Sky’s the limit as tech investors pile into cloud start-ups

The surging value of cloud software companies on public markets this year has been matched by a frenzy of interest in the private market, creating a wave of start-ups valued at hundreds of times their revenues.

Venture capitalists are racing to find the next Snowflake or Zoom, the data analysis and videoconferencing companies whose shares have risen this year by 176 per cent and 464 per cent respectively.

As a result, the median valuation for so-called software-as-a-service (SaaS) companies raising their third round of venture funding, or Series C, rose by 40 per cent to $210m this year, according to an internal study by the Silicon Valley Bank seen by the FT. Their median revenues grew by 20 per cent.

The top quartile of SaaS companies raising their Series D, meanwhile, saw their valuations jump by more than 70 per cent to a minimum of $1.7bn.

Gordon Ritter, a general partner at Emergence Capital, said private investors valued SaaS companies at as little as three to five times their forward annual revenues in the early 2000s. 

Less than two decades later, he said the most desirable start-ups can reach valuations of $200m to $250m with as little as $1m in contracted revenues.

Series C pre-money valuations

“Investors didn’t understand recurring revenue businesses,” Mr Ritter said. “Now investors see how valuable the stream of cash flows is and are willing to pay for many years ahead.”

But Miles Clements, a partner at the venture capital firm Accel, said that “valuations have been pushed to their extremes.” He added there was little room for error and “the risk is that you’re getting into these situations where it’s priced to perfection, and you have good companies raising at untenable valuations.”

Some venture capitalists believe these cloud software companies represent the next big shift, after the generation of mobile app companies that defined the last decade.

Hopin, the virtual events company, saw its valuation rise more than fivefold to $2bn in November from a previous fundraising in June. The fundraise valued it at about 100 times its annual recurring revenues.

ClickUp, a workplace productivity start-up that competes with companies like Asana, raised its first two rounds of funding in the span of seven months this year. Its backers include David Sacks, the PayPal co-founder who also co-founded the business social network Yammer.

The company’s most recent financing this month, led by the Canadian firm Georgian Partners, increased ClickUp’s valuation by about five times to $1bn, including $100m in new capital it raised. 

One person familiar with the company’s finances said its annual recurring revenues came to more than $25m, implying a multiple of almost 40 times that metric.

“These markets kind of go in cycles . . . I think there’s still upside from here, and the world has obviously changed,” said Zeb Evans, chief executive of ClickUp. 

Gaurav Tuli, a partner at F-Prime Capital, said he has seen “multiples expand across the board” this year compared to 2019, when the firm said the average SaaS deal that crossed its desk was valued at about 18 times a company’s revenues.

Some venture capitalists are still worried that the fear of missing out on the next big hit has driven investors to pay nosebleed prices for largely lossmaking companies, inflating valuations to unsustainable levels.

Derek Zanutto, a general partner at Alphabet’s growth investment fund CapitalG, said investors are increasingly focusing on the total addressable market of their companies, creating a “disconnect between current valuation multiples and underlying business fundamentals”.

“Many investors will take the mentality that they don’t care if they invest at 100 times revenue, so long as they are getting in at a valuation below $200m, $500m or even $1bn,” said Mr Zanutto.

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This environment has also created greater divisions between the most sought-after companies and competitors that are struggling to grow as quickly.

“On nearly every metric, companies are raising more capital, earlier and with higher valuations, and all the while the number of companies able to raise under these pressures is dwindling,” said analysts at Silicon Valley Bank in their report.

Some venture capitalists also worry that the good times may not last. “As interest rates normalise,” Mr Ritter said, “we could see a correction in the future.”

Additional reporting by Tim Bradshaw in London

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