile, it has been a turbulent time for Monzo, as it, along with many other fintech companies, tries to insulate itself from the coronavirus crisis and resulting economic downturn.
Planned layoffs in the U.K. were communicated internally earlier this month — up to 120, but now thought to be around 80. It followed earlier U.S. layoffs and the shuttering of its Las Vegas-based customer support office, and almost 300 U.K. staff being furloughed.
Like other banks and fintechs, the coronavirus crisis has resulted in Monzo seeing customer card spend reduce at home and (of course) abroad, meaning it is generating significantly less revenue from interchange fees. The bank has also postponed the launch of premium paid-for consumer accounts, one of only a handful of known planned revenue streams, alongside lending, of course, and the more recent business banking.
Separately, in May, Monzo co-founder Tom Blomfield announced internally that he was stepping down as CEO of the U.K. challenger bank to take up the newly created role of president. His replacement is current U.S. CEO TS Anil, who now also holds the title of “Monzo UK Bank CEO,” subject to regulatory approval.
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Strategies for surviving the COVID-19 Series B squeeze
Mikael Johnsson is a co-founder and general partner of Oxx, a venture capital firm investing in European SaaS companies at growth stage.
A generation of companies now needs to forget what it has learned. The world has changed for everyone, and nowhere is this more true than in fundraising.
I’ve been investing in technology companies for over twenty years, and I’ve seen how venture capitalists respond in bull and bear markets. I’ve supported companies through the downturns that followed the dot-com bubble and the global financial crisis, and witnessed how founders adapt to the new environment. This current pandemic is no different.
A growth company that only a few months ago was shopping for a $20 million, $30 million, or even $40 million Series B, with a choice of potential investors, must now acknowledge that the shelves may well have emptied.
VCs who were assessing potential new deals at the beginning of the year have had to abruptly adjust their focus: Q1 venture activity in Europe was under its 2019 average, and the figures for the coming months are likely to be much worse as the pipeline empties of deals that were already in progress.
The simple reason for this is that VCs are having to rapidly reallocate their two principal assets: time and capital. More time has to be spent stitching together deals for portfolio companies in need of fresh funding, with little support from outside money. As a result, funds will be putting more capital behind their existing companies, reducing the pool for new investments.
Added to those factors is uncertainty about pricing. VCs take their lead on valuation from the public markets, which have plummeted in tech, as elsewhere. The SEG index of listed SaaS stocks was down 26% year-to-date as of late March. With more pain likely ahead, few investors are going to commit to valuations that founders will accept until there is more certainty that the worst is behind us. A gap will open between newly cautious investors and founders unwilling to bear haircuts up to 50%, dramatic increases in dilution and even the prospect of down rounds. It will likely take quarters — not weeks — for that gulf to be bridged and for many deals to become possible again.
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DigitalOcean raises $50M more from Access Industries and a16z
Earlier today, DigitalOcean announced that it raised $50 million more from prior investors Access Industries and Andreessen Horowitz. The capital comes after the SMB and developer-focused cloud infrastructure company raised nine-figures worth of debt back in February.
DigitalOcean is a large private company that generated revenue at a run rate of around $250 million towards the end of 2019. The company announced today that it has reached $300 million in annual recurring revenue, or ARR. (We recently added the company to our ARR club here.) That’s growth of around 20% in less than half a year, though we don’t know precisely when the company reached the $250 million mark, making it hard to calculate its true growth pace.
Critically, DigitalOcean is walking toward profitability while expanding.
DigitalOcean’s CEO Yancey Spruill told TechCrunch earlier this year that his firm would reach free cash flow positivity in the next few years, a timeline that appears to have moved up (more on that shortly). Provided that the cloud company can keep its growth pace up over the same time period, it could be well positioned for an IPO.
The new $50 million values the company at $1.15 billion, meaning it was worth $1.1 billion pre-money. DigitalOcean is not being valued like a SaaS startup today in revenue multiple terms, then, though its new valuation is still nearly double its old Series B valuation (a company spokesperson confirmed the numbers on that page).
New capital
TechCrunch wanted to know why the company raised equity capital so quickly after it had added debt to its books. The capital was surely welcome given the world’s economic condition, but the timing was worth digging into.
