One of the hottest topics lately is valuations. With the public equities down dramatically over the last year and most startups deferring as long as possible to raise another round, it’s hard to know what’s market out there. Of course, some deals are getting done and the startup funding world is still turning, albeit at a slower, more jerky pace. 

On the public market front, the BVP Cloud Index shows cloud stocks trading at an average revenue multiple of 6.3x with an average growth rate of 29%. The median forward revenue multiple is 4.82x (using the expected revenue for the next twelve months). At the peak of the market on February 10, 2021, the median forward revenue multiple was 15.95x. Thus, we’ve seen a 70% drop in valuations.

On the private market front, I’ve heard of deals all over the place from 2x to 10x+ revenue run rate, often driven by how desperate the startup is to raise money to how desperate an investor is to put money into a startup. The days of 50x or 100x run rate valuations are long gone (ignoring outliers like Figma or OpenAI). 

So, what’s a generic valuation formula in today’s market? Absent more data, here’s a formula to ballpark a number:

Revenue Run Rate (most commonly annual recurring revenue)

Multiplied by

Rule of 40 Score

Multiplied by

.2 (market sentiment, in this case 20%)

Some examples:

• $20M ARR x 50 Rule of 40 Score x .2 = $200M
  Because of the high Rule of 40 Score, the startup gets a valuation of 10x run rate
  
• $10M ARR x 20 Rule of 40 Score x .2 = $40M
  Because of the normal Rule of 40 Score, the startup gets a valuation of 4x run rate
  
• $5M ARR x 10 Rule of 40 Score x .2 = $10M
  Because of the low Rule of 40 Score, the startup gets a valuation of 2x run rate

Rule of 40 Score is basically growth rate plus profit margin as numeric values. The easiest way to get profit margin up (or less negative) is through layoffs, and we’ve seen huge numbers of them lately.

Much like “animal spirits” from John Maynard Keynes, market sentiment here is subjectively and fluctuates regularly. While this formula isn’t perfect, it’s directionally useful in today’s market.

Last week I was placing a grocery order on Instacart and I noticed the following message after the checkout process:

You saved with Instacart 

565 hours

The “565 hours” is displayed bright and large to really stands out. It’s big, bold, and impactful. I know there’s a convenience and time saving element to the Instacart value proposition, only this makes it front and center as a regular reminder. 

Now, how does Instacart calculate this number? Is it an arbitrary allocation of one hour per order (thus, I’ve made 565 orders over the many years of usage)? Or, is there a slightly more involved calculation that incorporates the number of items ordered and assigns a value of time to each? Regardless, I do believe I’ve saved hundreds of hours of time over the years using Instacart, and for that I’m thankful.

Seeing this made me think of other ways products and services need to tie value back to the user, especially in the B2B context.

Some common ones:

• Return on investment
• Increase in XYZ metric (revenue, profitability, NPS, etc.)
• Decrease in XYZ metric (days sales outstanding, average response time, bounced emails, etc.)

Ideally, this is automated and prominent in the application. By using the product, the value is clear. Sometimes it’s more difficult to calculate and requires a person to do a quarterly business review where you meet with a customer to walk through how you’re contributing to their success. A word of warning: if you can’t clearly articulate the customer’s success, the solution isn’t likely to achieve large scale success.

The next time you use a product, figure out how it expresses value. Is it obvious or is it nearly hidden/non existent? The best products provide both tremendous value and make it easy to see the value.

With 2023 almost here, I was thinking about advice for entrepreneurs in the new year. It’s a tough time right now as the economy and most companies are in a defensive posture — many negative economic factors are still pulsing through the system. No matter the situation, I keep coming back to the most important general purpose tool entrepreneurs should use: a simple strategic plan.

The simple strategic plan, just like it sounds, is a high level overview of the business and the critical elements of the company. The goal isn’t to be the a comprehensive, detailed write-up of all aspects of the enterprise. Rather, the goal is to get everyone inside and outside the company on the same page with as much clarity and concision as possible. Put another way, if you could only use 250 words to tell someone about the business, this is the best formula to do so.

