Why Billion-Dollar Valuations Don’t Matter

In the last few years, there’s been a massive decoupling between private and public markets. A Goldman Sachs report shows that since December, five of the seven most recent IPOs for billiondollar startups came in at valuations equal to or below their pre-IPO valuations.

One of the most concerning bi-products of this decoupling is the migration away from focusing on underlying business metrics toward total and utter valuation optimization.

Let’s take Slack for example. No one would argue that their pivot didn’t work or that it’s not a fantastic product with lighting fast adoption (OpenView is an avid user). But, you’ve got to be a little skeptical any time an SaaS company is valued at 100x, even with an amazing product and opportunity.

Consider the following: At last check-in, data suggests that Slack has a $25 million run rate. Assume the company were to grow 100 percent for each of the next three years. At the end of three years, Slack would be a $200 million company. They’d surely be able to go public.

Now, apply the most aggressive SaaS multiples afforded to companies like Workday and ServiceNow (between 13 and 17x); Slack’s public market valuation would stand anywhere between $2.6 and $3.4 billion.

Embedded in my very simple analysis are a couple of major assumptions that may or may not hold true. For starters, my simulation assumes that Slack doesn’t raise any more money (which, if it does, would mean more dilution for all shareholders).

Secondly, it expects that current market multiples persist. And lastly, and most importantly, my calculations presume that Slack goes from $100 to $200 million in just one year.

By any measure, this scenario would be a total outlier, yet the last two investors would presumably see no return over a period of several years.

And this all assumes that the company would be able to maintain its best-in-class economics, which is a big assumption — scaling is very hard.

Someone actually has to be held responsible for the massive valuations we read about on a near daily basis.

It’s pretty clear that we’re currently in the frothiest funding environment since the late 90s. And all the cheap capital floating around has made it easier than ever for startups to raise funding — in just the first 100 days of 2015, we saw 16 newly anointed unicorns.

Dont get me wrong; cheap money is great for entrepreneurs looking to scale their companies. But the reality is that along with the money comes a huge responsibility to investors and employees alike to build large and enduring businesses. Someone actually has to be held responsible for the massive valuations we read about on a near daily basis.

My good friend, Eric Paley, hit the nail on the head when he said, “Raising a big round because your competitor just did, essentially keeping up with the Startup Joneses, is an all-too-common waste of time that can cripple your company.” This phenomenon of constantly raising money is distracting startup founders from the metrics that really matter.

The unfortunate downside of today’s environment is that many of the companies raising huge amounts of capital do so well before they’ve hit key operational milestones. And relatively free capital means companies aren’t forced to make the hard decisions required to build sustainable businesses.

Qualtrics’ Ryan Smith put it best when he said, ”Congratulating me for raising venture capital is like congratulating someone for taking out a mortgage.” Rather than talking endlessly about sky-high valuations, we should refocus the conversation on the metrics and milestones that actually determine the value and potential of a startup.

More Than 60 Percent Of Sales Reps Hit Their Quota

Early in a company’s development, they have the tendency to successfully hire one productive sales rep, a few mediocre reps and a few under-performers. It’s very hard to constantly push your sales team to perform and hit their quota on a quarterly basis, yet sales expense can be one of the largest components of operating costs.

The goal of every entrepreneur and VC for that matter should be to build sustainable and scalable businesses.

When companies grow quickly and are flush with cash, management teams are rarely forced to make the hard decisions around people and process. In fact, many VCs push them to hire faster. I recently heard a story about one VC pushing a company to drive their burn up from $1 million a month to $2.5 million.

Unfortunately, an inefficient sales force will always come back to bite you in the butt. We typically think of 60 percent as the benchmark for a healthy performing sales organization. Anything less and you dont have a repeatable model.

Your Sales And Marketing Payback Is Less Than One Year

This topic has been written about ad nauseam and was initially conceived by our good friends over at Bessemer. The key here is a simple notion that you shouldn’t spend more to acquire a customer than they are worth in their first year. Effectively, you are trying to measure product market fit.

Too often, we see companies acquiring logos for marketing purposes with the hopes of turning those flashy logos into profitable customers. That almost never happens.

Logo Retention Is Greater Than 85 Percent

We will get to net customer retention in a second, but without maintaining at least 85 percent logo retention, you run the risk of a leaky bucket; effectively every dollar you pour into the top of the bucket comes out the other end. And as you scale, and the size of that bucket increases, the leak grows even more problematic.

When the market turns, and it will, companies without negative churn will be turned into the proverbial emperor with no clothes.

Think about the difference between churning a few hundred thousand dollars per quarter versus a few million. Any slight negative change to that 85 percent retention rate coupled with a high burn can have a catastrophic impact on your company.

You Experience Negative Churn

This metric might be the most important over all others. It’s the basic notion of the dogs eating the dog food. If you’re unable to sell more product to your existing customers to offset churn, you’ve got a problem.

Ideally, after the first year, you should have negative churn (net retention = 100 percent) and ideally it should be 120+ percent. This is important because when the market turns, and it will, companies without negative churn will be turned into the proverbial emperor with no clothes.

The Time It Takes To Ramp One Sales Rep Is No Longer Than One Quarter

If you’re unable to ramp a sales rep within one quarter, there’s one of three things going on, all of which could be hugely problematic in the long run:

  • You’re not hiring the right reps and your hiring process is broken (many companies implement a systematic testing or scoring system to reduce variability in hiring).
  • You’re not training the reps properly and your training process is broken (one way to address this is to hire an outside group to conduct annual training at your sales kickoff).
  • You dont have enough leads to support new sales reps, which could mean you either have a broken marketing model or a broader market issue.

At the end of the day, it doesn’t matter how much money you’ve raised or what animal analogy you use to signify your company’s worth. The goal of every entrepreneur and VC for that matter should be to build sustainable and scalable businesses. The only way to do that is to focus on the metrics that truly matter.

The companies that nail many, if not all, of the above criteria will be the ones that make it to the finish line, and the balance will be wandering through the forest looking for someone to feed them.