The terms “Long-Term Value” and “Valuation” conjure very different images. The former connotes stories of company building, long-term capabilities, and competitive advantage. The latter is the realm of Wall Street, spreadsheets, and financial ratios. These questions are two threads of a fundamental rope, twining together to answer a question: what is a company worth? Spreadsheets are scoreboards that, when combined with current trading multiples, describe what a company is worth. Stories describe what an entrepreneur can build to support the spreadsheet's assumptions. Eventually, the validity of every story is proven in the spreadsheet.
Both stories and spreadsheets are critical to entrepreneurs and investors alike. They drive not only your valuation but your success at every step of the journey. The relationship between the two determines the following:
- Picking the right investor partner
- How you need to grow from a scrappy startup founder to a scaling professional CEO
- What you should use as your scoreboard and “North Star”
- Avoiding the profit trap of every emerging category leader and becoming the incumbent–“live long enough and every hero becomes the villain”
Ignore spreadsheets and current values, and you will have to raise money at a more dilutive price than you’d like (or worse yet, not be able to raise). Forget the longer-term story, and you will allow incumbents to catch up or startups to spring up from the weeds and overtake you.
This is true in a “normal environment,” but doubly so when the world turns to greed and pure story time—such as 2021’s excess or 2023’s attitude of being scared by your own shadow. I’ve been lucky enough to be a VC for over 20 years through the dot com bubble and burst, the mortgage bubble and burst, and the Covid bubble and burst. The wheel of chaos seems to spin faster and faster. Our firm, Tidemark, which I founded in 2021, has already gone through what appears to be a full cycle of bubble valuations, the trough of disillusionment, and now a return to normalization.
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Building a company is hard, and building it during a changing market cycle makes it even harder. This post is to help founders think through valuation in the context of cycle changes, especially how to strike the balance between story and spreadsheet, depending on where the cycle is.
Spreadsheets = The Past
Spreadsheets (and the financials they hold) are the scoreboard—it’s winning and losing. It’s how you get paid. A company’s financial profile (e.g., revenue, EBITDA, growth, and free cash flow), multiplied by its valuation multiple, is the ultimate determinant of its value. This value matters because you divide it by the number of shares, which determines how much each of us—management, employees, and investors— gets paid. Value divided by shares equals college tuition, first homes, Teslas, and Rivians.
However, just because the spreadsheet is important doesn’t mean this approach to company valuation isn’t riddled with flaws. Inherently, a scoreboard can only look backward while future cash flows drive stock prices. As an investor, I don’t actually care what happened last year; what I am paying for is greatness going forward. The only reason the past matters is it helps me better understand tomorrow. I need to know how the financials will grow to drive the company's value and what it will look like at exit to drive multiples.
Story = The Future
The future is where the story plays an equally important role. The management team needs to be superheroes with unique powers that will allow them to pull this off. In most stories I hear, the TAM is always “massive.” Founder math sometimes goes something like, “There are 8 billion people on the planet, each eats 5 candy bars a year at $2 per candy bar, we are serving an $80B TAM. If we get 1% of that TAM, we’re a $800M ARR company!” Obviously, it never works like this, but that never stops people from trying to pitch this storyline.
From there, the story moves into our superheroes beating the bad guys with a combination of dazzling UI, finely tuned UX, and a world-class GTM. Surely, this will be enough to beat the old and sleepy companies.
This story is important because it drives the exit multiple just as much as the spreadsheet does. Allow me to illustrate. If you’re a $100M business growing 20%—pretty good, not great—how long will it take you to double your business? 4 years of blood, sweat, and tears. This is true of all companies undertaking a similar journey. However, some companies with that exact profile will get significantly higher multiples. How? By having a more compelling market story. Multiples are driven by the fashion of the crowds as much as they are by underlying fundamentals. It’s what the voting machine of the market is saying this very minute. And it can change on a minute-by-minute basis! These things aren’t steady, and because you are forecasting the future, investors always want to hear about a great story.
In practice, the spreadsheet vs story dichotomy means that you have to know which tool to use and when. In general, you typically start with a compelling story and then move to spreadsheets. However, the most skilled founders are able to run each historical business line like a spreadsheet while preaching the story for the next S curve of growth.
This is simple! And somewhat obvious. However, the implications are not.
Implications
1) You Need to Know Your Investor’s Archetype
When you talk to a private equity investor, don’t get offended if your beautiful business is reduced to a series of metrics, a mere spreadsheet. Give them gross revenue retention rate, gross margin, & EBITDA, and they will tell you how much they like your business—e.g. a price.
On the other hand, a VC is likely much more narratively driven. If you get a chance to read their memo, there’s a protagonist with a tough upbringing (who then went to Harvard or Stanford) who struggled with a problem, found the magic ring (UI, data set, and, of course, AI) that changes everything, and then created a superpower to destroy an evil incumbent.
Why? We’re all a function of our environment and incentives:
- Time Horizon: The closer you are to exit, the less story and more spreadsheet your investor will want because you have less time for your story to turn into a spreadsheet in the future. For example, public companies with public investors get voted on every day. Public investors buy and sell shares on small differences in spreadsheets if it changes their view on the long-term story.
