COVID-19 quickly put the stock market in the ICU, with signs of unprecedented volatility and declines. However, the market’s resilience and swift action by the Fed made this downward spiral short-lived. The Russell 2000 Index, a benchmark for small-cap stocks, is one of several indices that highlights this.
Within a one-month period from late February into March, The Russell 2000 Index was down more than 40%, signaling the end of a long bull market and entrance into bear territory. Yet, two months later, at the end of May, the Index is up over 35% from its low. In the private market, the impact of volatility on healthy, pre-COVID-19 software company valuations is much easier to track. As SaaS founders consider their financing options, the picture might be a bit less glum than they might imagine.
Still going strong
Changes to private market valuations often lag behind what transpires in the public markets. Also, fundraising cycles for private companies generally take 2-3 months from start to close. Unlike the 2000 dot-com crash and the 2008 Great Recession, where valuations dropped for extended periods of time, private company valuations, for the most part, have not had time to adjust for the volatility seen in the public markets.
As a result, private company valuations for software businesses have largely been shielded from the chaos in the public markets thus far. As we invest in businesses based on where they could be three to five years down the road versus the next several quarters, it has been business as usual for Volition Capital. In fact, we are actively deploying capital while helping portfolio companies raise at pre-COVID-19 valuation levels.
While the full magnitude of COVID-19’s economic impact remains unknown, and with the expectation that turbulence is likely to persist, founders of high-growth, capital-efficient software companies may be pondering their fundraising plans and valuation expectations. The key for founders right now is to play offense, and as such, either: 1) push forward with their financing plans as price setters, or 2) take a wait and see approach until the picture becomes clearer. In no event should a company put itself in a position where it becomes a price taker.
Here are a few cases and best practices that software founders can use to help push a decision forward now if considering a capital raise in the current environment.
Why raise money now?
For many, there’s a significant opportunity amidst the larger economic and business chaos due to COVID-19. We are seeing many software businesses benefit from their cloud-first, digital everything approach, as well as from the shift to the virtual workforce. Valuations have remained strong with robust investor demand. This only increases if you have clear visibility into solid 2020 results and are still experiencing high customer retention rates. In fact, revenue multiples may have actually increased with valuations intact, as 2020 forecasts have come down due to the pandemic.
Why consider putting financing on hold?
While many software companies have a healthy business, if you are worried that growth will materially slow this year and your valuation multiple will take a hit, the best offense may be a strong defense. Continue to manage expenses tightly to extend your cash runway, and potentially strengthen your balance sheet with non-dilutive, flexible debt that you can service during a downturn. So long as you are not forced to raise equity to support your business, you should be immune from any short-term hiccups in valuation.
If you are curious about what the market is for your company, you can quickly gauge investor interest by talking with a limited number of firms without such conversations becoming a big distraction. You may be pleasantly surprised by what you hear. Regardless, if you are clearly hit hard by the pandemic, take actions to not put yourself in a cash crunch, and you will not be forced to raise equity at a depressed valuation.
The bottom line: control your destiny
Not being held to the volatility in the public markets is a huge benefit to being a private software company. Pursue capital when you want, with who you want, and control your destiny. This is particularly the case for capital-efficient, bootstrapped businesses that have the leverage of determining when to raise equity and at what valuation.