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If this is your first market drop, you may be especially confused by the conflicting advice that results from such an event. For some, the sky falls and you have to change models quickly. For others, the meadows are green and you have to take advantage of the weakened landscape. Which one you are depends on what the data tells you about your business.
Right now, the data from the venture capital world may feel bleak: Global VC funding fell 33% quarter-over-quarter in Q3 2022. SaaS, in particular, has seen ratings slide since early 2022. However, not all companies are created equal.
The fall in valuation was steepest for companies that were not focused on their data, especially their unit economy. In that unity economy, you will find out whether to weather the storm or attack the market to expand your dominance. Either way, the decisions you make now should be deeply rooted in your unit economy.
Related: The Top 2022 Trends Affecting the Financing and Growth of SaaS Businesses
The pendulum swing
We have all benefited from larger funds and higher valuations. A rising tide lifts all ships; unfortunately, that includes the leaky. The abundance of available capital meant that companies that performed at moderate and low levels from an efficiency perspective could still grow rapidly. In some cases, investors forced companies to take more risks and bet on future growth, sacrificing efficiency and certainly profitability.
Those days of “growth at all costs” seem to be behind us. As markets fell and capital tightened, financiers began to scrutinize their deals more closely. They are now looking for companies that demonstrate the basics of running a scalable SaaS business, featuring efficiency and a strong path to profitability.
The stats that matter
To be clear, SaaS businesses can’t survive without growth – dominating your space requires that. But growth can no longer come at any cost, and companies must adopt certain fundamental metrics to support faster growth. SaaS companies should follow dozens of statisticsbut to attract investment in the current market, companies need to address their efficiency metrics, especially:
Gross retention, targeting 90%+;
Net retention, targeting 110%+;
Gross margins, with a 75%+ target;
Purchase cost (CAC), with a payback period of <2 years
Achieving these efficiency metrics will help companies maintain or exceed their valuations. If you’ve already achieved these metrics, you’ve earned the right to talk about putting in more capital in exchange for growth. If you’re not, consider slowing growth and redirecting your strategy, especially if capital is tight.
Related: Four Ways to Make Sure Your Business Will Survive a Market Drop
Cost of capital without efficiency
The higher cost of capital can be incredibly expensive for companies buying time to achieve efficient growth. In addition to tightened funding requirements and low valuations, investors are placing more funder-friendly structures in deals with less fundamentally sound companies, including liquidation preferences, voting rights and even board control to reduce their downside risk. In fact, late-stage overly flawed companies may struggle to find financing on acceptable terms and may need to explore an exit or consolidation. But those who want to try it and buy time to see better stats have options.
What can leaders do now?
Start by researching your business fundamentals and assessing the efficiency of your key operational teams, then adapt them to reduce inefficient spend.
Sale: View metrics such as pipeline-to-bookings ratio (with a 4-5x+ target) and average sales quota achievement (with a 65%+ target). This information will focus your efforts and help you find breakthrough improvements before simply growing your sales teams without correcting underlying issues.
Marketing: Focus on efficiency metrics like your cost per opportunity for each channel and over-invest in well-performing channels.
Product teams: Consider tracking efficiency against a productivity benchmark and monitor user-to-issue ratios. You can invest more in customer features and platform stability over new builds to increase retention and enable higher conversion upsells.
Customer Success: Research the retention rates in different customer segments to understand the strengths and weaknesses of your customer base. Optimize your overview of rep ratios between companies and customers and consider customer Net Promoter Scores and other sentiment metrics.
As you adapt, you may need to downsize your teams and size your business. It’s an unpleasant reality, but you need to fill in any cracks in your ship before renewing your drive for growth. This can help you control your burn rate and save the time it takes to convince an investor that you are on your way to efficiency.
Related: 4 Tips To Keep Your Business Afloat In A Downturn
Where is the financing?
Valuations are unlikely to reach the 2021 numbers, but companies with strong fundamentals will find funding. Companies that correct their fundamentals and need to buy time with capital will encounter tougher markets. So, where else can you go?
Start with your current investor base. They have as much to lose as you do, and in the case of venture capitalists, they have often allocated “dry powder” for situations like this. They may also behave more moderately, as poor valuations and more structure often hurt their previous positions. Another way to avoid a short-term downturn is to raise through convertible bonds.
If equity is not an option, rising interest rates have made debt providers more active, creating an opportunity to explore debt financing. If it’s available to you and makes financial sense, using debt can help you raise non-dilutive capital that can save you time to achieve better efficiency metrics. Timing matters, however, as the debt market can fade quickly if monetary policy changes further.
Financing silver lining
Companies that straighten out their operations and control their combustion for the next year can find a funding pool at the end of the proverbial rainbow. Funds with charters to invest in private technology companies are pushing the troubled market to the sidelines. As the market improves, funds will further open their checkbooks to companies with healthy efficiency metrics.
Valuations may not have fully recovered by then, but companies will continue to increase with good multiples if they show solid fundamentals and maintain healthy efficiencies alongside growth rates. These companies are best prepared to contain the falling wave and catch the rising tide again.