SEG’s decision tree for SaaS executives evaluating business strategies in the COVID-19 environment.
SaaS executives face overwhelming amounts of information and decisions in the COVID-19 environment. The complexity is compounded for businesses positioned for a near term exit prior to the pandemic. To help SaaS decision makers, SEG outlined a handful of key considerations in the form of a decision tree. The tree can be used as a guide for SaaS decision makers to determine business strategies in the COVID-19 environment.
Is COVID-19 a Tailwind or a Headwind for the Business?
When assessing adjustments to business strategies, the first question to answer is whether COVID-19 is a tailwind or headwind. The COVID-19 pandemic has caused a tailwind for a fortunate few, including select companies in our SEG SaaS Index. If the company is experiencing tailwinds, its valuation may be impacted positively. As referenced in our SEG SaaS Index April Update, an obvious example of a tailwind during this crisis is Zoom. The skyrocketing demand for the product has driven incredible growth, resulting in a 146.8% increase in its stock price YTD*.
For most other companies, COVID-19 is a headwind. An example of a company facing a headwind is Eventbrite, an online platform for event planning services. Eventbrite has experienced substantial revenue loss since the beginning of the pandemic. The slowing demand due to social distancing measures resulted in a plunging stock price of 67.3% YTD*.
The examples provided are extremes and many SaaS companies likely fall somewhere in between. What is the best way to measure whether a company is experiencing a tailwind or headwind? How pronounced is the respective impact? There are countless metrics to analyze, but perhaps the most important, and what we are seeing buyers focused on, are comparing bookings, sales pipeline, and retention relative to how the business performed historically. If these metrics are faring well or improving in the new environment, the business is likely experiencing a tailwind.
COVID-19 is a Tailwind
If the business is experiencing a tailwind due to COVID-19 during this time, congratulations! But, there is still work to do. In order to properly capitalize on the business acceleration, executives must objectively assess the sustainability of the growth. Is this growth sustainable post COVID-19 and a new normal for the business? Or will growth return to pre COVID-19 levels or lower once COVID passes?
It is near impossible to determine the timeline of the virus and its total impact on the economy. If a pivot is necessary, it is advisable to do so as soon as possible to maintain business operations.
The Tailwind is Temporary and Likely to Disappear Post COVID-19
Though it is admirable, the growth the company is experiencing may flatten or decline post COVID-19. This can be the case if certain factors are affecting growth, for example, a company that is offering a product in high demand during this time, such as eLearning software or a virtual collaboration platform. This company may continue to be successful after the pandemic, but growth may stall as consumer behaviors return to normal. If accelerated growth is temporary, consider pivoting the current offering / business strategies to sustain growth post COVID-19. This pivot can be offering a new product, targeting a different market, or altering go-to-market strategies.
If the company cannot pivot its product offering, consider exiting to capture a short-term value increase and potentially an outlier bid on the business (Path 1). Of course, there are no guarantees as buyers may struggle with value given the short-term nature of the expected growth.
If the company can pivot to make growth more sustainable, are resources available to execute the pivot?
In the case that resources are available, weigh the opportunity cost of near-term liquidity vs. long-term potential and value increase (Path 2). If long-term potential is selected, focus on execution, growth, and capitalizing on the opportunity.
When resources are not available, consider exiting to capture a short-term value increase and potentially an outlier bid (Path 1).
The Tailwind is Sustainable Post COVID-19
For companies seeing considerable growth during the COVID-19 epidemic, they may have the resources and product offering to sustain growth after the crisis passes. There are a few different paths to sustain growth after a tailwind. One path would be to raise capital to fund the company’s growth. This would enable the company to take advantage of the increased demand for the product (Path 3).
The Tailwind is Sustainable Post COVID-19: Are Resources Available to Capitalize on the Opportunity?
If accelerated growth is expected to be sustainable post COVID-19, are resources available to take advantage of the accelerating demand for the product, in terms of FTEs, go-to-market strategy, and capital?
When resources are not available, SaaS executives must consider if they are interested and able to raise capital to fund growth.
If resources are available, consider reaching out to 3rd parties to raise capital to sustain growth. Sometimes when a company faces unexpected demand for their product, they may not have the resources to adequately grow at the same rate of demand. 3rd party capital can be essential in gaining quick access to the funds needed to expand the business. In this event, a debt or equity raise should be determined. This is dependent upon the business and goals for future growth. To learn more about the types of capital raises that are available or the process of preparing for an exit, it may be advisable to speak with a sell-side M&A firm.
If unable to or uninterested in raising capital to fund growth, weigh the opportunity cost of near-term liquidity vs. long-term potential and value increase (Path 2).
The Tailwind is Sustainable and Resources are Available
If the tailwind is sustainable post COVID-19 and the resources to capitalize on the opportunity are available, congratulations! The company is highly unique and in a strong position. Buyers may be willing to place a premium valuation on the business in the short-term. Consider whether the top tier buyers in the company’s space are still engaging in M&A during the pandemic.
If yes, weigh the opportunity cost of near-term liquidity vs. long-term potential and value increase (Path 2). If not, closely monitor the business, continue operations, make strategic pivots (if necessary), and reassess when market stabilizes (Path 4).
COVID-19 is a Headwind
Alternatively, some companies are likely facing difficulty in this market and are possibly seeing the demand for their offering plummet; for example, events or retail point-of-sale SaaS companies. The first factor to assess is the level of impact to your business: is the impact moderate or major?