DigitalOcean was not “seeking additional funding,” according to Spruill, but after “reviewing our business performance and outlook with our investors at Access and a16z, they were interested in investing for our next phase of growth.” The company accepted, Spruill said.
Presumably, Digital Ocean’s quick revenue growth from a $250 million run rate to $300 million ARR played a part in the investment decision. For DigitalOcean, receiving a new, higher valuation and a monetary top-off from well-known investors may even provide a brand boost (see this article, especially in light of recent coverage the firm has attracted).
Regarding its plans for the new capital, Spruill told TechCrunch that DigitalOcean can now “better support the increase in demand we’ve seen from entrepreneurs and SMBs around the world as more businesses are transitioning to the cloud, particularly as a result of COVID.” Mark DigitalOcean down as one of the world’s companies that is seeing an uptick from the pandemic; most aren’t, but the firms that are appear to be using the moment to put more capital onto their balance sheets.
TechCrunch also wanted to know if the new capital opened new ground for the firm, or if its priorities for the new capital were similar to its preceding goals. The CEO told TechCrunch that his firm’s focus is the same, namely expanding its business.
“We remain committed to reaching $1 billion in revenue, achieving free cash flow profitability in the second half of this year and, ultimately, position DigitalOcean to be a public company,” Spruill said in an email.
That’s clear enough.
By that measure we can expect to see a DigitalOcean S-1 in the first half of 2021, if markets recover. So a16z and Access Industries (longtime investors in the company) could see a quick return for their most recent checks if current plans hold up.
The company’s release made note of “accelerating growth,” which TechCrunch wanted to know more about. How quickly is the company growing? Spruill didn’t share numbers to confirm or deny our rough math based on his firm’s public revenue milestones, but did tell TechCrunch that the company is “actively working on a number of initiatives to accelerate our revenue growth rate,” adding that these are internally dubbed “Grow Faster” initiatives.
Finally, TechCrunch was curious about the impact that COVID-19 is having on DigitalOcean. The company told us that it has “seen a modest increase in churn as a result of COVID-19,” but nothing too bad, saying that the change was “not significant” when “compared with recent trends immediately prior to the pandemic.”
On the positive side of the ledger, DigitalOcean said that its “sign up of new customers has been accelerating” and that it is seeing “increased business from some existing customers.” Adding that up for the SaaS kids: A little bit more churn, good new logo addition, and some upsell tailwinds. Overall that adds up to growth.
More when we have it, but now we’re at least set up to understand what the company does next.
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Introducing the term-sheet grader
Jamie is the founding partner of Pillar VC, a Boston-based seed-stage venture capital firm. He has spent the last 22 years investing in early-stage startups.
When we launched in 2016, we took the unusual approach of saying we’d buy common stock in startups. We believed then, and still do, that alignment with founders was more important than covering our downside in investments that didn’t work as planned. Said differently, we wanted to enhance our upside through alignment, rather than maximizing our downside through terms.
The world has changed a lot since that time. While we are actively making investments, and still buying common stock, we know that many entrepreneurs may be trying to raise money now — and it is very hard.
Fred Destin wrote a great piece about the ugly terms that can creep into term sheets during difficult times. If you have a choice between a good term sheet and a bad one, of course, you’ll take the good one. But what if you have no choice? And how can you compare term sheets in the first place?
To this end, we developed the term-sheet grader, a simple way to compare different term sheets or help characterize whether a term sheet is good or evil.
Let me first point out that none of this has anything to do with the valuation of the round (share price), the amount of capital, the likelihood of reaching a closing, the quality of the firm or the trust you have with the individual leading the investment, all absolutely critical pieces of the puzzle. Here, we are just looking at the terms and conditions, the legal structure of the investment.
We’ve listed nine key terms below — five that have to do with economics and four that relate to control and decision-making:
- Each key term can earn +1 for being friendly and -1 for being tough.
- There are a few really friendly terms that have a score of +2 each.
- Likewise, there are a few really tough ones that earn a -2.
- The best a term sheet could score is a +11, the worst is a -11.
- The “Industry Standard” deal scores a 0.
FWIW, the Pillar common stock standard deal earns a +8 (shown below).
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