Investor demands for profitability catch tech companies flat-footed

Shares of DocuSign are off 25% in pre-market trading today after it reported earnings last night, pushing the value of shares in the e-signature company under pre-COVID levels.

Given that the market is valuing DocuSign at a cheaper price than it did in early 2020, you might think that it is struggling. Hardly. Coming off a huge period of pandemic-fueled growth, DocuSign posted 25% in top-line expansion in its most recent quarter, with revenue coming in at $588.7 million, around $7 million ahead of street expectations. Even more, the company’s growth target for its current fiscal year brackets investor expectations.


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Confused by DocuSign undergoing such a sharp repricing after reporting better-than-expected trailing growth and in-line guidance? Don’t be. DocuSign has committed the new cardinal sin of technology companies: losing more money as growth slows.

As market mania fades from 2021 highs, investor expectations are changing rapidly¬†and it’s catching a host of technology companies flat-footed.

The shock of the end of the growth-at-all-costs era is not merely a shift from a preference for revenue expansion toward profitability. No, many tech companies are currently navigating a deceleration to their more natural rate of growth, while profit demands are rising. It’s hard to retard a growth deceleration while also making more money, but that’s what investors want. And signs abound that it’s not going well.

Pivot to profits

DocuSign’s quarter included free cash flow of $174.6 million, up from $123.0 million in the year-ago period. But at the same time, GAAP net income got worse at the former unicorn:

GAAP net loss per basic and diluted share was $0.14 on 200 million shares outstanding compared to $0.04 on 194 million shares outstanding in the same period last year.

That’s a no-no.

Tech companies are racing to avoid the same fate. The pivot to profitability — really the pivot to losing less money — is in effect around the world. A few recent bits of news make our case:

  • Quick-commerce company Gorillas raised $1 billion in Q4 2021. Now it’s cutting costs and may exit certain geographies. The Q-commerce market, in general, is in retreat, despite recently being one of the most rabid and aggressive fundraising niches among startups.
  • Stitch Fix, a former startup that went public during the pandemic, is cutting 15% of its salaried staff after its losses roughly quadrupled in its most recent quarter.
  • Coinbase, Redfin and Twitter are not only halting hiring but yanking extended job offers. This is the corporate equivalent of investors pulling term sheets, a move that is generally considered reputational suicide.

If we extend our time horizon, the list is far, far longer than just that handful of examples.

What does this mean for startups?

The problem that changing investor expectations presents for startups is the natural tension between growth and profitability. The more of one you have, the less of the other you generate. So if a company is working to conserve profitability, it does so at the price of slower growth. And as it boosts growth, it will tend to spend ahead of gross profit, leading to worsened profitability.

Startups were valued in recent years on the pace of their revenue growth. This means that many private companies in recent years maxed out spending to chase new revenue, running deficits that in hindsight are terrifying. How much burn are we talking about? We have more coming on this matter Monday, but let’s just say that burning $10 million per month wasn’t even possible in prior venture cycles; a lot of companies spent wildly and inefficiently during the pandemic, and they won’t be able to pull the brakes all at once.

This means that startups that want to or need to raise more capital in the next year or so are stuck with a devil’s bargain. DocuSign shows that even hitting “the plan” won’t cut it with investors today if losses are scaling. Startups are going to have to thread a very small needle indeed to defend their valuations in the near term if they are not sitting atop a pile of money.

The good news

TechCrunch has reported that while the market is messy when it comes to technology valuations, there’s good news on the customer demand front. Both GitLab and Salesforce showed that there is still a lot of demand for at least a chunk of the software market. This means that growth won’t be impossible for startups in today’s technology market. Sure, sales may get a bit more difficult, but instead of the market sweeping the legs out from underneath companies, it’s more changing investor sentiment that’s causing the headaches today.

For startups with lots of cash, then, things are somewhat OK. Not amazing, mind, but all right. Startups that have more than a year or two of cash in the bank can keep spending to secure market share while their competitors are in a defensive posture. Smaller private companies actually have an edge on their public rivals in this area. How so? Big companies get graded daily and quarterly by investors for their trailing results. This means that public companies have to endure every market bump, divot and wobble.

Startups, in contrast, are repriced far less frequently and can delay new valuation marks by simply not raising more money. Having cash is not simply what startups need to survive — it’s a possible ticket to thrive. While other companies are pulling back on hires, startups rich with cash can bring in new employees. Startups with lots of money can also buy smaller companies that lack liquid funds. You get the picture.

Startups don’t make money by design. They spend it to grow at unnatural rates, allowing them to capture new markets that they can later milk for huge incomes. This is the result that everyone in startups and venture capital wants. It’s kinda shit for startups that macro conditions have kicked over their milking pail. But that’s business, period. And for the lucky startups that did raise too much last year, they are oddly well positioned to survive, and perhaps dominate, thanks to everything going to hell for public companies and their cash-poor rivals.

Call it the have-not technology market.