How can tech companies adapt to new norms in growth, profitability, sustainability, funding (and more)?
In this article, we examine how companies can thrive amid funding and sustainable business growth model changes, and evolving investor expectations regarding profitability and growth.
During this period, valuations were often based on revenue multiples. Companies that could show exponential growth in their top-line revenues were rewarded with high valuations, even if they were burning through cash and operating at a loss. This was underpinned by the belief that once these companies achieved sufficient scale, they could easily monetize their user base and transition to profitability.
However, this perspective has shifted significantly. Investors have become more discerning and risk-averse, moving their focus towards profitability, cash flow, and sustainable growth.
There are several reasons for this change:
- Market maturity: As the tech industry has matured, there are fewer untapped markets left, making it harder for companies to achieve exponential growth solely through user acquisition.
- Past failures and burn rates: High-profile failures of companies that followed the ‘growth at all costs’ model, along with concerns about excessive burn rates and unclear paths to profitability, have made investors more cautious.
- Economic conditions: Economic uncertainties and tighter financial conditions have led investors to prioritize financial stability and profitability over unchecked growth.
- Regulatory environment: Increasing regulatory scrutiny on tech companies has added another layer of risk, making investors more vigilant about the companies they choose to back.
Implications for Tech CEOs
For tech CEOs, this shift in investor sentiment means that they need to balance growth with financial discipline. They are now required to:
- Show a clear path to profitability: Investors want to see a sustainable business model that leads to profitability, even if it means slower growth.
- Manage cash flow prudently: Efficient cash flow management has become a critical component of a company’s financial health.
- Focus on unit economics: There is an increased emphasis on positive unit economics to ensure that the business is fundamentally sound.
- Build resilient business models: CEOs need to build businesses that can withstand economic downturns and other market uncertainties.
Another big shift fast becoming the new normal
The increasing focus on sustainability and Environmental, Social, and Governance (ESG) criteria reflects a broader shift in societal values, as well as a growing recognition of the long-term risks and opportunities associated with these factors. Investors are progressively acknowledging that companies with strong ESG practices tend to exhibit better risk management, more innovation, and greater long-term financial performance. Companies that have started and progressed here are an indicator of management's values and capabilities.
Why the focus on sustainability and ESG?
- Risk management: Companies with poor ESG practices may be exposed to a range of risks, from regulatory penalties for environmental breaches to reputational damage due to unethical labor practices. Investors recognize that strong ESG practices can mitigate these risks.
- Consumer demand: There is a growing demand from consumers for sustainable and ethically produced products and services, driving companies to integrate sustainability into their operations.
- Regulatory environment: The regulatory landscape is evolving to include more stringent requirements around sustainability and corporate governance, making ESG compliance a necessity.
- Attracting talent: Companies with strong ESG values are more likely to attract and retain top talent, particularly as younger generations enter the workforce with a greater emphasis on working for socially responsible companies.
- Long-term performance: There is increasing evidence to suggest that companies with strong ESG practices deliver better long-term financial performance, making them attractive to investors looking for sustainable returns.
What’s the impact on tech companies raising capital?
- Increased expectations and scrutiny: Tech companies seeking to raise capital are facing increased scrutiny from investors regarding their ESG practices. Investors are looking for evidence of sustainable business models and responsible corporate behavior with a credible plan to improve over time
- Valuation impact: Companies with poor ESG practices may see a negative impact on their valuations, while those with strong practices may command a premium.
- Access to capital: Some investors, particularly those with a focus on sustainable investing, may choose to only invest in companies with strong ESG practices, affecting the pool of available capital for companies that do not meet these criteria.
- Strategic opportunities: A focus on ESG can open up new strategic opportunities for tech companies, including access to green financing options, partnerships with sustainable businesses, and the development of innovative products and services that contribute to sustainability goals.