Growth vs Profitability in 2022: What Matters More?
By Vivian Guo | October 5, 2022
How 2022 impacted the balance of growth and efficiency
Last month, we published our annual update of The ICONIQ Growth Enterprise Five, a scorecard of five key metrics we believe to be strong indicators of a company’s long-term success. While we still believe these metrics to be a North Star for what companies should measure themselves against, we would be remiss in not covering how macro trends from the past year have changed the way markets, entrepreneurs, and investors think about the weighting of these metrics and in particular, the balance of growth and efficiency.
After years of rapid growth, enterprise SaaS companies in the public markets are seeing their largest sustained period of valuation deteriorating in the last 13 years. We’ve also seen the IPO market slow to a near-frozen state, with uncertainty around when we will see the next batch of SaaS IPOs.
Historically, growth above all else has been most correlated to valuations in both private and public markets. However, the tides have started to shift - requiring more founders to put an emphasis on efficiency earlier in their growth journey. In the past year, we’ve seen the convergence of growth and profitability when looking at correlation to forward revenue multiple - driven by a surge in the importance of Rule of 40 (Revenue Growth + FCF Margin) as it relates to valuations, in contrast to purely Revenue Growth.
In 2022, we have already seen the impact of this shift in focus to profitability on the public markets. Software companies with top quartile FCF margins in January of 2022 have since outperformed the broader software market by 10% [1], compared to companies with top quartile revenue growth who underperformed the market by 2%. Macro trends in the public markets tend to trickle down to the private sector, and we have seen that this year has brought profitability back into focus for many private SaaS companies as well.
The shift towards the importance of profitability is likely here to stay, so what does this mean for those building companies during this turbulent period? Below are a few take-aways from our 2022 Topline Growth & Operational Efficiency report.
1. Long-term success is driven by a combination of top-line growth and strong operational efficiency.
As incremental efficiencies are achieved, operating costs should decrease until revenue outpaces total spend - an inflection point that usually happens as B2B SaaS companies exceed $250M ARR. As shown above, the average spend to revenue ratio changes from ~2.5x in the early stages of a company scaling to ~0.7x by the time a company reaches $90M in quarterly revenue.
2. Resilient companies maintain Rule of 40 or higher, regardless of scale
While average Rule of 40 has declined since 2020 for companies in our report, resilient companies [6] have been able to maintain a Rule of 75%+. We believe this focus on profitability in addition to growth is a big reason why these same companies have been able to continue beating topline and bottom-line plans in 2022 even against a more challenging macro backdrop. For later stage companies, we typically see companies achieving 50%+ Rule of 40 in the years leading up to IPO.
3. On average, SaaS companies approach profitability 6-7 years after reaching $10M ARR, with top performers achieving profitability within 4-5 years
Regardless of the macro environment, a shift in focus back to operational efficiency is healthy and overdue. During this challenging period, we recommend companies have at least a clear path to profitability and a focus on reducing burn in the current environment.
More details on each of these metrics and more insights related to topline growth and efficiency can be found in our 2022 Topline Growth & Operational Efficiency Report. In our next posts, we’ll also explore topics around burn, go-to-market efficiency, and customer health.
Notes & Disclosures:
1 Includes all software companies with an IPO data in 2013 or later; Financial data sourced from Factset accurate as of 8/31/22
2 EV / NTM Revenue Multiples from Factset
3 Quarterly operating and financial data from select B2B SaaS companies. Includes data from all ICONIQ Growth portfolio companies where data was available, and select public companies were included. More detail can be found on page 6 of our 2022 Topline Growth & Operational Efficiency Report
4 “Above Median” is greater than or equal to median, less than top quartile
5 Within 2 fiscal years of IPO
6 Resilient companies defined as ones that achieved a top quartile health score based on performance against attainment, Rule of 40, growth, and runway metrics defined on page 10 in our 2022 Topline Growth & Operational Efficiency Report
7 Quarterly operating and financial data from select B2B SaaS companies. Includes data from all ICONIQ Growth portfolio companies where data was available, and select public companies were included. More detail can be found on page 6 of our 2022 Topline Growth & Operational Efficiency Report
