Redpoint Venture - State of the Market '24 Report Review

This episode provides an in-depth review of Redpoint Venture's annual "State of the Market" report for 2024, presented by Ray Rike and Dave Kellogg.

1. The valuation of high-growth software companies has normalized to approximately ten times revenue after significant fluctuations.
2. Public market dynamics strongly influence private market valuations and strategies, especially in terms of fundraising and growth metrics.
3. The rule of 40 remains a consistent measure of SaaS company health, despite shifts in growth and profitability metrics.
4. Investment and valuation trends indicate a return to more traditional metrics and intervals between funding rounds.
5. Current market conditions suggest a cautious approach to investment, emphasizing sustainable growth and profitability over aggressive expansion.

1: Introduction and Background

Overview of Redpoint's annual general meeting and the origins of the market report. Includes insights into the structure and purpose of the report.

• Ray Rike: "We're diving into Redpoint's state of the market report today, a key resource shared at their AGM."
• Dave Kellogg: "It's a well-crafted deck that provides a high-level take on where the market is heading."

2: Market Trends and Analysis

Discussion of current market trends, including NASDAQ valuations and their impact on private SaaS companies.

• Dave Kellogg: "The public markets set the tone for private markets, influencing fundraising strategies significantly."

3: Growth and Profitability

Exploration of growth vs. profitability metrics and their implications for company valuations.

• Ray Rike: "Despite the premium for growth, there's an increasing focus on profitability in the market."

4: Funding Rounds and Investment Trends

Analysis of trends in funding rounds, including the intervals between rounds and the prevalence of down rounds.

• Dave Kellogg: "We're seeing a normalization in the interval between funding rounds, with a focus on growing into valuations."

5: Conclusion and Future Outlook

Summation of the episode's insights and predictions for future market conditions.

• Ray Rike: "The market is correcting itself, and companies need to adapt to these changes to thrive."

1. Monitor Public Market Trends: Keep an eye on NASDAQ and other indexes for cues on broader market sentiments that could affect your business strategies.
2. Emphasize Sustainable Growth: Focus on building a business that grows at a sustainable pace without sacrificing profitability.
3. Prepare for Longer Funding Intervals: Plan financial strategies assuming longer periods between funding rounds to avoid frequent capital raising.
4. Understand Valuation Metrics: Stay informed about how growth and profitability metrics affect your company's valuation.
5. Adapt to Market Changes: Be ready to adjust your business model in response to shifts in market dynamics to maintain a competitive edge.

Logan Bartlett, Managing Director at Redpoint Ventures recently shared the Market Overview Report they presented to their Limited Partners in March '24 at their AGM event at the Chase Center in San Francisco. Ray "Growth" Rike and Dave "CAC" Kellogg review the key insights during this episode.

People

Ray Rike, Dave Kellogg

Companies

Redpoint Ventures

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Dave Kellogg
Live from Schenectady, New York, it's SaaS talk with the Mettrix brothers, growth in CAC. And I'm growth, better known as Ray Reich, founder and CEO of Benchmarket. And I'm Keck, better known as Dave Kellogg, independent consultant, eir at Baldurton Capital and the author of Kell Blogger. And together we are the Metrics brothers. And we go together like Jolly and Roger.

Ray Reich
Ah, so we're pirates today, Mati. That's CAC to you, growth. Ruth. Well, some people call me because I'm Ray Reich, so I thought you'd like that. Whose ship are we boarding today?

Dave Kellogg
Ah, Mati, we're gonna be boarding the USS Redpoint. Logan Bartlett, a partner there, shared on x a great kind of state of the market deck that they use at their annual general meeting, or AGM. And I thought it'd be fun to highlight it and walk through it today. Well, shiver me timbers, we're reviewing a vc deck. We are, Ray.

But before we shiver raise timbers, we need to hear a word from our sponsor. SAS Talk is presented by Gainsight, the first digital customer platform, including customer success, management, product experience, customer communities and customer education. Find out why more than 1500 companies, including SaaS leaders like Zoom, Atlassian and Okta, and hundreds of early stage startups rely on gainsight to efficiently retain and expand existing clients through an integrated digital first post sales customer journey. Gainsight has affordable packages for younger companies and goes live in two to four weeks or less. Visit www.gainsight.com.