Now, here’s the outline of the simple strategic plan:

Purpose

• One line purpose

Core Values

• General – fit on one line
• People – fit on one line

Market

• One line description of your market

Brand Promise

• One line brand promise

Elevator Pitch

• No more than three sentences for the elevator pitch

3 Year Target

• One line with the numeric target, often the most important KPI

Annual Goals

• 3-5 annual quantitative SMART goals in table format with the start value, current value, and target value

Quarterly Goals

• 3-5 quarterly quantitative SMART goals in table format with the start value, current value, and target value

Quarterly Priority Projects

• Three one-line priority projects with the percent complete for each

Simple strategic plans are most effective when managed in a Google Doc, Notion Doc, or similar collaborative system. The plan should be widely shared, updated regularly, and talked about frequently. As a living, breathing document, it represents the foundation of the company whereby everyone is aligned and organized.

If you make one action item for the new year, make it to build and maintain a simple strategic plan. Good luck in 2023!

In the early days of Pardot we were cranking out features left and right. With no technical debt, a rapid development environment (PHP on Symfony), and a race for product/market things were moving fast. Super fast. Only, with speed and little to no input from customers, it was too easy to build features that didn’t make sense. How about building X? Sure! How about building Y? Go for it.

Naturally, with hindsight, we built modules that shouldn’t have been built. One such module we built was called Site Search. At the time, products like Algolia didn’t exist and it was a pain to add an internal search engine to a website. For Pardot, the goal wasn’t the actual site search functionality. Rather, it was to capture the search terms from the site visitors and prospects — intent. This intent could then be scored, tied to automation rules, and placed in the CRM. Imagine searching for “pricing” on a website as a known prospect and an email gets triggered automatically from your assigned account executive in the CRM with detailed pricing information. Pardot automated that whole process.

To make this module work, we had to build the site crawlers, background jobs to regularly re-index the sites, and all the other infrastructure. It wasn’t the best use of time. Rather, we should have made it easy to tie into other search products, even if they were scarce, such that when a search was done on an external system a Javascript call-back function would send the search term to Pardot. Pardot was a marketing automation platform, not a site search platform.

The next time an idea for a module comes up, think through how well it fits the overall mission and vision of the product. Does it make sense as a native feature or as an integration to a best-of-breed product? Will a material percentage of customers now and in the future use it? What’s the priority of this feature relative to other items in the queue?

Misguided product features are more common than expected. Work hard in the product planning process to minimize them, and if they get built, stay vigilant to remove them if it’s clear it wasn’t the right direction.

In the early days of Pardot, the idea of sales or business development reps for SaaS companies started to gain popularity. While not a new concept, the idea of cold calling and cold emailing potential prospects was thought to be old fashioned and not effective. It was wildly effective. As part of building the process around outbound sales activities, we also learned an important lesson in output vs. outcomes.

Initially, we focused on output. Every rep had to make 40 calls and send 40 emails per day with a quota of one scheduled demo a week. Reps received a base salary plus $100 per demo. Eighty calls and emails per day, when done diligently with high quality talking points and content, should result in scheduled demos. The output of the calls and emails was scheduled demos.

Only, after a number of scheduled demos, and paying out the commissions, we realized output and outcome are two different things. The reps were scheduling product demos with anyone that would take a demo, regardless of fit. If someone on the other end of the line said ‘yes’ to a meeting, the rep scheduled that meeting. 

Our desired outcome was a completed demo with a potential prospect that was a good fit. So, instead of $100 per demo scheduled, we changed it to $200 per demo completed (not just scheduled) where an account executive accepted the meeting and the potential prospect showed up for the call. Now, not only did the meeting have to be scheduled, the potential prospect be the right type, but the meeting had to take place (lots of no-shows in sales prospecting). We moved the outcome from being worthwhile on occasion, to a well-defined outcome that was useful most of the time.

Output is what happens as a result of effort.

Outcome is the value from the output.

