Back to the 2000s for startup valuations?

Have been watching and analyzing the public tech markets and broader markets for the year. Like everyone else, I have been taken by surprise by how rapidly valuations for loss making growth companies have fallen. Some examples ranging from those with really bad financials to those with slightly better ones:

  1. Carvana has fallen 90+% in value. It’s now trading at just 1.65b usd or about 0.15 times of its revenue. So what does that say about what Carsome or Carro is worth and the IRR and TVPIs of their VCs?
  2. SEA has fallen 88% from peak and is now worth just 20b or barely 1.5 times revenue. And they have a profitable gaming unit some more.
  3. Grab, Goto, Crowdstrike, Twillo, Teladoc all crashed 50-90+%.
  4. QQQ which is profitable big tech mainly has fallen 34%. But at least the valuations are supported by profit. That’s an important point- profits and not revenue now support valuations more.
  5. And to add to all this pain even China tech and consumer companies- which frequently are profitable too have not been spared. They too are down >>50%. Their issue is a combination of worldwide revaluation + slowing economy + lack of trust in Chinese markets.

For us in Asia, I am hearing most investors are hit bigger by the China & SE drop than by the DM fall in the form of QQQ or SPY as we started the year feeling that China stocks were cheap.

What does all this have to do with earlier stage startup founders in ASEAN? I hope I am wrong but current multiples remind me of post 2000s tech crash when it was normal for tech companies to be worth something serious only if profitable or approaching profits. A company with 10m revenue and 3m profit back in 2005/6 was worth more than a 100m revenue company with 10m losses because it is the PE ratio that matters more.

And the PE ratios for fast growing companies were usually ranging from 15 to 40. So the profitable tech company with 3m net profit off high gross margin of 70-80% was still just worth $45m give or take depending on growth rate. But the loss making one is probably worthless to public market investors or just worth its NAV especially if it cannot show path to profits and has widening losses.

So if I am a founder today running a loss making startup, I would plan for a “profit and cashflow hungry” capital market. Revenue growth matters much less than narrowing losses and profits. It’s also far more sustainable.

And if I were a fund, I would aim to make the current portfolio profitable and focus on getting distributions for LPs. Forget about raising a new fund for a while until the dust settles. Any LP will want to see this situation clear up and stabilize first. We also want to see distributions being done before just believing in current fund IRR and TVPI as it includes unrealized gains which have not reflected public market reality. Very soon LPs will see that 6x TVPI and 40% IRR means little if distribution is only 0.1x for a 6-7 year old fund. I would much rather have a 1x distribution and TVPI of 3x.

Unfortunately, there seems to be a state of tension going on between optimism/kicking the can down the road and being honest and realistic. Eg. bridge financing is needed but are still being done on last round valuation even though clearly the listed comparables have crashed to a 1/3. This deliberate mispricing by VC and PE funds is self serving behavior and will result in unhappy LPs if the write down ultimately happens 1-2 years later.

Let’s see how this plays out. I would not be surprised if this downturn worsens on revenue front as businesses and consumers cut back.  if that happens,  there will be big loss making startup failures or down rounds in 2023 or 2024 as there is no way to justify 10x or more revenues when growth disappears and profit is absent.

As investors, we have been hiding out in profitable companies for listed market (only one nostalgic position in loss making SE) and some quality bonds since start of year. Even so, still down for the year but better than Acwi benchmark. For startups, we intend to continue investing but we will only do so at reasonable market valuations led by new lead investors to the round. No internal round at last round valuation for us if business has not improved dramatically.

As for our existing portfolio companies, we continue to ask them to prioritize ebitda and cashflow over revenue growth. Don’t count on always having investors to fund you and instead get customers to do it. Focus more time/energy on product, on customers and on employees. That always pays off.

Happy to see that many of our founders seem to get this and have moved to lower spend and drive revenue growth.  In the 2000s, it  was normal and desirable to turn a net profit if you have a few million gross profit. It was also normal to grow costs only if revenue grows in tandem or better still grows proportionately more. It’s time to bring that mindset back in vogue and stop being proud of losing money and using investor money to stay afloat!

Leave a Reply

This site uses Akismet to reduce spam. Learn how your comment data is processed.