Ray Reich
Now back to the show. Okay, Dave, let's talk a little bit about the deck, where it came from and just kind of provide your initial high level perspective on the deck. Sure. How are your timbers doing, Ray? They still shivering?

Aren't you funny? You know that expression? I had to look it. Up it comes. It's obviously a pirate expression and it's from running aground.

Dave Kellogg
So when you run aground, the timbers of the boat shake. And that's so it's an expression of surprise. You're like, oh, we hit the bottom. Yeah. Running the ground is the perfect metaphor for what's happened to the sass industry the last two years.

Shiver me timbers, indeed. So this deck was written by a guy named Logan Bartlett, who's a partner at Red Point. They shared it at their annual general meeting. It looks like they have an advisory committee. If you see it on the title slide, it's about two months old at this point as we speak here on May 1, 2024.

Ray Reich
Okay, so I know one of the first things they shared was the Nasdaq value and what's been going on. But, Dave, I want to remind everyone. We don't provide investment advice. Yeah. Once again, we're going to be talking about things related to valuations in stock and listen to our end of episode disclaimers.

Dave Kellogg
But, yeah, we don't give financial advice. But we'd like to look at this because the public markets set the tone for the private markets. And if you're a private company, as most of the companies Ray and I work with are, these numbers eventually reflect on your fundraising strategy. So on slide two of this deck, he just highlights the Nasdaq since February 19. And he went through February 24 because this report is about two months old, and he had Nasdaq at 16.

Ray Reich
Oh, 92. It's down a little bit today, Dave, here on May 1, when we're recording this, I think it's like around 15,900. So it's down about a little over 1% right now. All right, cool. Yeah, so.

Dave Kellogg
So that's probably the slide that's most vulnerable to the passage of time. You know, overall, I like this deck. At first. I think it's a well made deck for metrics. Let's just comment there.

It's got one chart per slide. Typically when there's two, they both need to be there. It makes simple points. So just as a piece of work that presents numbers, I actually think this is a pretty good deck. The other thing I'd say is provides a nice high level take on where the market is, which we're going to talk about in a minute.

And I'll just jump in here, Ray, and lead us off here. I'm on slide four in the deck, which talks about high growth cloud software multiples. And what he's showing is that basically, if you go back to February of 2019, high growth software companies are typically valued median valued at ten x revenues. At the peak of the craziness, they were valued at 25.1 x revenues. And then as the roller coaster hit at the trough in December of 22, a little less than a year later, we were down to 7.2 x.

And that's not a median for all software companies. That's a median for 30% plus growers. So that was a heck of a ride down there. And the answer is, we seem to have bounced back to normal levels here. The slide doesn't go back far enough in time to really give you a real sense of history.

But I think that high growth software companies are typically valued around around ten x. I think just all growth software companies are typically median valued around 6.5 x. So I do think we're back to normal on valuations. I agree. And I wanted to highlight, you mentioned that 6.5 x at median, and we talked about this during our pre recording episode.

Ray Reich
And that is we're still not paying for low growth though, because those companies that are growing less than 15% per Jammin balt. Did I pronounce it right? Jameen? I think it's Jameen. We looked this up on pronounced names.com.

Dave Kellogg
Ray. We know how to do this. But if you're growing less than 15%, that multiple is 4.2 x on forward looking revenue next twelve months. So the market still is paying a premium for growth, Dave. Yeah, absolutely.

And you can see it just in these multiples. Ten x to me is always I'm a little bit old fashioned, but I view that as a rich valuation for a software company. And the reason you're getting it here is because you're a high grower. So let's move on. By the way, median growth rates I think are around 11% in the software business.

Just to give you an idea of how good these companies are, I think the median companies growing around eleven and these are the people who are growing 30 plus. So let me add something to that. Dave, please, because I know a lot of times we're talking about we're returning to normal, right? Not in the Zurp era. But I also did a little additional research on median growth rates back in 2015, 1617.

Ray Reich
I did just want to highlight it even back then for public companies. And median growth rate hovered around 30%. So even though we've reverted back to median multiples, we sure are not back to historic median growth rates for public companies. Yeah, and I'm guessing we'll get to it in two slides. I'd love to know what the median free cash flow was back then too, because it's going to take us to the rule of 40 conversation.

