Where are Tech Valuations Going?
As 2023 pushes ahead it’s worth reflecting on the global economic challenges we face in the wake of an eventful 2022: high inflation, supply chain disruptions and political disharmony, to name a few. We saw the S&P and Nasdaq drop around 20%, and numerous SaaS and data companies experienced decreased valuations. A measured approach of independent and sustainable growth, heightened efficiency and focused regional development will elevate savvy tech firms with an eye toward digitization, leaving the rest to flounder in the current climate.
The technology sector has enjoyed an uninterrupted rise since the 2008 financial crisis, particularly since 2017, with many key players who had been expected to see a plateauing growth cycle instead continuing to rise to meteoric heights. This growth was driven by momentum, innovation and government policies implemented during the global pandemic, including easing spending and money supply, as well as keeping interest rates near zero. As a result, companies such as Apple and Microsoft have become multitrillion-dollar companies in terms of valuation.
Meanwhile others, like ServiceNow, have seen their valuation increase from $40 billion to nearly $120 billion before falling back to just shy of $90 billion. Enterprises that went public through special purpose acquisition companies (SPACs) – a strategy now falling out of favor with the market – are faring similarly. Companies like AFRM in the “buy now, pay later” area, OPEN in the housing market, and RobinHood and Klarna in the fintech sector, initially saw huge jumps in their valuations, only to then suffer significant cooling periods. Likewise, India’s ed-tech firm Byju and hospitality company Oyo, and Brazil’s fintech bank Nubank, have all experienced significant growth followed by dramatic drops in valuations.
Valuations had hit 40x revenues for cyber companies, 30-35x revenues for business platform companies like AFRM, PLTR, SOFI and OPEN, and it was common to get 20x revenues for SaaS operations, despite lacking earnings or visibility to near-term positive earnings.
Now we are paying for it!
A confluence of economic and financial factors contributed to the current market conditions. Firstly, the zero-interest rate environment attracted borrowing, leading to an influx of capital into various markets. Secondly, the Venture and Private Equity sectors witnessed a fervent bidding war, characterized by a cyclical pattern of acquisition and divesture of companies at increasingly elevated valuations, despite minimal modifications to their underlying business models or structures. Lastly, a vigorous positive risk sentiment persisted, evident in the substantial growth of speculative cryptocurrencies such as Bitcoin and Ethereum, along with an influx of capital into both public and private equity markets, particularly in the technology realm. These major factors resulted in a proliferation of unicorns and IPOs in the technology sector, with 4,876 entities formed between 2017 and 2021.
As we look towards the future, I expect we will experience a period of slow growth which will serve as a true test of the capabilities and resilience of both management teams and the companies they run. It will likely result in the failure of many entities, while a select few will emerge as stronger and more dominant players within their respective industries. Characteristics that differentiate the companies that succeed from their less fortunate counterparts will include the following factors:
1. Achieve independent growth without relying (significantly) on outside capital to grow the business. Companies that reach product market fit and scale to sustain cash flow will grow rapidly as they help propel global digitization. ServiceNow CEO Bill McDermott’s message from Davos last week about all companies deriving value for money and the need for optimization was on point; his SaaS company is growing and hiring while others are retrenching. ServiceNow many use outside capital for strategic M&A, but the core business is meeting the drive toward global digitization and is expected to grow in excess of 40% annually, delivering enough cash flow to sustain that growth.
2. Become a necessary part of the value chain within your industry. Offer a product that is a “must have” and not a “nice to have.” For example, wealth managers must have a core accounting system; likewise, merchants must have services like Shopify and Amazon to get their products into the hands of consumers.
3. Deliver products and services that help reduce cost and increase efficiency. The last five years have been about growth: more clients, more markets and more products. The next five will be about running a more efficient core business and trimming excess capacity built up during the easy money years.
4. Look to local markets for growth opportunities. Larger players with market caps in excess of $500 billion will continue to expand globally, but most companies will see stronger growth by serving their home markets. This is certainly true for US-based companies, though European, Israeli, Indian and Chinese firms will continue to seek growth in overseas markets.
5. Increase collaboration between North America and South America. Demographic trends suggest the natural next market for many US companies will be in Latin America. (Nucleus DNA already initiated an early-stage VC fund focusing on LatAm fintech companies focused on financial inclusion.)
While valuation for most firms are indeed going down, there is asymmetry in the potential for good news and bad. The prospect of resolution in the ongoing conflict in Ukraine would certainly provide a boost to the market, however companies looking to operate on a global scale continue to face significant challenges due to the widening divide between the US and its allies and nations such as China, Russia and certain regions in the Middle East. As a result, valuations for the most successful technology companies are likely to return to a multiple of 10-15x revenues, while others may see valuations in the range of 6-8x revenues. These represent significant deviation from stronger valuations observed in 2020 and 2021.
Interesting times ahead to be sure, however a few large and many earlier-stage companies will see this as an opportunity to grow and consolidate their positions. Our transformation to a digital world is not slowing down.
Jayesh Punater
Jayesh Punater is a successful Entrepreneur, Investor, Fintech Strategist and Thought Leader. He focuses on bringing innovative technology and business models to the FinTech industry. Mr. Punater is the Founder and CEO of Nucleus, a FinTech studio and venture investment platform. Nucleus invests in, advises, and provides services to start-up and advanced stage scale-up firms.
Besides Nucleus, he is an advisor to Mission OG, a finance and technology venture fund. He is the Executive Chairman and CEO of Nucleus Emerging Markets Ventures a fund investing in LATAM fintech companies. He also is a Board Member of Untap, a private equity value creation SAAS company, member of the Advisory Board of Thales, a technology-based brokerage firm, a member of the Advisory Board of Bridge FT, a wealth management software platform, Board Member of Life Plugin, which is a personal growth platform for entrepreneurs, a member of the Economic Club of NY, a member of Mavericks 1000 an impact entrepreneurship organization, member of Mind Valley University and a member of C2Cwhich is a peer CEO organization in New York City.
Previously, Mr. Punater founded Gravitas, a leading technology services platform servicing the Asset Management industry. As Founder and CEO, he organically grew the business to a global firm with 300+ employees, with clients managing more than $1.2 Trillion in AUM. Gravitas was sold to a European listed company in 2017.
Jayesh is a strategist and focused on growing companies and has had roles in market facing functions – always looking to adapt innovative ideas to practical business problems – focused on helping firms grow their business or generate alpha or achieve operating efficiencies in the operations of the firm.
Mr. Punater is a graduate of Arizona State University with a BSEE and a minor in Economics. He has attended Executive Education courses at Harvard University, Stanford School of Business, Wharton, Columbia University, Northwestern University and has taught an entrepreneurship MBA class at Fordham University as an industry CEO.
