Staying ahead of the game
Nevertheless, with deal volumes unlikely to match 2021's record numbers, founders will need to step up their game and pay attention to the metrics if they are to attract investors. The error margin for investors is much slimmer, so they will be looking for companies with a focus on cost and sustainability.
Valuations are going to look very different from how they were a year ago. The average multiple of a cloud company over the past ten years is roughly between 9x and 10x. Today, the top quartile of cloud companies are trading at a 70% premium to everybody else, at roughly 9.2x, so back at that ten-year average.
Late-stage investors would expect a private company to trade at a premium because of the growth potential. So instead of 10x, they might expect 12x or 15x.
It's important to remember that some of the best companies are born in times such as these. When we emerge from the crisis, the world will look different for a longer period of time than it did after the 2000 or 2008 recessions. This is because of the systemic effects of the war in Ukraine, the energy crisis, supply chain challenges, and a focus on onshoring, all of which are leading to higher inflation and higher interest rates. But entrepreneurship and grit thrive in adversity, as we see from the continued volume of early funding rounds.
While money is becoming increasingly expensive, well-run technology companies with strong cultures and a focus on short-term sustainable unit economics will come back to a market flush with capital and eager to invest. In Europe, autos, energy, telcos, pharma, and financials will have over $1trn of free cash by 2024 to distribute and modernize via M&A and investments, according to Morgan Stanley.
Valuations will look more like the average of the past ten years, leaving room for a handful of exceptional outliers. But many will face the equivalent of short-term down rounds, which will enable them to survive and ultimately thrive as leaders in the long term.
The absence of free money reduces the error margin for entrepreneurs and investors, leading to a flight to quality in both groups: the best will shine and the average will be wiped out. For the great, this is an incredible time of opportunity.