(Currently writing from Tokyo so bear with my somewhat sleep-deprived cognitive functions) Dave Madden is one of my favourite people in the ad world for many reasons, one of which is the brutality of the post he wrote about the near future of the adtech world being mostly liquidations rather than consolidation.
A lot of difficult conversations with boards, investors, employees and founders were required in 2023. It is increasingly likely that 2024 will see more.
Pricing has changed, obviously. But it also feels like a moment where everyone is actually doing the calculations on where valuations come from. A lot of people (founders, investors) throw around ‘five times revenues’ as a market comp. But I think many of those same people fail to grasp that (all things being equal) a revenue multiple comp is predicated on an underlying profit margin. So if you’re operating with, say, a normalised EBITDA of 10% and market valuations are 10x ebitda (meaning very loosely ‘I will pay you ten years of profits to own your company’), that backs out to one times revenues. Five times revenue on a 10% ebitda margin is 50x EBITDA multiple. Assuming the growthiest of growth projections, that is still a very optimistic view of your future profits.
There are SO MANY exceptions to the elementary math I just described. I can hear the investment bankers howling that historic comps, replacement cost, expanding TAM, unique teams and other important-sounding phrases justify a strategic premium. And some of that, in some cases, at some times, is genuinely quite true. But mostly it isn’t and if you assume that the majority of future acquirers will be PE funds, then you should conservatively assume a strategic multiple is off the table and that EBITDA multiples will be your guide.
Back to Dave:
“For sure, over the next two years, we’ll see some consolidation in ad tech, but probably only among the best companies and most precious and valuable assets. I suspect instead we’ll see a bunch of companies just go away, most of them pretty quietly. I feel for those that won’t make it, but that’s just part of what it means to build businesses and industries. Not everything goes up and to the right.”
To be fair to investors and operators both, building successful companies is really, really hard. One of the very last things Charlie Munger said before he passed was ‘even great companies die’, which I’d never heard him say before1. Byrne Hobart (I recommend his excellent newsletter) made this point eloquently:
“But that’s ultimately what growth is; the straightforward, single-variable part is brief, but in the long run, the real world is multivariate and uncertain, and every well-run great business is diversifying into a merely good or actively mediocre one just to stay alive a bit longer.”
There is a cultural point about making profits which has taken me a long time (and at least three startups) to truly understand. Building companies that are culture-obsessed about products and customers is good but you need apply that same cohesive element to your financial performance too. What are the things which need to be true for this product to be profitable? The world is filled with opportunities where the cost of the problem simply doesn’t equate to the price of the solution. You must make money to survive and it’s totally okay to say that out loud (and to the rest of the company).
The obvious response2 to that last paragraph is ‘well obviously cheap finance will create that environment’. Yes but I think a more subtle contributing factor has been the erosion of status of sales teams in technology companies.
A couple of decades back, Larry Page said some version of ‘Companies have always succeeded because of excellent product people but never because of excellent business people’ and everyone started believing that myth. ‘Tell me about your sales team’ is a thing you rarely hear investors say yet I continue to believe that sales teams are the single most undervalued asset in any company’s line-up. It’s probably my answer to the Thielian question of ‘what do you believe that everyone else thinks is wrong?’. One of the least known facts about the success of SuperAwesome (ostensibly a compliance product company) was that it was driven by a brilliant sales team without which it simply wouldn’t have scaled.
It’s fascinating that, to a large degree, sales went from being at the heart of Silicon Valley to a second-class citizen (or certainly playing second fiddle to product and engineering). The best thing I’ve read on this topic is Matthew Symond’s Softwar which looks at the rise of Oracle (I think it’s out of print but there are second hand copies everywhere) which was highly sales-driven. It is also an excellent read for seeing the challenges of growing (and selling) a consulting service when you already have a product sales org.
“Only call me if the topic is profit/not for gossip” Chy Cartier
- The Collapse of Complex Societies isn’t about companies but I found it very applicable. It’s a bit tricky to find but worth reading. And yes, I’m well aware about Munger’s views on EBITDA as a measure. ↩︎
- Actually the most obvious response is for many people who know me to think I’m talking about them. ↩︎
Half-formed thoughts and musings 