There’s been lots of chatter on recent tech IPO performance (and failed attempts); thanks Dan Primack at Axios. Some, like Alex Wilhlem at Crunchbase, have suggested gross profit margins neatly capture underlying issues. Folks like Fred Wilson have suggested winners and losers could more simply be attributed to business / revenue models (SaaS vs. tech-enabled).
We like numbers and wanted to see if we could find a simple explanation. So we quickly examined potential factors (no complicated regression analysis here): namely revenue growth, gross margin, “contribution” margin, and even EBITDA margin. We define contribution margin as gross margin less sales & marketing expenses, which may better illuminate issues of attracting and retaining customers vs topline growth or gross margin.
Unsurprisingly revenue growth matters. But, of note over this 2+ year span, public markets aren’t requiring a drive to positive EBITDA. On average those companies with valuation improvements increased EBITDA margins from -24% to -20% (an improvement but still significant cash burn). The data suggest that while changes in gross margins aren’t a significant factor in moving valuation, “contribution” margin may be more indicative of company health and value.
Contribution Margin's Impact
Digging further, companies that improved their contribution margin experienced a 12% average annual increase in valuation, while those that saw their contribution margins deteriorate had an average annual decrease in market cap of 10%. The impact becomes even more pronounced when you look at annual changes in contribution margins in increments of 10%.
Growth Really Matters in Driving Valuation, All Else Equal
Lastly, when you look at the winners in more detail, revenue growth really drives the magnitude of valuation improvement (especially since absolute levels and changes in contribution margin are relatively similar).
What it Means for Growth and Venture Lenders
Admittedly this analysis doesn’t distinguish between D2C and other stickier revenue models, although contribution margin likely captures such differences with less sticky models accelerating spend to maintain growth. It would make sense, given churn dynamics, that unit performance is likely much tougher to scale in D2C models (like meal delivery services) than enterprise SaaS.
So what does this mean for what’s near and dear to our hearts (growth debt and venture debt evaluation)? Unlike most venture equity, lenders (even venture lenders) are downside-protection focused. In fact, they’ve already determined that lower contribution business models (such as D2C and adtech) involve greater risk and have remained quite conservative with such models. Not discounting the upside potential, but the chance of enterprise value erosion is significantly greater; and that’s the primary ‘asset’ that growth and venture lenders use as collateral.