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If this is your first market downturn, you may be especially confused by the conflicting advice arising from such an event. To some, the sky is falling, and you should quickly change your model. To others, the pastures are green, and you should take advantage of the weakened landscape. Which one you are depends on what the data tells you about your business.
Right now, the data from the venture capital world can feel bleak: Global VC funding fell 33% quarter-over-quarter in Q3 2022. SaaS, specifically, has seen valuations slide since the beginning of 2022. However, not all companies are created equal.
The valuation decline has been the steepest for companies not focused on their data, specifically their unit economics. In those unit economics, you’ll discover whether you should bear down to weather the storm or attack the market to expand your dominance. Either way, the decisions you make now should be strongly rooted in your unit economics.
The pendulum swing
We all benefited from larger funds and higher valuations. A rising tide raises all ships; unfortunately, that includes the leaky ones. The glut of available capital meant companies performing at mediocre and poor levels from an efficiency perspective could still grow quickly. In some cases, investors were pushing companies to take more chances and bet on future growth, sacrificing efficiency and certainly profitability.
Those days of “growth at all costs” seem behind us. As markets sank and capital tightened, funders scrutinized their deals harder. They now seek companies demonstrating the fundamentals of running a scalable SaaS company, with efficiency and a strong path to profitability as hallmarks.
The metrics that matter
To be clear, SaaS companies cannot survive without growth — dominating your space requires it. But growth can no longer come at all costs, and companies must display certain fundamental metrics to support faster growth. SaaS companies should track dozens of metrics, but to attract investment in the current market, companies must address their efficiency metrics, especially:
Gross retention, with a goal of 90%+;
Net retention, with a goal of 110%+;
Gross margins, with a goal of 75%+;
Cost of acquisition (CAC), with a payback goal of <2 years
Achieving these efficiency metrics will help companies maintain or exceed their valuations. If you’re already achieving these metrics, then you’ve earned the right to discuss deploying more capital in exchange for growth. If you aren’t, consider slowing growth and redirecting your strategy, especially if capital is tight.
The cost of capital without efficiency
The higher cost of capital may prove incredibly expensive for companies buying time to achieve efficient growth. Beyond tightened funding requirements and depressed valuations, investors are placing more funder-friendly structures into deals with less fundamentally sound companies, including liquidation preferences, voting rights and even board control to reduce their downside risk. In fact, overly flawed later-stage companies may struggle to find funding on acceptable terms and may have to explore an exit or consolidation. But those wanting to tough it out and buy time to see better metrics have options.
What can leaders do now?
Start by scrutinizing your business fundamentals and assessing the efficiency of your core operating teams, then adjust to reduce inefficient spending.
Sales: Review metrics like pipeline-to-bookings ratio (with a goal of 4-5x+) and average seller’s quota attainment (with a goal of 65%+). This information will focus your efforts and help you find needle-moving improvements before simply growing your sales teams without correcting underlying issues.
Marketing: Focus on efficiency metrics like your cost per opportunity across every channel and over-invest in high-performing channels.
Product teams: Consider tracking efficiency based on a product productivity benchmark and monitor user-to-issues ratios. You might invest more in customer features and platform stability over new builds to increase retention and enable higher converting upsells.
Customer success: Examine retention rates across various customer segmentations to understand your customer base’s strengths and weaknesses. Optimize your book of business-to-customer rep ratios, and heed customer Net Promoter Scores and other sentiment metrics.
As you adjust, you may need to shrink your teams and rightsize your operation. It’s an unpleasant reality, but you should fill any cracks in your ship before renewing your push for growth. This can help control your burn rate and buy the time needed to convince an investor you’re on the path to efficiency.
Where is the funding?
Valuations likely won’t reach 2021 numbers, but companies with strong fundamentals will find funding. Companies correcting their fundamentals and needing to buy time with capital will find tougher markets. So, where else can you go?
Start with your current investor base. They have as much to lose as you do, and in the case of venture capitalists, they often have allocated “dry powder” for situations like these. They may also behave more moderately as bad valuations and more structure can often hurt their previous positions. Another way to avoid a down round in the short term is by raising via convertible notes.
If equity is not an option, climbing interest rates have made debt providers more active, creating an opportunity to explore debt financing. If it’s available to you and makes sense financially, leveraging debt lets you raise non-dilutive capital that buys you time to achieve better efficiency metrics. Timing matters, however, as the debt market can ebb fast should monetary policies change further.
The funding silver lining
Companies that rightsize their operations and control their burn for the next year might find a funding pool at the end of the proverbial rainbow. Funds with charters to invest in private tech companies are riding out the troubled market on the sidelines. As the market improves, funds will further open their checkbooks to companies with healthy efficiency metrics.
Valuations may not have completely rebounded by then, but companies will keep raising at good multiples if they demonstrate solid fundamentals and maintain healthy efficiency metrics alongside growth rates. These companies are best prepared to ride out the falling wave and catch the rising tide again.