As an entrepreneur, it’s easy to get too focused on output and not provide enough attention to outcome. Both are needed and both are critical to growing a startup. The next time you’re thinking through activities and effort, breakout the output and outcome elements and ensure they’re aligned properly.

Last week I was talking to a well known entrepreneur about his journey. After several background questions I asked how his role has changed going from solo founder to leader of a company with nearly 1,000 employees. His answer:

Before, I was ideator and doer. Now, I’m the editor and curator of ideas.

An editor and curator of ideas. Of course, that makes perfect sense. Only, I hadn’t heard it presented that way. In the past, I’ve heard the entrepreneur’s three jobs presented as the following:

• Set a mission and vision
• Find and nurture the best people
• Ensure there’s enough cash in the bank

While I believe those three to still be true, a fast growing business that’s transitioned from startup to scaleup needs a strong editor and curator. More scale results in more competing interests and complexity. More scale results in more initiatives and more opportunities. Scaleups, even with an incredibly successful core business, can easily lose their way chasing The Next Big Thing. Saying “no” becomes even more important than saying “yes.”

As an entrepreneur, the next time 10 ideas are thrown at you, imagine yourself as the editor of a well regarded magazine. What articles do you let in? What does your readership expect? What’s the tone you want to set? Where are you heading? Put on your editor hat and evaluate the ideas in the context of the overall mission and vision.

Entrepreneurs should be the editor and curator of ideas for their business.

Last week entrepreneurs reminded me several times of one of my favorite adages: if you don’t ask, you don’t get. While it seems obvious, the reality is most people assume if something isn’t offered up or available, then you can’t get it. We’re conditioned to assess what’s in front of us, what’s obvious. Only, pushing beyond the perceived limits is what moves the world forward.

One entrepreneur shared how he really wanted to ask a well known business person for advice. Everyone told him it was a waste of time — he’d never get to the person. After trying the networking route with no luck, the entrepreneur made the ask in a cold email. Yes, a cold email. Unexpectedly, the business person promptly responded, they connected on the phone, and hit it off.

If you don’t ask, you don’t get.

One entrepreneur shared how he really liked this adjacent business where the owner claimed they’d never sell. The entrepreneur put an annual reminder on his calendar — December 1st — and every year he’d check in. Like clockwork, he was persistent. 10 years later the owner decided it was time to sell. You know who bought the business? The entrepreneur that stayed pleasantly persistent for a decade.

If you don’t ask, you don’t get.

One entrepreneur shared how he really loved this house he’d drive by on the way to the office everyday. Randomly, a for sale sign appeared one day and he promptly called. The house was already under contract, that same day. Bummed, he let it go. Only, no one moved in and the grounds became unkept. Realizing something was up, he contacted the new owner, who had since changed his mind, and promptly bought the house from him.

If you don’t ask, you don’t get.

Making the ask starts out uncomfortable, unnatural even. With effort and practice, it becomes easier and easier. Start now and always remember: if you don’t ask, you don’t get.

Lately, one of the big challenges I’ve been discussing with entrepreneurs is the massive reset in valuations. The huge ARR multiples are gone for all but the most exceptional of business models. If the last funding round valued the business at X, and the public markets value businesses with similar metrics at 2/3rd to 1/4th the value, the reality is that the business is considerably less valuable now. Human nature is to ignore the data and try hard to grow into the valuation so that the next round is at least flat, if possible.

The better solution is to make the hard call and reset the valuation and mental anchoring internally.

Internal valuations, for stock options, can be set at any amount equal to or higher than the 409a valuation from a third-party. The 409a looks at the landscape of similar company valuations, does a variety of calculations, and comes up with a valuation for the startup. A recent 409a will reflect the latest data, and likely a lower valuation than the last round.

Now for the tough part: what to do with the existing stock options that are underwater (the strike price is significantly higher than the the company’s valuation)? It’s time to make a plan and roll out new options to employees. As the company valuation is likely lower, this will result in more dilution to achieve a similar level of equity ownership for employees. My favorite methodology for equity grants is from Fred Wilson’s post: Employee Equity: How Much?