I'm growth, I only worry about growth. Okay, fair enough, says the former sales leader. Now let's talk about the relative weighting of growth and profitability. This is a topic we talked about in our episode on the rule of X from Bessemer, or what software equity group Seg calls the growth weighted rule of 40 score, where you basically take growth and weight it two to one relative to profit. In calculating rule of 40 scores, the increasingly popular way to look at one way to look at that kind of metric, it's not the exact same thing, is to do a two factor regression and look at the relative power or weight of growth relative to profit.

Dave Kellogg
And as talked about in the prior episode, in the peak at around August 2021, growth was eleven times more important than profit in determining valuations. At the trough, it was 2.2. And it typically hovers between two and 2.5, or actually between two and three. I think if you will pick a single number, people go 2.3. I personally just use two.

I use the software equity groups weighting. But in any case, what you see when you look at the chart five here in Redpoint is that the relative importance of growth to profit has come back to normalcy once again, running between two and three and down from the crazy peak of eleven. And that's on slide five of the deck, the red point deck we're talking about today, it shows the 2.9 premium on revenue growth versus free cash flow. Markman but Dave, I look at slide number six of the deck, and that's showing growth rates. And I don't know if it's premature, but can we talk a little bit about the trending of growth rates versus FCF?

Sure. This is the most interesting slide in the deck, in my opinion. Ray, this slide, slide six, basically shows median growth versus median free cash flow from March 2021 to today. And just to make it easy for those not looking at the chart, in March 2021, the median growth was around 25%. The median free cash flow is around five companies have basically, this is Maritex data.

So these are public SaaS companies. These companies have kind of reconfigured their profile from 25 five to 1414, meaning that the median revenue growth is 14% and the median free cash flow is 14%. Now, the interesting thing about this chart, so you imagine two lines just converging on 14. They start out once at five, ones at 25, and they come together at 14. The interesting thing here is the rule of 40 score basically doesn't change.

25 plus five is around 30, right? These numbers are approximate. 14 plus 14 is around 30. Let's just say it's close enough. So the rule of 40 score effectively has not changed, which is interesting, because if you think rule of 40 is a predictor of value, it means valuation, multiple should not change, which, by the way, they haven't.

I think if you go back, there's a lot of up and down along the way. But the interesting thing here is, if you're a believer in the rule of X, that this is a worse profile. The rule of X score starting is two times 25 plus five, which is 55. And the rule of X score today would be two times 14 plus 14, which is 42. So if you believe that growth is truly more valuable than profit, and you use either the rule of X or a growth weighted rule of 40, the industry has basically reconfigured itself to be less valuable, which I find pretty amazing.

Ray Reich
I still cannot get my head wrapped around this because slide five shows that growth is value, and they say here 2.9 times higher than free cash flow. But then the next slide, which shows that growth is down from 25% to 14%, but free cash flows up to 14%. Have we, as an industry, over rotated to profitability because we thought that was Wall street wants. However, simultaneously, Wall street is still paying a premium for growth. It seems incongruent to me.

Dave Kellogg
Yeah, the mystery of Mister market, I guess I can't explain it. I think I could just observe it that. Look, if you believe in growth weighted rule of 40, these companies are worth less than they started out in terms of revenue multiple, because they've reduced their rule of x score, their growth weighted rule of 40 score. So I can't explain all of it. I do think some of it, Ray, look, cash flow went from 5%, which is almost nothing, to 15%.

And I think some of it might just be absolute values. I remember at some point, Ray, we saw that, provided. I can't remember what it was, but provided your free cash flow was above x, growth got rewarded. Remember that chart? It was in some prior episode.

That's what I feel like when I look at this, that the market's actually saying, hey, provided your free cash flow is above ten, then we're going to value you on growth. And if it's not, we're going to punish you. Maybe that's what's going on. Dave, that's really good recall, because that was another maritech capital chart from many episodes ago. And the maximum enterprise value to next twelve months revenue multiple was for companies that were 30% or higher growth in between ten and 20% free cash flow margins.

Ray Reich
But at the same time, the market started penalizing companies that had a free cash flow margin over 20% because they didn't think they were reinvesting in growth. Yeah. All of life is not a linear regression. Sometimes other things come into play, much as we might like it to be. The other one you found, Ray, I don't know if you talked about this already or is in the warm up, but the breakpoint on Jameen Ball's data on enterprise value to revenue as a function of growth actually, yeah.

