What happens to technology companies with slowing growth and a rising focus on profitability before they reach behemoth scale? How much does the market value hypergrowth?
Just because a technology startup has a hot start, that doesn’t mean it will grow quickly forever. Most will wind up somewhere in the middle — or worse. Put simply, there is a larger number of tech companies that do fine or a little bit worse after they reach scale.
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But what every investor hopes for is the hot company that can keep growth alive even after reaching material scale, running through walls, competitors, economic headwinds and anything else that comes its way. Those companies don’t end up worth a few hundred million, or a billion, but can end up valued in the dozens of billions or more.
In reverse, tech companies — even those with strong gross margins — with slipping growth can see their multiples compress rapidly. Then, the vultures circle.
Which explains some of the news we’ve seen recently in the market. As Dropbox comes under fresh pressure from external parties, joining its erstwhile rival Box in the public-market growth penalty box, we’re seeing companies like Braze, Gong, Shippo and others rip ahead with rapid-fire funding rounds or public brags about their growth.
While the differential between the two groups is clear, it’s still worth exploring in more detail. Let’s talk about the growth dividend. Or, if you’d prefer, the existential cost of growth deceleration.
Grow or die
The news this week that Dropbox has attracted an activist shareholder should not have been a surprise. Its former rival Box is in the midst of a long-running struggle with an activist investor of its own. (More here.)
The reason why Box is under fire is pretty clear: Its growth rate decelerated into single digits recently, and some folks think it could do better.
Dropbox is facing similar headwinds. In Q1 2020, for example, it posted anemic-if-kinda-alright growth of 18%. In Q1 2021, that number slipped to 12%, a deceleration of around one-third. That’s painful for a company that sports a sub-10% GAAP net margin.
I have no view on the product mix at either company; they may have lovely tools and services and teams and employees. But from a purely financial perspective, the ability of both to post improving profitability numbers has not lessened market pressure to reignite growth. Why? Because a technology company that doesn’t grow is modestly useless.
Rare is the tech firm that pays enough of a dividend and finds itself in a stable enough market to become a valuable cash cow for investors. We can see some of this in the payouts that the wealthiest firms in tech shell out for. Apple’s dividend yield is under 1%. So is Microsoft’s. Alphabet and Amazon and Facebook don’t pay dividends at all.
So even among the most valuable tech shops, shareholder return is concentrated in share price appreciation, and buybacks, which is the same thing to a degree. Slowly growing tech companies worth single-digit billions can’t play the buyback game to the same degree as the majors. And they are growing more slowly, so even a similar buyback program in relative scale would excite less.
Grow or die, in other words. Or at least grow or come under heavy fire from external investors who want to oust the founder-CEO and “reform” the company. But if you can grow quickly, welcome to the land of milk and honey.
Gong and friends
Shippo announced a new round of funding yesterday: After attracting $45 million earlier this year at a roughly half-billion dollar valuation, the company added $50 million more at a $1 billion valuation.
Was it growing quickly? Yep. During its first funding round of the year, Shippo noted that it had “more than doubled total shipping spend on its platform in 2020 and grew over three times faster than the rapidly accelerating U.S. e-commerce shipping market.” At the time, it said it had 70,000 customers.
Three months later, it reached 100,000 customers. That was quick. So it doubled its valuation, raised its largest round to date, and now has more capital than ever to pursue its shipping dreams.
Gong is another company on a tear. Now worth north of $7 billion, the sales software firm told TechCrunch that it grew its ARR more than 2x from Q1 2020 to Q1 2021. And according to my colleague Ron Miller, the company’s growth rate is accelerating to around 3x in the current quarter.
In come the dollars, up goes the valuation. It’s a tale as old as time, but in the same week that we’re seeing venture rounds become more and more frequent, and larger and larger, it’s notable to watch two former startup darlings become the targets of such censure while their younger brethren attract financial accolades.
The only difference is growth. The cliche that growth covers up all sins is true, sure, but incomplete. Growth absolves all other sins would be a more accurate presentation of the vibe. And I’d add that growth also generates FOMO, a protective halo around any company’s valuation that provides it with a cushion from reality to boot.
A final word on Braze: The company announced this week that it reached the $200 million ARR mark. TechCrunch covered it around the $100 million ARR mark. It took the company 18 months to double and it just hired a chief accountant. Smells like an IPO, yeah? The company declined to answer a list of questions from TechCrunch this week concerning its financial performance beyond what it shared publicly, but if our general point from above holds, we should see a huge check, or S-1, from Braze in short order. Unless it is cash-flow-positive.
We’ll see.