A status update.
Conditions are challenging for tech companies right now. There has been a material correction in the valuation of public cloud companies and this has rippled down through the market. On average, multiples of public cloud companies are off by more than 60% with the median multiple dropping from 22x to 5x, as per the following graph:
Source: Clouded Judgement
Later stage private markets are closely correlated to this as you can see from the CB Insights analysis:
Against this backdrop, earlier stage rounds of Seed and Series A are holding up well in terms of valuation. However, deal volumes are well down, reflecting a flight to quality over quantity. There is also an unprecedented amount of dry powder in the VC market:
Worldwide venture-capital money raised but not deployed. Note Full-year totals except for 2022 total, which is through July.
Source: Preqin Ltd. and Wall Street Journal
There is money available but, at the same time, the macro-economic environment is far more uncertain. This is what is driving the flight to quality. So it seems like the most interesting question is what does quality actually mean in the context of this market?
A startup needs to have the potential to be a category leader. In times of easier money, too many more derivative startups were able to raise funding; and they will find themselves more exposed in these more challenging conditions. We know that there is a ‘power law’ in tech whereby the majority of value goes to the top 2-3 winners in any one category.
A startup needs to be visibly approaching a problem differently, if it is to be successful. This means true innovation rather than just iterating on what has come before. To leave clear water between the business and its predecessors, the team need to be domain experts with the talent and vision to develop a truly better way to solve their chosen problem.
Of course, one powerful indicator of quality is the track record and composition of the founding team. Look for founders who have had some success in the past, either in founding roles elsewhere or in senior roles in other successful tech companies. This significantly reduces the risk in an investment opportunity. In terms of composition, the data shows that having more than one founder, with complementary skills, meaningfully increases the chances of success.
One of the great things about investing in SaaS is that there is a well established set of metrics that you can use to benchmark companies against the broader market. These metrics have come under ever closer scrutiny in these more challenging times, with particular weight attached to efficiency-oriented metrics. Those we most closely examine and benchmark at Notion include: growth, gross margin, NRR (net retained revenue), ACV, CAC payback, burn multiple and revenue per head.
“Discretionary” is defined as “something that is not deemed to be essential” - more of a want than a need. As a startup in current market conditions, you want your proposition to be as far removed from discretionary as possible! Startups should aim to become an essential part of their customers’ operations - something business critical that they can no longer live without. That way it will still resonate in a cash-constrained environment, rather than being singled out in the product rationalisation that many businesses will be undergoing right now.
When I look across the companies that have made it into our Top 100 list I can see many of these attributes clearly in place. This gives me confidence that many of these companies have the strength and the resilience to succeed no matter the market conditions.