Employee Equity: How Much?

The sooner the internal valuation is reset, the sooner the team can start buying into the creation of new value from a lower starting point. Of course, it’s incredibly hard as everyone has the last valuation in mind. By reseting the mental anchoring, and issuing new stock options in a corresponding manner, alignment around the creation of new value becomes achievable. No one wants to go back to then go forward, yet that’s a common theme in life. 

Entrepreneurs would do well to evaluate cutting the internal valuation and focus on value creation from a new starting point.

Last week I was talking to an entrepreneur about his latest progress and growth plans. After a few minutes into the conversation it was clear the main issue to be discussed was the dilemma between selling future investors on a grand vision of becoming a unicorn vs the personal desire to build a solid business and have the optionality to sell for high eight figures and set up his family financially for life. With the news stories over the last few years, it’s easy to get sucked into the hype that the only path forward is a billion or bust. In reality, most tech entrepreneurs want to work on cool things, make an impact, and get fairly compensated for the value created.

My advice to this entrepreneur based on his personal goals: think of it as a calculated marathon to $10M ARR. To have financial optionality for a full or partial sale, the SaaS startup typically needs to get to $10M in annual recurring revenue growing >30% per year to be valued in the $50M – $100M range based on gross margins, net dollar retention, addressable market, capital efficiency, etc. Now, working back from this $10M ARR target, we know the yearly milestones:

Year 8 – $10M ARR @ 35% growth

Year 7 – $7M ARR @ 45% growth

Year 6 – $4.5M ARR @ 55% growth

Year 5 – $2.8M ARR @ 65% growth

Year 4 – $1.6M ARR @ 75% growth

Year 3 – $900k ARR @ 85% growth

Year 2 – $500k ARR @ 95% growth

Year 1 – $250k ARR @ 100% growth

The huge assumption here is that growth slows down ~10% per year and the company can be capitalized in a way where everyone is aligned around this strategy. On paper, this isn’t a venture-backed business. In reality, there are so many seed funds and angel investors that it’d get funded with the hope (yes, hope!) that’s there’s an opportunity to grow faster and build a bigger business should the opportunity reveal itself.

Entrepreneurs would do well to think through how their personal goals align with their current strategy and consider a calculated marathon to $10M ARR, when appropriate.

Todd Gardner has an excellent post up titled Use the Dolphin Strategy for Efficient SaaS Growth (with Lowered Risk) where he shares a strategy many entrepreneurs, SaaS or otherwise, would do well to consider, especially in uncertain times. Much like dolphins can stay underwater for long periods of time, they do need to come up for air regularly before heading back down. For investor-backed entrepreneurs, venture or debt financed, the default approach is losing money perpetually until the sale of the company. Instead of constantly losing money — being underwater — the entrepreneur would achieve a quarter of profitability — coming up for air — every 18-24 months. This is profoundly different from today’s standard playbook of growing as fast as the growth metrics and capital markets allow.

Here are a few quick thoughts on the dolphin strategy:

• Less capital will be burned and, correspondingly, the business won’t grow as fast
• If capital markets change quickly, as they have this calendar year, the business will always be on a plan to control their destiny — profitability — and isn’t as subject to market timing
• Employees actively looking for a more measured approach to the startup playbook will appreciate this while others that want the go-big-or-go-home approach will be repelled
• Profitability, even if only for a quarter on occasion, provides clarity to future investors and acquirers, especially private equity, what the business actually looks like when operated for cash flows, even if operating income is modest

The dolphin strategy will appeal to entrepreneurs that already have a capital efficient lens to their style and want to take it one step further and demonstrate real sustainability in their business model. Unfortunately, the dolphin strategy doesn’t work as well for smaller startups as it requires some level of scale and predictability — at least a few million in recurring revenue — to work unless the startup is super lean.

Entrepreneurs would do well to understand the dolphin strategy for more measured SaaS growth and consider it for their business.