The economy underwent a huge transformation as the country adjusted to a new way of life according to the unwritten rules of a worldwide pandemic. And just when we thought things might start to settle down, it is shifting again. For companies and investors, one of the most significant of those changes will be the disappearance of the revenue multiple.
A revenue multiple measures the value of the equity of a business relative to the revenues that it generates. It’s the idea that companies can trade based on revenue and not on profit. Simply, it is a metric used often during times of excess money—times in which we recently experienced. The incredible amounts of money that went through the market over the past few years and the resulting high valuations created more strategies based on revenue growth only.
In the first quarter of this year, companies with high revenue growth, unique technology or customer list have closed deals based on 5 to 6 times revenue. Most of these companies had minimal infrastructure and/or no earnings. This is how valuations and sales have been going. But times are changing …
Today, with all that is happening in the economy, a much-needed shift is occurring in trading. This shift is taking us from a prioritization of revenue to a prioritization of profit. The result? Creating a dramatic drop in value for thousands of companies throughout the country.
Is the Past Repeating Itself?
The current changes in the economy are not unlike the events of the Dotcom Boom that occurred in the late 1990s. During that time, the popularization of the internet led to a massive swell in the stock prices of technology companies. In 2000, the bubble burst (as it generally does) and certain technology companies saw stock prices plummet before their eyes, causing several to close their doors permanently.
The Dotcom Boom had a variety of causes. One of them was obviously the popularization of the internet, but there were several other external factors that created the intense drop in capital. To begin, the years prior to the burst saw record-low interest rates, adding to the public’s ability to spend. Once the utility of the internet was realized, investors rushed to the stock market, eager to invest in the new technology.
There was also a sense of extreme pride in helping these companies cultivate the future. And with low interest rates, investors invested millions in startups with no track record and, sometimes, not even a business plan. Right or wrong, these startups somehow made it to the stock market where the public was able to invest in them. And it made sense that what followed was the increased valuation of many tech companies. But when it all burst and those companies went under, thousands of people who believed in the future without worrying enough about the present lost everything.
The Economy Today
What we are experiencing today is eerily similar to the Dotcom Boom, but there are some key differences. Leading up to the pandemic, interest rates were also very low, and money was being poured into the economy in the form of stimulus checks and PPP. People were spending their days at home, and not spending their money on vacations or expensive dinners or concerts. And for those who were fortunate enough to keep their jobs during the pandemic, it was time to invest. Yet, other factors were brewing that would impact it all.
We saw the Great Resignation, where millions of American workers voluntarily left their jobs in search of better pay and working conditions, creating a labor shortage we haven’t seen in decades. Now, thousands of companies across the country desperately in need of labor are paying more to get new employees in and to keep the ones they have. This trend is ongoing and is unlike anything the U.S. has ever seen. We have also seen supply chain issues like never before—delays and empty store shelves, leading to skyrocketing prices for what is available.
With all types of companies feeling the pain of the labor shortage and the supply chain challenges, the economy has been affected at nearly every level. After all, less labor means less revenue and less revenue means less profit, putting many companies at risk in future valuations. Additionally, as interest rates inch upward in the government’s attempt to curb the record inflation, consumers are becoming more conservative with their money.
Shifting to Earnings and Profit
While this shift in the investment world will undoubtedly cause increased inflation as companies raise prices to make profit, it’s a shift that must occur. We must focus on earnings and profit rather than revenue. With decreased spending and no solution for the labor shortage in sight, CFOs are challenged with making the numbers add up and are finding it increasingly difficult to pay the bills. And if they do not have the books and records in order to know what the profit is, it will be incredibly difficult to manage through this valuation shift.
Understanding what causes these fluctuations and shifts, and comparing them to instances of the past can be beneficial to navigating economic changes in the future. Thinking about how your company is able to address the issues at hand may be the key to avoiding going under as the market experiences yet another crucial shift.
Barker Associates provides strategic guidance and outsourced CFO services to companies of all sizes. We can provide the higher level of strategy your company needs to grow, including advising on systems and process updates. If you need assistance, or have any other questions, please click here to schedule a 30-minute consultation at a rate of $100.
