Many tech companies used EBITDA (Earnings before interest, taxes, depreciation and amortization) or even Adjusted EBITDA as highlighted profitability measures. EBITDA excludes financings costs, taxes, depreciation and amortization and Adjusted EBITDAs exclude a bunch of other costs and generally are all over the place as Adjusted EBITDA is not an official GAAP (Generally Accepted Accounting Principle) measure. Safe to say, neither is a perfect way to measure profitability.
Following accounting principles and laws are one thing, but they alone are not the best tools to understand how valuable a company is or can be.
It is often said that the value of a company is the discounted value of its future cash flows. But neither EBITDA or net profit are actually measures of cash profit. And the often used free cash flow metric is not a GAAP measure, and thus different free cash flow formulas treat e.g. stock-based compensation differently. While stock-based compensation might be “non-cash”, it is an economic cost to current shareholders.
To get a better understanding of a company’s profitability one need to look at multiple measures. Unit economics (non-GAAP), gross margin, EBITDA, EBIT, Net profit, Free cash flow (non-GAAP) etc.
What weight an investor assign to each measure should differ depending on the type of investor. A small private investor in public stocks will view profitability in one way, a private equity fund buying a mature company in another, and a venture capital fund will think about it in a third way. To quote Charlie Munger “It is not supposed to be easy. Anyone who finds it easy is stupid.”
First day of 2023. My ambition is to write something everyday this year. Even if it might be both short and not terribly groundbreaking most days, I think writing something each day will lead to more interesting writing overall.
For startups in Stockholm and Sweden/Nordics at large, I believe 2023 will be quite a good year for companies raising pre-seed and seed rounds as a new fundraising environment establishes itself.
For Series A and beyond I think it will be messier as it will take longer (second half of the year) to establish a stable new baseline for valuations and terms. Especially as there will be a bunch of companies that raised on great valuations in 2020 and 2021 that will have to raise new capital. Many on worse terms and/or valuations than the previous round.
Mark Leonard founded Constellation Software, a serial acquirer of niche software companies, in 1995. Today it has revenue of more than 4 billion Canadian dollars and thanks to high revenue growth, strong margins and predictable growth by acquisitions is valued very highly.
Jamin Ball writes Clouded Judgement, and is anything but, about SaaS and valuations and the last issue of 2022 included a wrap-up for the year. A chart of enterprise value divided with expected revenue for the next twelve month shows just how high valuations got in 2020 and 2021.
Inflation and higher interest rates have been two major triggers, but another factor why valuations of great tech companies are down 60-90 % in 2022 is that their valuations doubled to tripled from multiple expansion in 2020 and 2021 to very high levels.
Financial gravity exists, so what goes up will come down to more normal levels.
Have enough cash on the balance sheet to either get to profitability or to get to a compelling set of milestones that makes raising additional financing a “no brainer” — even in a poor market environment.
Roger Ehrenberg highlights one of the eternal truths, regardless of the market environment, for founders and CEOs building a startup: At any given point, make sure you have enough cash to take the company to profitability or build things that will allow you to raise capital before the cash runs out. This regardless of if you are six months from running out of cash or if you just raised $20 million and have 36 months of runway.
Sometimes old technology die over a couple of years when new technology comes along, sometimes it takes a much longer time. If technology is embedded into core systems that works, even if not perfectly, there’s a bunch of reasons to “if it is not broken, don’t fix it”. Which is good for legacy sellers like IBM, but also open up for companies like Constellation Software and private equity shops like ThomaBravo and Vista Equity Partners to acquire smaller companies with the same dynamics as IBM’s mainframe business.
Good discussion with Brad Gerstner about large tech companies (incl Meta), software stock valuations, interest rates etc. Nothing entirely new if you’ve been following what has been going on the last 6-9 months, but worth a listen/watch regardless.