A framework for downmarket navigation

There’s a downturn in the market, and every other blog or Twitter storm seems to offer the same general advice: save cash, stretch the runway, and switch from focusing on growth to focusing on efficiency. We’ve advised many late-stage growth companies on the ups and downs of the market, and we’ve come to realize that when the market falls, founders are eager to go beyond cliché advice and provide a tangible framework for quantifying the magnitude of market changes. Valuation and what that means for their next round, and plan their future course.

In this post, we’ll cover the diagnostic framework to use when sitting down with founders: reassess your valuation, understand your burn multiple, and plan a scenario.

Reassess your valuation

We start by quantifying the change in valuation multiple (your valuation multiple is the ratio of your valuation to revenue). Here, public markets provide the best basis for recalibrating private growth valuations, as public markets tend to see the impact of falling valuations first. For example, in the current market (as shown in the chart below), the median public company software valuation has fallen from 12x forward revenue since the October 2021 high to 5x or less, a drop of nearly 60%. The same goes for fintech and consumer internet companies, which are also down more than 70-80%.

However, the impact on risk markets will not be apparent until the data is filtered in the coming months and quarters, and even then, many of the deals announced in the second quarter are likely to be priced in the first. In other words, it may take us more than 6 months to see the impact of the public market downturn on venture capital.

An economic downturn affects different industries differently, so it’s important to keep an eye on the relevant public companies to best gauge your position. For example, a year ago, late-stage private companies were typically funded at 100x ARR (equivalent to run-rate revenue). If your last round had an ARR of $20M, a 3x increase, you may have raised money at a $2B valuation.

But things look very different now. You can get a rough estimate of your valuation change by looking at the leading public companies in your industry. If they’re down 60%, there’s a good chance you’re in a similar position. When looking at high-growth public software companies, you’ll want to compare your ARR valuation multiple to its revenue valuation multiple, as it serves as a GAAP accounting metric.

Software Forward Revenue Multiples by Industry

Once you know how much your segment has fallen, how do you refocus your targeting for this new low valuation environment?

A useful exercise is figuring out what ARR you need to achieve to revert to the previous round of valuation and plan accordingly. To do this, use the estimated change in valuation multiples of leading public companies in your field and add a growth- and efficiency-adjusted premium to your faster growth. Then use this number to calculate the ARR you need to achieve. Your goal should be to hit this revenue goal on at least 12 months of the runway. If you can do this, you will be able to raise the next round of funding. Raising money on the runway in less than 12 months sends a negative signal to the market, making it more difficult to raise capital.

Continuing with our example, a $20M ARR business, last raised at $2B, might observe a leading public company earning 10x, not 100x, on its space deal. Considering the faster growth rate of startups relative to public companies, assuming an ARR of 15x is a reasonable valuation for their next funding round. (Note: 15x ARR represents a 50% premium for their industry-leading companies, and a 200% premium over the software average of 5x, but the appropriate multiple varies from company to company.) This means they should aim to hit $133 million ARR, or 20 Billion divided by 15 times, 12-month runway.

control your burn [Multiples]

Now that you have a target ARR, how do you assess whether your business is growing efficiently to achieve it?Here we turn our attention to Burn multiple, which we define as cash consumed divided by net ARR added. For example, if a company burns $40M to increase its ARR by $10M, its burn multiple will be $40M/$10M, or 4.0x. Burn multiple is a metric you can evaluate every quarter, and tracking it closely will ensure you stay on track.

Compared to other efficiency metrics, we prefer to recalibrate burn multiples when market conditions change because they cover your business activities. Unlike other efficiency scores (eg, LTV/CAC) focus only on sales and marketing, the actions you take in each business function will affect your burn multiple. Because it’s all-encompassing, it will look different at different stages — a company with an ARR of $5 million will have far less operating leverage than a company with an ARR of $100 million. With the company cash flow positive, you should see a reduction over time, with the goal of crossing zero.

We looked at burn multiples for private companies at various stages of growth to come up with some general guidelines for what good and not-so-good burns look like as they scale.

Burning multiple benchmarks with ARR

These metrics are a useful starting point for companies at various stages, but you should never go beyond the limits of your business. If you need to add $100 million in ARR and $50 million in burn, you should have a plan in place to ensure your burn multiple is less than 0.5x. If your burn multiplier is not where you need it, there are many ways to increase your burn multiplier to grow more efficiently, including properly sizing different functions, Improve profit margins, or reduce the CAC.In this post, we’ll continue to focus on our diagnostic framework, but we’ve previously covered how to use your financial situation Navigate market volatility.

scenario plan

Burn multiples and valuation multiples tell you how efficiently and how much growth is needed, respectively. However, when the funding environment changes and access to capital becomes more uncertain and expensive, you must also take a close look at your cash balance and manage your runway. Scenario planning helps to consider how macro events (wars, supply chain issues, inflation) affect performance indicators such as growth and CAC. Keeping a close eye on cash spending and developing a scenario plan will allow you to quickly adjust spending and investments based on performance.

We recommend planning for at least the following three scenarios:

  1. basic situation: 80% confidence plan, you know you can hit with a good burn multiplier. In response, you slowed or flattened in customer acquisition investment and operating expenses (opex). From 6 months ago, revenue growth will be lower than your operating plan, but you will increase efficiency and absolute cash burn.
  2. Best case: ARR growth and burn rates may be equal to or better than your operating plan six months ago. You grow efficiently without worrying about runway issues, and you can increase your operating expenses and customer acquisition investments.
  3. Worst case: You need to slow down the burn significantly and lengthen the runway. Even if you slash sales/marketing spending, you plan to increase ARR to a level you know. To survive, you may need to reduce operating expenses, including headcount.
Scenario planning in a down market

Once you have these plans in place, evaluate your progress quarterly or monthly, then adjust your spending and hiring accordingly.While we hope you’re heading for the best, if you find yourself heading for the worst, you may be making a tough decision – whether you need to layoffs? you need to borrow or a next round? There is no one-size-fits-all answer to these questions, and if you find yourself facing these questions, it’s time to turn to a consultant who knows your business best and can help you chart a path to survival.

Through market uncertainty and downturns, it’s important to remember that markets are cyclical, and downturns come with silver linings. Some of the strongest businesses are built during the toughest times, and those that survive market shifts typically gain greater market share and leaner, more efficient operations.


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