While it ultimately depends on the type of business, for many, a moderate business impact is, relative to pre COVID forecasts, attainment of 75% or more of forecasted bookings and churn of 125% of forecast or less. A major impact is far more catastrophic. Bookings at 75% of forecast or below and churn of 125% of forecast or more. Oftentimes, cuts to expenses are necessary to maintain cash flow and keep business operations running. Some of the nonessential reductions we are commonly seeing are:
- Travel expenditures
- All discretionary spending
Sometimes a company may need to make major cuts to their business in order to maintain business operations. In our most recent webinar, three SaaS experts provided their advice on how address this during a downturn. We summarized key points in this blog: Managing Employees During a Recession. Sometimes a company may need to make major cuts to their business in order to maintain business operations. Some of essential reductions could include:
- Reduction in force
- Hiring freezes
- Halting pay increases
- Cutting non-essential personnel
- Cuts to employee perks/benefits
- Above-market executive salaries
The Headwind is Moderate: No Cash Runway for at least 12-18 Months. Can Necessary Cuts to Expenses Be Made?
When the impact to the business is moderate and bookings/retention are taking a hit in the short-term, CEOs need to assess cash flow and how to maintain company operations. Does the business have cash flow to sustain operations for the next 12-18 months? Due to the uncertainty of when markets will normalize, we chose the 12-18 month benchmark to remain conservative.
If the answer is no, then SaaS executives must act and cut non-essential expenses. This may include moderate reductions in personnel if needed. Eliminating headcount is hard and we recognize staff is essential. If a SaaS executive is unwilling or unable to make moderate cuts, consider raising capital or exiting (Path 5).
The Headwind is Moderate: Cash Runway of 12-18 Months. Are Resources Available to Pivot?
If a company has cash flow to survive the next 12-18 months, executives need to ask whether they have resources to emerge stronger from the COVID environment.
Resources needed to pivot may include cash, personnel dedicated to pivoting, and an action plan to execute. Serious complications in keeping the business afloat may arise if capital and resources are tied up in a downturn. An investment of capital may allow the company breathing room to continue operations for the next 12-18 months. In this case, it may be worthwhile to consider raising capital or, if need be, exiting (Path 5). If the company is willing and able to make moderate cuts to expenditures and pivot the company to meet new consumer demand, it is advisable to maintain business operations while keeping a close eye on cash flow and utilize the necessary resources to best reposition the business (Path 4). See our related blog discussing three ways to shift business strategies in COVID-19.
The Headwind is Major: Cash Runway of 12-18 Months. Can the Business be Fundamentally Changed?
Companies negatively impacted by the pandemic may have unsustainable bookings and churn, causing lasting impacts. The first thing CEOs will need to assess is cash flow: can the business be sustained for the next 12-18 months with the expected cash?
If CEOs cannot maintain business operations with the expected capital, they will need to make major cuts to the workforce or other business operations as detailed above. When necessary cuts are made, a reassessment is needed to look at cash flow. Some methods to develop additional revenue streams include migrating to cloud, making affiliate sales to the existing product offering, APIs, creating a premium service, publishing content, and advertising, among many others. If creating additional revenue streams after cutting costs is possible, it is advisable to continue operations and reassess the company’s position when the market stabilizes (Path 4).
If the company does not have runway for the next 12-18 months, and it is unwilling to make the major cuts to the business, the cash flow outlook may remain dim and the company may be distressed. In this scenario, a SaaS executive may find it necessary to consider raising capital or exiting (Path 5).
If the company’s cash flow can sustain company operations over the next 12-18 months, it may be worth trying to fundamentally shift the business into a better position. Whether through a strategic pivot or another means, repositioning the business to become more mission critical and/or create additional revenue streams creates the opportunity to emerge from COVID-19 in a stronger position. To identify what categorizes a “nice to have” vs. a “need to have” product, please see our relevant blog. If this is possible, keep a close eye on business operations, make the necessary pivots, and reassess the exit strategy once the market stabilizes (Path 4).
The Headwind is Major: Can Additional Revenue Streams be Created to Support Business Operations?
If a company has the cash flow to survive the next 12-18 months, but cannot fundamentally change the business to be more mission critical, what does the future for the company look like?
After cutting discretionary and possibly nondiscretionary expenses, the company still might not have the resources to survive. It may be necessary to create additional streams of revenue, whether that be through major cuts or pivoting the company. If the company is able to create additional revenue streams, it may be advisable to keep a close eye on the business and reassess when the market stabilizes (Path 4).
Certain verticals, such as travel or events, may be hit incredibly hard. These verticals may have the resources to continue operations, but their assets may become distressed with the lack of customer demand. If companies within these verticals don’t have the ability to pivot, make their product more mission critical, or create additional revenue streams, it may be worthwhile to consider entering a process to exit (Path 5).
Every Business is Different:
These unprecedented times have impacted every business differently. The decisions a SaaS operator must make are dependent on the type and scale of the impact. These key decisions impact business strategies, operations, and exit strategies in the COVID-19 environment. With the right questions to ask and data to analyze, executives can make the best decisions for their companies, while keeping an eye on maximizing shareholder value.
We have resources available if you would like to understand strategic buyers’ or private equity investors’ outlook on the market. As always, please let us know if you have any questions, we’re here to help. Contact Us.
* Data as of 05/14/20.