Should early-stage startups join the cloud market fun?

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As much as I love spotting new trends, it’s just as important to get confirmation of previous predictions we’ve made or heard. This week brought us some fodder in that regard, in two sectors that are pretty high on my radar: SaaS and alternatives. Let’s explore. — Anna

Shrinking SaaS multiples, tough times for IPOs

Alex and I spent a lot of time this week diving in Battery Ventures “State of OpenCloud 2022” report. It drew our attention to some predictive data — cloud adoption, for example — but also confirmed something that’s impossible to ignore: that SaaS multiples — enterprise value compared to revenue projections — are shrinking.

“The average forward multiple for SaaS companies has fallen from about 16 times forward earnings to roughly 6 times today,” said Battery General Partner Dharmesh Thakker.

The multiples have not only shrunk, but also compressed, with less reward for the fastest-growing companies than the slower-growing ones. There are many factors, but the bottom line is that yields seem to matter to the markets again.

As a result, we see the revenge of some old rules. “Adjusted for growth,” Thakker said, “companies today that show efficient growth as implied by the Rule of 40 (ie, companies with a growth rate + free cash flow margin greater than or equal to 40 ), trade at a premium to those that grow regardless of profitability.”

Note that it’s not about either growth or profitability: it has to be both, and the bar for satisfying investors seems to be getting higher and higher.

A more demanding market is a worrying picture the many unicorns waiting for an IPO, as well as their counterparts that have already gone public but are struggling to maintain their market capitalization. Let’s also spare the thought of Alex, who might not get his hands on another juicy S-1 before the second quarter of 2023.

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