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Cash Management for CFOs in Profitability Mode
Navigating new public market expectations and engineering efficient growth in a downturn
For later-stage private companies with abundant cash and aspirations to eventually go public, 2022 has been a challenging climate to navigate. Many companies in the midst of IPO readiness efforts have been forced to put their public debut on hold, while others are waiting to see how market conditions over the next few years might impact their strategies for growth and spending.
In times of uncertainty, having a solid cash management strategy is critical. In the first two parts of our Cash Management conversation series with CFOs in The Circle, we discussed strategies for extending runway and reprioritizing spend amidst turbulent market conditions. Part three focused on how pre-IPO companies can calibrate their cash management strategy with a new set of public market expectations and leverage a market downturn to drive growth and increased market share.
Leading the discussion were three experienced finance leaders with deep capital markets experience and IPO scar tissue: Kristin Roth DeClark (Managing Director and Co-Head of Global Capital Markets at Barclays); Tim Cabral (former CFO turned board member and advisor); and Rob Krolik (former CFO of Yelp, VC, board member and advisor).
Here are the key takeaways from the conversation:
Assessing the New Public Market Landscape
After two years of record IPO activity, the IPO market has come to a grinding halt in 2022. Now, the question on the minds of many CFOs is: when will the IPO window re-open?
“The market and investors don’t like uncertainty. Right now, there’s a lot of uncertainty around inflation, consumer confidence and recession fears, the war in Ukraine, and other macroeconomic factors. That’s what is moving the market, not necessarily specific company fundamentals.” – Kristin Roth DeClark, Managing Director and Co-Head of Global Capital Markets at Barclays
Volatility has become a significant roadblock for companies considering going public. Typically, companies are advised not to go public when the Cboe Volatility Index (VIX) is above 20 points. As of the end of July 2022, the VIX hasn’t dropped below 20 in three months.
For CFOs, all of this means they may be in an extended holding pattern and need to keep a close eye on leading indicators of a recovery. “Investors are still waiting for the market to stabilize,” said Kristin. “I would want to see fundamental buying from long-only investors to know there’s actual investor confidence for the IPO market.”
The Pendulum of Growth and Profitability
In the meantime, CFOs of IPO-ready companies can adjust their strategies to meet a new set of investor expectations. For the last year and a half, most companies and VC’s have been focused on “growth at all costs”; now, there is much more focus on the balance of growth and profitability.
“Investors want to see either that you’re already profitable or that there’s a clear path to profitability,” said Kristin. “That profitability doesn’t need to come at the expense of growth entirely, but investors want to know that the unit economics of your business work if you’re going public.”
A value metric that is becoming important to investors is the Rule of 40 – the principle that combined annual growth rate and profit margin of a company should exceed 40%. The Rule of 40 is used as a simple rule of thumb for investors to measure the combination of growth and profitability. Lately, higher revenue multiples have been associated with companies that are stronger on the Rule of 40 calculation. “Meeting or exceeding the Rule of 40 sends a strong signal to investors that a company can fund their growth to profitability without having to go back out and raise additional funding,” said Kristin.
Market expectations around revenue thresholds for going public have also changed. Where previously $100 million in forward-looking revenue might have been enough to attract mass interest in an IPO, now the threshold is closer to $250 or $300 million, depending on your growth profile. For CFOs that are trying to balance growth with profitability, now is the time to start charting the next several years of revenue. “You should be able to pencil out a path to $1 billion that takes into consideration how your cash flow and EBITDA percentage will need to grow to get there,” said Rob.
Adjusting Your Growth Narrative
An essential part of IPO readiness is having a strong and consistent narrative about the future of your company. Given how the market has shifted, CFOs should now be thinking about how to craft a compelling narrative around growth and the company’s path to profitability.
Rob and Tim noted that while revenue growth numbers and metrics like the Rule of 40 are still important to investors, CFOs need to be able to contextualize growth with the company’s total addressable market and the competitive landscape. If you have a large addressable market and a lot of room to grow, investors want to see how you’re prioritizing growth or profitability to capture more market share.
For well-capitalized companies that are not as adversely impacted by the current macroeconomic environment, now may be the time to examine how you’re going to maintain or accelerate growth.
“One of the key attributes of a CFO is having a steady hand. If you’re a well-capitalized business, the next two years may be a great opportunity to increase your position through acquisition or expansion. But to do so, you’re going to need to put discipline into your operating model to ensure you’re going to get to where you need to be in three or four years. I wouldn’t necessarily take a foot off the gas, just make sure you’re in the right gear.” – Rob Krolik, former CFO of Yelp
Kristin added that a lot of the financial discipline and thoughtful growth strategies that CFOs are developing now will help increase their credibility when it comes time to go public. “If you’re planning to go public in the next few years, investors are going to ask what you did during this downturn to institute certain disciplines and build a cash advantage over other companies.”
Aligning Leadership Towards Responsible Spending
As we heard in parts one and two of the Cash Management series, CFOs play an important role in influencing efficient spending and cost-cutting across the organization, but resistance from CXO peers or other leaders in the organization makes that work much easier said than done. That’s why your “internal roadshow” is just as important as your external messaging to investors.
Leveraging scarcity to drive efficiency is a challenging exercise, said Tim. A good first step is to provide leaders with the full scope of how the financial strategy is changing due to market conditions.
“This is a multi-quarter and, in some cases, multi-year exercise. When talking with operating leaders, pivot the conversation from annual planning to a longer-term view of the company’s financial strategy. Be transparent about how public investors are measuring company performance and how that trickles down into the decisions they’re making within their functional areas.” – Tim Cabral, former CFO of Veeva Systems
Rob added that sharing feedback and common questions from outside voices like VC board members and investment bankers can provide helpful context to senior leaders about what the market cares most about.The flipside to all of this is that CFOs need to continuously ensure that cost-cutting and unforeseen IPO delays aren’t diminishing employees’ confidence that the company is well-positioned to weather the current market and enter the next growth stage. Retaining top talent is critical to navigating successfully through a downturn.
Market conditions may remain volatile for the foreseeable future, but CFOs can ensure their companies remain IPO-ready by focusing time and energy on recalibrating mindsets internally and externally towards efficient growth and profitability.
If you’re a CFO looking to connect with other growth-stage leaders on current challenges and long-term strategies, apply to join The Circle.