The following is an excerpt from my quarterly market intelligence memo that I send to DWP friends and limited partners. If you would like to have access to the entire letter, which includes information on deal flow pipeline and valuation ranges, please leave a comment and let me know. I’ll be sure to add you to the distribution list.
Public Market Overview:
This year has seen a positive recovery in the public stock market, particularly in the technology sector (NASDAQ increased by 16.8%). However, the market is favoring companies that prioritize profitable customer acquisition over growth at any cost, which is reflected in higher valuations. Among public companies, Apple (+11%), Microsoft (+12.6%), and Amazon (+19%) have shown promise in the first quarter of 2023. Additionally, the market is showing appreciation for RIFs, as they can lead to stronger earnings and showcase financial discipline from leadership.
Despite the strong performance of FANGS, software companies are still maintaining reasonable valuations. In 2023, the median growth SaaS companies (15–30% growth) have a forward NTM revenue multiple of 5.4x, while the leading growers (❤0%) stayed above 6.0x NTM, providing clarity and aligning with the trend in 2016–2017. However, enterprise software spending is forecasted to decline due to budget tightening, raising concerns about future earnings.
Private Market Overview:
Funding activity in the private markets has significantly reduced in both volume and deal count. Firstly, Q1 of 2023 recorded a year-over-year decline of approximately 55% in US venture activity, with a corresponding 53% drop in deal volume. A recent surge in domestic venture activity during March offers a glimmer of hope but it remains to be seen if it is a sustainable trend. Startups in their late stages are struggling more than their early-stage counterparts, while software startups require 3.2x the amount of capital they are receiving from venture investors. Furthermore, early-stage capital needs deployment at a ratio of 1.8x. However, anecdotal evidence suggests that the late stage is suffering more while the early stage is in a stage of trepidation. Concerning late-stage software startups, alternative funding methods are also drying up, causing a crisis.
Valuations are yet to reset, with many companies issuing convertible and SAFE notes to avoid repricing. At DWP Capital, we refrain from participating in such bridges. Our valuation criteria for companies with <$1M of ARR is <$10M, and above $1M, a forward NTM ARR of 3x-5x (assuming they grow at 100%+).
The funding dry spell is a concern, and while historical trends suggest 9–10 quarters for the markets to bottom out, the number of new funds raised in 2023 is down 73% compared to Q1 of 2022, dampening prospects of sudden capital rush. Exits are taking longer due to lack of IPOs, limiting the cash recycling in the system, and as a result, the VC LP funding pool is closed for business, as stated by a renowned investor.
In conclusion, DWP Capitals portfolio companies are well-equipped to sustain their cash burn and reach profitability, aligning with our consistent philosophy. Our focus remains on identifying outstanding B2B vertical SaaS companies that deliver meaningful ROI to customers, tapping into the potential of automation and AI to drive efficiencies. We will keep you updated on our progress next quarter, and if you have any questions or concerns, please do not hesitate to contact me. A special note of thanks to Red Point Capital and Pitchbook for providing insightful data graphs for this letter.