Yeah. And in fact, just so in cloud of judgment that Jamie does, it's great and he does it weekly. But if companies he considers high growth 27% and above versus 30% in his deck, so very close that the enterprise value to the next twelve months revenue multiple is 11.0 for 15% to 26% growth, we're still paying a ten x multiple. But if you're less than 15% growth, that median multiple is only 4.2 x. So we are really punishing low growth as defined as less than 15% x.

Wow, 15%. So, as usual, Ray, I can't see the timer on my computer. I don't know why. I never can. So you're going to have to keep us honest on time.

Dave Kellogg
I'm going to move through to slide seven here and just say, this is another Jermeen ball slide that the red point guys took for their deck. And it basically says, and I like to just remind people of this, you know, if you feel like it's tough out there, it is. This slide is showing median net new ARR growth year over year. And in Q 221, the median was 71% net new ARR growth. Wow.

It's just been in a kind of monotonic dive since then. It goes by quarter 534-5229 negative ten, negative 14, negative 27. And then it bounces in Q one of 2023. It comes up to negative ten in Q two of 2023, up to 1% in Q three. And I think it's not on this chart, but it goes back down to negative ten.

So it has been a rough ride down. I think we may have gotten what I think they call a dead cat bounce. So we had a little bit of a bounce, but we didn't come all the way up. So I think it is tough out there. Driving growth is hard.

Ray Reich
It is very hard. But I've seen a couple of Wall street analysts predict that Q four is going to be the magic turning point. But I also heard people saying that was going to be Q three and Q two six months ago. So if growing is hard, Ray, let's talk about something else you like to talk about, which is also hard, which is making quota. Yeah, let's talk about that before we actually talk about the time between rounds.

But let me just go to that, because I believe that slide eight of this deck and what it shows is quota payment by quarter for software sales reps. Back in Q 420 21, 53% of people were making quota Q four of 2022, which was when we really hit the middle of the sassacre, only 23% of reps were making quota. Q four of 2023, we were all the way up to 29%. And they say in this report, and it says the source is bravado network, we're up to 41% of sales reps are making quota. But I question it because the number one.

I don't know the methodology, but having set quotas for 25 plus years, q one, quotas were always lower. I ramped them as the year went up. So my belief here is this is selection bias, because the lowest quarter of quota is almost always q one. It's a good point. They're comparing three years of q four, and q four is typically the highest attainment quarter.

Dave Kellogg
So those numbers are actually quite scary. If this is enterprise software, you might get 40% of your year in the last quarter or more. And they're showing pretty dismal, I mean, very dismal attainment of 23%, 29% in 2022 and 2023. And you're right, it's non comparable. You can't compare three q four s to one year to date.

And by the way, it's not even year to date. It has to be q one. Nobody reports quota table by week. So we should actually dedicate an entire episode to quota attainment. Because I think what we've done as an industry and the bridge group just came out with some great new benchmarks for private SaaS companies.

Ray Reich
I think we are shooting ourselves in the foot with the way we're allocating quota and burning reps out. But that's a whole other topic. Yeah, and rep view is also producing some pretty interesting data about that as well. So there is good material to discuss there. Ray, I gotta leave it on you to remind us to get that on the list for a future episode.

Dave Kellogg
I think it's a great topic. We still got about five minutes left, so let's go to funding trends. Yeah. So on funding trends, there's a couple of things. This chart, this deck shows on slide ten, they're showing the interval between.

Between rounds measured in months. And the pattern of the chart is basically, I'd say that the norm. Well, I believe the norm here is 18 to 24 months, frankly, and I derive that from first principles of, hey, it's kind of a pain in the neck to raise money. So you don't want to do it much more than 18 months, right? You want to go at least 18 months before you have to go out and raise money again, because it's often a six month process.

So, you know, if you're raising money every twelve months. You're almost in a constant fundraising mode. Or the market's so crazy you can raise it very easily, which is what I think happened in the past few years. But I'd say the traditional norm on fundraising is you raise around it should last you two years and you're raising money every 18 to 24 months. Grosso Moto and this chart actually brings the data starting in 2018.

I'm just going to read some numbers to you. So it starts at ten months, then goes up to 14, then up to 18 and down to 17. Then during Zurp craze, it's down almost in the single digits, 1139 in the second half of 21. And since then, it's kind of been building slow and steady from 912 15 1921 22, getting back to be what I consider to be the normal between fundraising rounds. In fact, my rule of thumb used to be you can always guess someone's burn rate by dividing their last round by eight.