- Capital Intensity and Stage: Bigger dollars require a significantly more precise spreadsheet forecast. When you’re investing $1M early in a company’s life, a compelling story will do. If you want to raise $100’s of millions, you better bring your spreadsheet game!
- Growth Rate: The slower you grow, the less investors will focus on what your company could be (story) and the more focus on what you are today (spreadsheet).
2) Beware of Banker Certainty
Investor and banking presentations are filled with great visualizations that describe the relationship between certain metrics and valuation multiples. There is always some new “Rule of…” that supposedly is the one metric to index on. The Rule of 40 is great for integrating growth and profit, but why 40 and not 25 or 60? Why is the relationship between growth and margin a straight addition and equal weighting instead of a more complex relationship? Standard metrics become standard because they are just visualizations of the crowd’s wisdom. That means that these supposed goalposts move all the time. They’re totally nonsensical. All that matters is consistent, steady performance in markets, good and bad.
Remember, current trading multiples are only a mosaic of how people trade that day. All the fancy science and regressions visualizations are ultimately the wisdom of the crowds. What you care about is how people may value companies over time!
3) Growth Journey for Founders
The particularly hard part for founders is the growth journey. In the early days, you were almost exclusively a storyteller. Then, you have to transition to intuitively understanding your company's spreadsheets—a totally different skill set. To make it even more challenging, the employees and investors who joined you during the storytelling phase will have a challenge leveling-up their understanding with you. They’ll likely rely on heuristics that will hurt you in the long run.
I’ve seen too many founders get burned by their investors as the cycle ends. You want someone who knows the spreadsheet and the story. If your “spreadsheet game” isn’t great yet, don’t bring on big capital investors or small capital from primarily big capital investors.
4) Watch Out for the Profit Trap
In 2023 (we’ll see for 2024), all investors were preaching profits. Even VCs are getting into the spreadsheets and preaching capital efficiency. Assuming you are fully financed, this may be the absolute wrong time to push for profit. As part of your growth journey, you need to learn as the founder when to push back on the spreadsheet even when your investors are the shortest-term of short-term thinkers—public investors—to avoid the profitability trap.
I see two types of profitability traps:
- Not Taking Your Shot: Chaos creates opportunity. Warren Buffet famously said, “Be greedy when others are fearful.” The best CEOs know that the best time to double down is when everyone is hesitant. Recently, think of how Meta had a quarter with high CAPEX spend. The markets were furious! Investors were calling out for blood. Zuckerberg was coy about what the money was spent on besides “AI and infrastructure.” It turns out that all that spend was him grabbing GPUs at discounted rates before the current LLM boom, enabling him to pursue GenerativeAI in a huge way. As Ben Thompson said, “The quarter they got killed in the stock market was actually one of the single most important investments they made for the next five years.” Invest while others aren’t. In the private markets, a great example is ExactTarget. Initially, the company grew to ~$50M ARR and profitability, with less than $6M in primary capital. Then, in 2009, in the heart of the global financial crisis, ExactTarget engaged in an aggressive investment and scaling effort. They took negative margins and raised $200M+ in funding to reach $400M in ARR and category leadership. For more, see our interview with their co-founder, Scott Dorsey
- Stack the S-Curves: As a successful company wins a market, it invariably slows down in its ideal customer profile as it reaches saturation. A good company becomes great because it is able to drive operating leverage and profits out of its core business while successfully investing in the next S curve of growth (such as Reed Hastings and Netflix using their disc business to kickstart the streaming business). Not every company gets this right because they are reluctant to extract margin in their core, or their growth businesses take a while to work. Then, per the theory above, as a company slows, investors (particularly public investors) will be increasingly spreadsheet-driven and push for profits. This may choke off the new S curve of growth, optimize the core market, and prevent a team from funding that next s-curve. It’s a downward cycle of doom that starts from an understandable place of wanting to achieve profitability.
Conclusion
When I think about the company that has best struck the balance between story and spreadsheet, it's Amazon. The company has consistently knocked it out of the park through multiple market cycles, an enormous amount of product innovation, and thousands of S-Curves. The two great examples were the company raising $2B in convertible debt in 2000, right before the bubble burst. This capital was necessary to keep them fully financed through the crash and build their necessary network. They ensured they had the funds to invest during the downturn and used that capital wisely.
The other, most obvious win is AWS. I still remember when Amazon finally debuted the AWS line on its earnings report. This company, supposedly relegated to the margin-thin retail industry, had quietly built a monster of a business. Bezos is one of our most talented founders, and one of his strongest skills is the ability to invest in things at the right time.
As a founder, you should take a page from Bezos' playbook: raise capital from a position of strength and build out your next big thing while everyone's still applauding your first hit. It's not easy, but if you can master this balancing act, you'll be just fine if (when) the funding music stops.
If you’re looking for a partner to figure out how to do this for your own business or if you are a gifted storyteller but need an investor to help you with your spreadsheet game, let’s talk. Our strategy uniquely straddles both areas—we can help story founders ground the business in numbers, and we can help the spreadsheet jockeys dream bigger.
