Based in Toronto, Laura Lenz is a partner with Omers Ventures, leading the fund’s technology investment activity in Canada. This week, more than 850 investors will join Collision from Home from major funds including Omers Ventures. Here, Laura discusses the changing environment for founders seeking funding.
Three months of global lockdown have had far-reaching effects on business. With no real end in sight, it is important for founders to understand an investor’s mindset during, and after, an economic shock.
Investors’ approaches will vary depending on their source of capital, the amount of dry-powder in their fund, and the pressures they face. Founders should understand how the metrics they are measured against may be shifting.
Today’s situation may be unprecedented, but we can certainly learn from historical financial shocks. Omers Ventures looked at the annual number of venture capital transactions and the annual dollar value of capital invested across North America between 2004 and 2012.
We also looked at public market valuation multiples for a group of well-established, blue-chip tech companies. Our goal was to see if we could find any correlation between tech valuations in the wake of economic downturns and, if so, how long it would take the market to recover to pre-downturn valuations. If you want to dig deeper into the data, my colleague has written a post about it here.
- Economic shocks precipitate a reduction in the average dollar size of venture capital financings
- There was a macro downward pressure on valuation
- Only the best-managed companies with the best fundamentals are able to preserve and increase their pre-downturn valuations
- Revenue multiples tend to fall off a cliff
- After the 2008 crisis, some businesses did not see a return to pre-2008 multiples until 2016
We have been in a 10-year bull market. The data tells us that we can’t simply look at a two-year horizon to get us back to where we were this time last year. But, there is still a lot of capital available and investors will be under pressure to deploy it. If you are a company with solid metrics, you will have options in this downturn and a much larger available talent pool as you continue to build your business.
“If you are a company with solid metrics, you will have options in this downturn and a much larger available talent pool as you continue to build your business.”
Measure what matters
At some point over the last 10 years, our industry started taking big bets based on something other than the core economics of a business. Investors are renowned for chasing ‘pattern recognition’, but it’s hard to pinpoint exactly when profitability stopped being part of the pattern we seek. According to Seeking Alpha, over 80 percent of the IPOs in North America in 2000 and 2018 were for unprofitable companies. This number dropped dramatically after the market correction in 2003 (to 45 percent) and in 2010 (to 40 percent). It stands to reason that the effect of this current shock will be similar.
CAC/LTV ratio: A business only makes sense if the lifetime value (LTV) of a customer is at least three times greater than the cost of acquiring that customer (CAC). However, typically this CAC calculation only includes sales and marketing costs. A more realistic metric would include other expenses in the business, such as R&D, operations and general admin. Founders who’ve started their business in the last decade have only ever known a bull market. They have likely been pushed by at least one investor to grow at all costs, with blatant disregard for profit. ‘Buying’ growth is not good growth.
“At some point over the last 10 years our industry started taking big bets based on something other than the core economics of a business.”
Naturally, we are still interested in investing in companies that have demonstrated 100 percent year-over-year revenue growth. But now, we are more conscious of how much capital they have burned to generate that growth rate.
Revenue per employee: Offers a true view into the health and efficiency of a business, especially in software companies. In publicly traded tech companies, the average revenue per employee is US$480,000 per year. According to a KeyBanc Capital Markets SaaS Survey, $139,000 is the median annual recurring revenue (ARR) per employee for businesses over $5 million in ARR.
It’s easy to automatically jump to ‘we need more people’ when addressing challenges on your growth journey. Having a firm eye on revenue per employee will help you keep that knee-jerk response in check, and explore the option of using technology to solve your challenges.
Showing your true colors
It’s important to reflect on what you want from your investor. A good investor is going to be actively engaged as a board member of your business. You want to be sure they will give you energy rather than act as a drain.
When doing your diligence on an investor, speak to other founders in their portfolio companies. Ask the investor what they can contribute beyond just a cheque. Do they have a strategic eye on the business? Do they have operational experts you can draw on if you need them, or networks to assist with recruiting talent? Can they help you secure additional funding when it comes to raising capital at the later stages? You also want to figure out if you will be pressured to exit your business for reasons relating more to their fund cycle than your long-term goals.
“It’s easy to automatically jump to ‘we need more people’ when addressing challenges on your growth journey.”
It has been really interesting to see founders adapting to the challenges of the last three months. I’ve been drawn to companies who have jumped in to trial new products or services. Seeing how founders react under these circumstances has answered the questions I always ask when meeting companies:
1. Does the company have an intimate knowledge of its customer base – pain points, personas, financial situations?
2. Can the management team identify new opportunities and innovate quickly?
3. Does the company have the resources to bring a product to market rapidly?
4. Can the management team make decisions to reallocate resources in a timely manner?
5. Do customers see immediate time to value and convert to paid, or do they have potential to churn early?
6. Are product deployment and integrations seamless?
7. Can the company build their top-of-funnel at a low customer acquisition cost?
Think about ways you might be able to demonstrate some of these, especially if you have had challenges along your own growth path.
We’re all trying to figure out how to make the right decisions when we can’t meet in person. Such a significant part of venture investing is belief in the founder gained through a relationship built over time. It doesn’t mean it can’t be done in the virtual environment, but it does mean the more connections we can make at events like this, the better. If you think it sounds like we might have some common ground, get in touch!