The momentum of the the most active 12 months ever for venture investing did not go well into 2022, to say the least. As interest rates and inflation rose, geopolitical challenges arose and the economy began to trend downward, driving fundraising throughout the year dramatically slowed down.
But if 2022 was a year of paradigm-shifting dynamics, 2023 will be a year when we will determine the winners and the losers – and, more importantly, when sharper methods for evaluating success will emerge.
The landscape for software companies
The tech ecosystem has gone through a few downturns (though none were significant) since cloud computing emerged as a dominant trend more than a decade ago, but inflation is a new beast for many of us.
It’s been 30 years since inflation was a tangible, real-world macroeconomic consideration. If inflation is 7%, if you don’t grow at least that much, you shrink.
In a tough budget environment, high gross retention rates can be a strong signal that customers love and really value your products.
Along with inflation, the demand curve is swelling – we first saw a period of strong product growth due to the COVID-19 pandemic, and now we see budgets and spending tightening as both startups and mature companies prepare to weather the storm.
We enter 2023 with a large number of known issues and a limited ability to predict what lies ahead. One thing’s for sure, though, this year is more about nailing it than scaling it.
The predictors of success
In this environment, investors will look for efficiency metrics such as high gross margins, strong gross retention rates (how many customers continue to subscribe each year), rapid expansion within customers, lower customer acquisition costs, shorter sales cycles, and productive salespeople.
Gross retention, in particular, will be critical as companies need to be able to retain customers to stabilize their 2023 growth plans. In a tough budget environment, high gross retention rates can be a strong signal that customers love and really value your products.
Investors also monitor the path to break even based on the current balance sheet – through metrics such as cash burn as a multiple of net new annual recurring revenue.
Assuming you have high gross retention rates, it might make sense to burn cash, but it won’t if you burn more capital than the amount of new customers. As growth rates decline, many companies reduce their burnout rates accordingly, resulting in a wave of layoffs, even among companies with strong balance sheets and market positions.