Money Matters: How the market is impacting venture-backed software companies
“If you are willing to do only what’s easy, life will be hard. But if you are willing to do what’s hard, life will be easy,” T. Harve Ekert wrote in his book “Secrets of the Millionaire Mind.”
I like to phrase the same idea this way: “If you choose the easy, life gets hard. If you choose the hard, life gets easy.” Life is hard for many companies in this economy. Others, however, are seemingly recession-proof. What explains the difference? When it comes to venture-backed software companies, “choosing the easy” means getting as much funding as possible. “Choosing the hard,” on the other hand, means only raising as much as you need for the near future, and focusing more on customer satisfaction to help you be successful.
As the CEO of a venture-backed software company, GUIDEcx, I’ve learned valuable lessons about how these two approaches to fundraising make a vast difference in achieving business success through market changes. While this economy is presenting new challenges, it’s never too late to make strategic changes that can improve your chances of future wins.
The state of the market
In the market we just came out of, money was relatively easy to access. In that environment, investors valued top-line growth above all other metrics. So, many venture-backed software companies aimed to raise as much money as they could, no matter the cost.
But things are different now. With the U.S. economy shrinking for the second straight quarter, investors are putting a premium on efficiency metrics rather than top-line growth. They’re looking for businesses that are recession-proof.
What happens when you raise as much money as possible?
When the economy is unquestionably doing well, you’ll see companies brag about how big their rounds of funding are. You don’t hear that anymore. That’s because we’re now stepping into the harsh reality of a tight market.
There are software companies out there that have raised valuations that are 100 times their earnings. Unfortunately, in an exit, there’s no way today’s buyer would pay that amount for the business, no matter how phenomenal the organization. These companies are finding that they need to work 10 times as hard to validate their valuation because investors have exceedingly high expectations of them.
Why? There’s a simple equation that helps illustrate. Let’s say a company raises 100 times its annual revenue of $10M, giving them a $1B valuation. To satisfy that investment, they’ll need to earn one-seventh of their valuation, or approximately $143M in annual recurring revenue. That’s quite a bit more than their annual revenue of $10M!
With those inflated expectations, the company has to be ultra-efficient, even laying off employees en masse, despite their massive bank account. They have to run their company almost perfectly for years to make their funding last, satisfy the demands of investors and create wins for employees. And that doesn’t even take into account what the market will look like. Look at Netflix: Who could have guessed that such a majorly popular company’s stock would be down 70% from its high?
Companies in these situations are now in the position of being acted upon rather than being able to proactively act as they see fit. They chose “the easy” and are now facing “the hard.” On the other hand, more financially conservative companies have much more autonomy in today’s tight market.
The benefits of being a financially conservative company
Companies that chose “the hard” during the good times are faring much better than their high-raising counterparts. These financially conservative companies took a more disciplined approach in the lead-up to today’s market, not raising more money than they needed for the near future. This strategy yields a relatively high net dollar retention, with high customer loyalty and less of a need to rely on investors for success.
For example, at GUIDEcx, we don’t raise more than we need for the next 12 to 18 months. I’ve had investors willing to give us more; my answer was that I have faith and confidence in our business, but I don’t know what the market is going to do in 18-plus months, let alone several years down the road. Why would I create expectations when I don’t know what the market is going to look like?
It’s better to base your investment thesis on what your productivity will be, not on what the market may be doing. Now that we’re in a down market, financially conservative companies aren’t being acted upon by the market. The market isn’t making decisions for their business. Rather, they’re making their own decisions without pressure from their investors, which is the ideal, empowering situation for entrepreneurs.
In my years as an entrepreneur, I’ve found that strong relationships and a rock-solid support system make all the difference. Any time you raise more funds, it’s going to come with higher expectations — that’s just how it works! Focus on building positive, long-term relationships with your investors and support system. The next round of investors will see how happy your current investors are and be more eager to contribute to your success.
We’re in a down market, but there’s still hope if your investors are pressuring you. Moving forward, do what you can to avoid the pitfalls of raising too much capital, and follow principles of financial conservatism as much as possible. As you do so and build strong relationships along the way, your company will be better equipped to succeed despite downturns in the market.
Peter Ord is the founder and CEO of GUIDEcx, a client implementation and onboarding project platform based in Lehi.