That was one of my many hacks. So if they raised $60 billion, you could assume they're burning 2 million a quarter because they want to make it last two years. And that pattern was not valid during the Zurp era. But I think we're coming once again, kind of back to normal. But there is a silver lining in this dark cloud of having more time between rounds, and that is you don't have the raise as a down round.

Ray Reich
So can you talk a little bit about what the deck says regarding percentage of rounds that are actually down rounds right now? Yeah, let me just address the thing you said, because I think there's a couple of things, but the extension is, in my mind, a good thing because you're fundraising less often. It's also potentially a bad thing, which is you might want to raise money now, but you can't. Right, because valuations are down and you'll have to do a down round, as we'll see in a minute. While down rounds are increasingly common, people still don't like them.

Dave Kellogg
So some of this, I do believe, is down round avoidance. That is put more positively growing into your last round valuation. And people do that by reducing operating expense. They do it by taking debt is another popular strategy. They do it potentially by doing an inside extension round.

There's a number of ways to try and basically grow into your last round valuation before doing a new round. And those are the reasons why this interval is going up. It's going up, but it's coming back to normal at the same time, because it got very short. And I think it proves a bunch of reasons why that happened, but it got quite short. Dave, we've only got about a minute left, so do you want to talk a little bit about the shutdown trends?

Yeah, well, no, let me do the down rounds, Ray. I'll do both, actually, I'll cover them both real quickly. So, down rounds, look, there are 15% of down rounds. 15% of rounds have been down rounds this year. That's up from 2021, where only 8% were.

I would say the historical average is around 15%. Just looking at the chart here on slide eleven, it got really high in the Internet bubble, it was 53% in 2002. In the global financial crisis, it was big, 35%, but it got quite low during Zurp, but it's bouncing back to normal. So my main message here is there's no shame in a down round if you have to do one, a lot of things worse going to happen to a company that down round, and one of those is shutting the company down. And this is pretty amazing.

This is not normalized to anything, it's just absolute count. So it's not as a percent of total companies or a percent of fundraisings or something to normalize it, but the absolute numbers. Typically, since 2019 to 2022, between 30 and 40 vc backed startups that raised more than $10 million shut down 2023. 122 did so. And this is something relatively rare.

In my experience, venture companies almost never actually died. They kind of become zombies or they go low growth or they do an aqua hire. But actually shutting operations, in my experience, is pretty rare outcome and not so much these days, pretty rare. But I'm going to go out in the limb hot take here on SAS lock with metrics brothers from the growth guy, that 122 shutdowns in 2023 will be eclipsed before we hit Q three. Got it?

Okay. Well, you heard it here first. I see so many companies right now that, you know, have tried to preserve cash. They've only got six or so months left, and I don't think those are the companies who are going to be raising money because they've slowed their growth down from 30% down to 10%. I would say, by the way, if you find yourself in that situation or you see that you've still got five or 10 million in the banks, you're not literally going bankrupt, but you're worried about the business.

You've tried three pivots, they're not working. There is a certain honor in just shutting down the business and returning the money to the investors. You don't need to drive the tank to zero if you're sure it's not going to work. It's a better use of your time to stop and go make something else, and it's a better use of your dwindling investors money just to just give them back and throw in the towel. So no shame in that either.

Ray Reich
Hey Dave, I see some cannons coming on the horizon out there. I think they want to shut us down for the day here with the pirate theme. So that's a wrap to today's SaaS talk with the Metrics brothers. Thank you Brother Kak. Thank you, brother Growth SaaS Talk is a production of the Metrics Brothers growth in CAC and a member of the Benchmarket podcast Network.

C
By accessing this podcast, you acknowledge that the metrics brothers make no warranty, guarantee or representation as the accuracy or sufficiency of the information presented or the humor content of the jokes provided. Ray, the information, opinions, and recommendations presented are, according to our spouses, probably wrong, and provided for general information only. This podcast should not be considered professional or for that matter, unprofessional advice. We disclaim any and all liability for any direct, indirect, undirect, misdirect, incidental, special, ordinary, consequential, inconsequential, or other damages arising out of any use of or God help you, reliance upon the information presented here. Ray Growth Reich is based in New York City and available on Twitter x rayreich.

Dave Kellogg is based in Silicon Valley and available at Kelblog Schedecti, which is French for unspellable, is not our actual production location. You can reach us@sastalkpodcastmail.com thanks for listening.