The Economic Downturn: How To Thrive In The Era of Profitability

The Economic Downturn: How To Thrive In The Era of Profitability

July 20, 2022

This month, the S&P 500 entered bear market territory for the second time since the start of the pandemic. With economic indicators suggesting that this recovery will be slower than in 2020, it’s no surprise that the media and industry leaders are sounding alarm bells.

But where everyone else sees challenges, you should see opportunities. Profitable, growing companies like yours can take advantage of this moment to attract top-tier talent, drive growth, and beat the competition – if you respond proactively to the realities of the changing economy.

In this article, we’ll look at how you can find opportunities in this moment that will position your company for success in the years to come. Let’s start by taking a closer look at the key trends that are driving this economic environment.

Four Trends Driving The Market Downturn

The Stimulus

At the start of the COVID-19 pandemic, there was widespread agreement that a massive influx of capital into the economy was needed to prevent a serious recession. Loose monetary policy and negative real interest rates created an unprecedented fundraising environment that drove record valuation levels for growth-focused tech companies.

Sources: Cambridge Associates LLC Private Investments Database (as reported by investment managers), FactSet Research Systems, and Frank Russell. Note: Outliers were identified and excluded, and the same methodology was applied to the private equity and public company universes.

 

But now the party is over. Capital is no longer free. Interest rates are rising. And that shift is already having a tremendous impact on fundraising and valuations.

Inflation

Governments around the world implemented fiscal and monetary stimulus measures to fill a massive demand hole created by the COVID-19 pandemic. As the economy started to reopen, this liquidity creation created supply chain challenges and price pressures throughout the economy as demand overwhelmed supply. This month, the government reported that consumer prices increased 8.6% through the end of May, the fastest rate in forty years.

The Fed is now focused on tightening liquidity conditions to control inflation. In June, the Fed announced an interest rate hike of 0.75%, the largest in nearly three decades. But five year forward inflation expectations remain at the highest levels in years, reflecting a pessimistic long-term attitude in the market.

The Cost of Capital

For years, capital was free. It’s suddenly become expensive. And that shift has major implications.

When capital was free, companies that burned through enormous amounts of capital and neglected profitability in the pursuit of hypergrowth were seen as the most promising startups. But in a world where capital is expensive, they’ve quickly become the worst performers.

Now that capital comes at a cost, investors are reassessing how much credit to give companies for expected profits that could still be many years away. The net effect of all these changes appears to be slower deal velocity until valuation and risk come back into balance.

The Shift to Profitability

While market challenges don’t approach the level of the dot-com crash or the Great Recession, the tech sector is trading down significantly. As of May of this year, Big Tech has shed over $1 trillion in value over the last three trading sessions.

With revenue multiples in the tech sector cut in half in the last six months and growth-adjusted multiples falling even further, the market is shifting away from hypergrowth companies – and toward companies that can generate cash right now.

In this environment, profitable, growing SaaS companies offer an ideal balance of risk to reward. SaaS businesses have a track record of consistent performance due to their revenue subscription models, and here at Serent, operating performance for our portfolio companies remains strong. While high interest rates will put pressure on valuations across the board, unprofitable hypergrowth companies are likely to be most affected.

If you’re a profitable business with a consistent record of growth and a devoted customer base, that’s great news. You’re ideally positioned to make the most of this moment and leapfrog ahead of the competition. For companies like yours, today’s market uncertainties aren’t something to fear. They’re a rare opportunity. And you should make the most of them.

How Your Company Can Make The Most of This Moment – And Emerge Stronger

Face Reality

The era of free capital is over. Times have changed. And while the market is shifting, now is not the time for panic or wishful thinking. The companies that thrive in the years to come will be those that are most responsive to today’s changing conditions – not those that wish things would go back to the way they were.

Now is the time to reevaluate and look for opportunities to capitalize on today’s changing market conditions. Whether it’s scaling your hiring process, increasing your market share or implementing more value-creating initiatives, you now have an uncommon opportunity to position yourself strategically for success in the years ahead.

Focus on Profitability

The companies that have been most heavily impacted have been high-flying, hypergrowth companies that were growing at 100% or more year over year – but weren’t generating a profit.

In the new market landscape, the winners will be profitable companies experiencing steady growth. Historically, privately held, PE-backed companies have experienced stronger revenue growth than public companies:

Sources: Cambridge Associates LLC Private Investments Database (as reported by investment managers), FactSet Research Systems, and Frank Russell. Note: Outliers were identified and excluded and the same methodology was applied to the private equity and public company universes.

 

Vertically-focused B2B SaaS companies that have happy customers, engaged employees, and consistently growing year over year will stand out from the crowd – and have an opportunity right now to get ahead of the competition.

Look for Opportunities

For years, startups have been operating in an exceptionally competitive recruiting and hiring environment. With the FANG companies implementing hiring freezes and staff reductions happening across the tech sector, now is an ideal time to bring on exceptional talent. If you’re a first-time CEO or working with a lean team, our Human Capital team has developed repeatable processes to make your executive recruiting process successful – and scalable.

Now is also an ideal time to start exploring revenue-generating initiatives, such as cross-selling to your customer base or integrating payments into your platform. Our Growth team has extensive experience partnering with our portfolio founders, CEOs, and management teams on value creation initiatives that make a real impact on the top and bottom line – like partnering with one of our portfolio partners to build a payment facilitator.

And with valuations coming back to earth, you now have an opportunity to increase your market share through strategic inorganic growth or mergers & acquisitions. Whether it’s adding a new product, growing into new markets, or acquiring new customers, our Growth team are experts in understanding your market and building relationships with the key players.

If you’re new to M&A or looking for support to finance an acquisition, our team partners with our portfolio companies across all stages of the process – from identification, to due diligence, to financing, to post-merger integration. Learn more about how Aria Care Partners partnered with Serent to enter new markets.

The market is down. But profitable, privately held companies are positioned to thrive in the new economic landscape. Succeeding in the years to come will require hard choices, but companies that look for opportunities in today’s changing market will come out ahead.

At Serent, we’re excited to help founders maintain profitable growth – and emerge from this moment stronger than ever before. Inspired to capitalize on the market and advance your company? Connect with a Serent team member.

Serent Capital invests in growing businesses that have developed compelling solutions that address their customers' needs. As those businesses grow and evolve, the opportunities and challenges that they face change with them. Principals at Serent Capital have firsthand experience at capturing those opportunities and navigating these difficulties through their experiences as CEOs, strategic advisors, and board members to successful growing businesses. By bringing its expertise and capital to bear, Serent seeks to help growing businesses thrive. Learn more about our portfolio companies.

Disclaimer:

Nothing presented herein is intended to constitute investment advice, nor sales material, and no investment decision should be made based on any information provided herein. Information provided reflects Serent's views as of a particular time and are subject to change without notice. Any forward looking statements or forecasts are based on assumptions and actual results are expected to vary from any such statements or forecasts. While Serent has used reasonable efforts to obtain information from reliable sources, we make no representations or warranties as to the accuracy, reliability, or completeness of third party information presented herein. Past performance is not indicative of future results. There can be no guarantee that any investment strategy employed by Serent will be successful. A full list of portfolio holdings is available on Serent's website.