It’s an open secret: efficient growth is being rewarded over growth at all costs. 

Over the last 12 months, the slower equity market has meant a shift to rewarding capital efficiency over top-line growth. Founders had to weigh up raising more equity at a higher dilution or be more efficient with less. 

The EMCLOUD Index, created by our venture friends at Bessemer, tracks the performance of public emerging cloud-based software businesses, such as Atlassian, PayPal and Snowflake, providing a great proxy for how software is valued on the public markets.

Enterprise Value/Annual Recurring Revenue (ARR) is the key valuation multiple that software investors use to value both early and late-stage companies. The two graphs below speak to the correlation of the valuation multiple to two key variables:

1. Revenue growth YoY.
2. Rule of 40 (a measure of revenue growth AND profitability).

As you can see, the R-squared, or the strength of the correlation, is higher between valuation multiples and a company’s Rule of 40 metric than between valuation multiples and revenue growth metrics. In other words, the market values profitable and efficient growth over simply revenue growth. 

This shift has tempered top-line growth across the board, but it's more pronounced in early-stage companies rather than late stage. While every company’s situation will differ, the marked difference for SaaS startups <$1m ARR (USD), may be because they have fewer proof points, making it harder to sell a new product to software purchasers tightening their purse strings. Later-stage companies have had time to develop their credibility with buyers and have the benefit of expanding contracts within their existing customer base, which can offset lower net growth.

By mid-2022, the market had fundamentally changed, and we were working with founders to help them understand and adjust their plans to the new normal. We also make granular benchmarking available to our portfolio companies so they can understand where they sit relative to their peers and how they are positioned moving forward. 

Getting stuck into business fundamentals has meant that despite what’s playing out at large, we’re seeing huge bottom-line improvement across our portfolio. Notably, the improvement is occurring not only at the EBITDA level but also at the free cash flow (FCF) level. 

FCF is arguably more important than EBITDA because it reflects the money a company has left over after paying its operating expenses (OpEx) and capital expenditures (CapEx). 

Some examples of what has driven bottom-line growth for AirTree’s portfolio companies include:

• Cutting inefficient sales and marketing spend. For example, reductions in performance marketing (post Apple’s App Tracking transparency reform), less exploratory above-the-line spend, and a shift to lower base, higher commission models for sales teams.
• Taking out low-margin product lines and, in some cases, low-margin customers. 
• Negotiating usage-based pricing on subscriptions. 

We’ve also seen burn multiple improvements across all stages. For our early-stage and growth cohorts, it has improved by 35-40%. The burn multiple tells us a lot about the overall health of a startup and how efficient its growth is. It measures how much cash the startup is burning to generate each incremental dollar of ARR. The lower the burn rate, the better. 

It hasn’t been easy for companies to reduce their burn multiple. Companies have pulled back spending in research and development (R&D) and general and administrative costs (G&A), which has painfully resulted in headcount reductions, particularly for Series A stage companies.

Tough decisions were made with purpose. A conscious effort to reduce operating expenses has enabled AirTree’s startups to extend their runway and combat any uncertainty around the availability of capital. 

It’s not all bad, though. Companies are growing their teams, but the right has to be earned. The most efficient quartile of a top US VC’s portfolio companies are expanding headcount, but only when they’re growing revenue more than 100% YoY.

 Being a founder is tough, period. The market over the past 12 months has not made things any easier. 

It’s not easy to cut burn; it’s a delicate exercise that deserves to be well thought through. Lean on your investors, who see this play out across different companies and industries, and your fellow founders, who are in the same boat as you. But if your burn multiple is running hot, it can't be ignored and will drag your core valuation variable down.

Give yourself financial optionality by working towards profitability. Rule of 40 is a good benchmark for trading off growth with burn. My colleague Dan Coughlan has also put together a target burn multiple guide based on business size. 

Treat spending as investing, not as an expense. Top founders have been more intentional with spend, driving their teams to think and act like owners and using more data-driven ROIC frameworks to justify spend.

Going into 2024, we’re seeing green shoots, but we’re not out of the woods just yet. Bitcoin has gone up, while China has printed deflation. Rates have stabilised, and so has inflation. Employment is looking good, but we’re dipping into savings. Whatever happens, build optionality, earn the right to expand and be default alive.