Startup Valuations in the Time of the Everything Bubble

Last week I was talking to a prominent investor and I asked about the current state of the investment climate. He said that startups a year ago raising money at 30-50x revenue were off limits to his firm and today they’re commonplace. Hearing this, it made me think of Fabrice Grinda’s excellent Welcome to the Everything Bubble.

Ten years ago, a hot, fast growing SaaS company would get a 6-8x run-rate valuation (see ExactTarget at IPO in 2012). Then, in the last 4-6 years, hot, fast growing SaaS companies moved to a 10-12x run-rate valuation (see Zoom raising $100M at a $1B valuation in 2017). Now, there are dozens of public SaaS companies trading north of 20x run-rate and plenty trading north of 30x run-rate (see BVP Cloud Index). What gives?

The main factors:

• Market Size – The total addressable market for SaaS is much larger now, providing more confidence that startups can grow to a scale even bigger than previously anticipated.
• Digital Transformation – COVID has accelerated the adoption of many SaaS products as companies have been forced to work in a distributed fashion, driving up growth rates.
• Interest Rates – With the Fed interest rate effectively at 0%, the bar for a quality rate of return has been dramatically lowered, making investors willing to pay a higher price to achieve the same outcome.
• Money Supply – With so many stimulus dollars flooding the system, and not a corresponding drop in overall incomes, the money has to go somewhere, and many people have put it in the stock market, thereby driving up valuations.

Ultimately, I think about it as a function of startup growth rate and how many years of future growth an investor is willing to pay for now. Let’s say long term, in a normal financial environment, SaaS companies are worth 4-8x revenue because of great gross margins, ability to have high free cash flow margins, predictability of business, growth expectations, etc. If a SaaS company is expected to grow 100% top-line in the next 12 months, and grow 80% in the following 12 months (growth rates typically decline such that growth is 80-85% of the previous year’s growth, depending on a myriad of factors), there’s some basic modeling to look at potential valuations:

• Year 1
  • $10M ARR
  • 100% expected growth rate
• Year 2
  • $20M ARR
  • 80% expected growth rate
• Year 3
  • $36M ARR
  • 60% expected growth rate
• Year 4
  • $58M ARR

Assume at the end of 36 months, the $10M ARR SaaS startup will be at $58M ARR with a trailing twelve months growth rate of 60%. Assume, for simple math, it has a constant future valuation of 8x run-rate (growth rate will slow but economies of scale will expand). At the end of 36 months, it’ll be valued at $464M ($58M x 8).

Now, take different hypothetical valuation climates:

• Ultra Hot – 30x run-rate representing a $300M valuation
• Hot – 20x run-rate representation a $200M valuation
• Great – 12x run-rate representing a $120M valuation
• Good – 8x run-rate representing an $80M valuation

If you could predict the future, and know with certainty the outcome, whether investing at 8x run-rate or 30x run-rate, all scenarios generate quality returns. Reality is much more complicated, but as interest rates go down and availability of money goes up, there are still worthwhile returns even paying what appears to be exceptional valuations.

SaaS valuations are part art and part science. In the age of the Everything Bubble, as long as there are good returns to be made paying ultra hot valuations, looking for high multiples to persist.