Finding the right investor, who is interested in your company and you, begins long before you actually may need money. Preparations include thinking about businesses that investors want to invest in and then modeling yours accordingly, maintaining up to date financial data, and building a strong consumer base. Once you’ve made the decision to search for capital to grow your business, you create two pitch decks (yes two), and the clock is now ticking. Your goal should be to secure funding within three months from making this decision. And the best way to do so is to have targeted contact list.
First, Some Introspection
Before you can ask anyone for money, you should first ask yourself some important questions. First and foremost, why are you raising money? Be very clear as to why you are doing so, why now is the time, and what the funds will ultimately do for your business. These answers should be weaved into the fabric of your business’s story and included in your decks and any accompanying materials you may present to potential investors.
You should also do a check on your core values. Are they aligned with the company’s vision and mission? Are they still as relevant as when you developed them? Are changes needed? Only when you are confident in what you stand for can you try to find someone who shares …
Who Should be on the List?
Your targeted list may include any combination of some or all of the following: family and friends, angel investors, angel groups, venture capital firms, private equity firms, and corporate investors.
Gather data by performing research on Crunchbase or Pitchbook, and simply networking with others. You should identify vertical industries to see what is happening there. Startup accelerators are also an invaluable resource. Follow groups on social media to see what they’re talking about and what they’re interested in.
Keep in mind that you are not just looking for money. You are looking for someone (or a group) who shares your values, will be excited about what you offer, and who fits with what you do and who you are. Identify who has money and is actively investing.
Factors to Consider in Building Your Contact List
Industry. Who is investing in your industry? Why? Is there some personal connection or is it just about the potential profit? Note that those interested in one particular type of industry often have a background, experience, and connections that can help your business.
Location. Some investors want to be close to the businesses they are investing in. Others give preference to local startups. It’s important to understand if this is a priority for them.
Amount. How much do they typically invest? Some may invest only smaller amounts than what you are looking for, whereas others may invest amounts that are larger that what you need. Ensure there is a good fit.
Longevity. Are they looking for long-term or short-term relationships? Will they be involved for your next round of fundraising or will they want out before then?
Track record. How many successful exits do they have? How many businesses they’ve invested in have failed?
Value. What value do they bring? Investments into a venture are rarely just about money. Do they have operational experience? Industry experience? What are their connections and network? Will they provide advice based on their knowledge and experience? All of this will factor into how quickly you scale.
This process is about targeting the right types of investors, focusing on quality over quantity. You want the best fit to bring the most value. As is with much in business, and life, it is about networking and cultivating relationships.
Once you’ve identified some strong potential investors, gather as much contact information as possible, including email, social media accounts, website, phone number, and address. Understand that they will want to see your pitch deck to determine if it is a good fit with their investment thesis before moving forward. Being prepared sets the right expectations from the start.
Your list should be an ongoing concern. Contacts will fall off and new ones will be added. By keeping it up to date, you can ensure that you will be ready for each round of funding in the future.
Your most limited resource is your time. And the time you spend finding investors is less time you have to focus on operations, marketing, or sales. Protect that time fiercely by targeting the right investors from the start. With increased focus comes increased efficiency and clarity on what and who you really need. You may need to talk to 100 or more contacts to get some interest, but you don’t want it to be thousands. That’s where your targeted list comes into play. So you’re not spending too much time and energy and burning out before the right person comes along.
Ultimately, if you need money for your business, you need people to pitch to and the more targeted your list, the more possible yeses you’ll have, and the greater ROI on your time.
What do making your bed and pitching to potential investors have in common? According to Admiral William McRaven, in his book, Make Your Bed (available at Amazon.com), it’s the simple steps, taken each day, that achieve great results.
To better link these two seemingly unrelated activities, consider this: Chief Executive and Financial Officers may feel overwhelmed by the need to focus on daily tasks and raising capital. But by executing a simple task, such as making your bed each day, the tone is set for the rest of the day’s attitude and accomplishments.
Combine the responsibilities of a C level position with the priorities of kicking off a new year, and CEOs and CFOs may lack the required focus to also prepare to meet with potential investors. I suggest you personally implement one to two simple habits successfully, then move on to other new habits. The success of achieving even simple changes will reinforce your mindset for success.