Tech-enabled companies straining under weight of software-sized valuations

There’s a misalignment going on, a void between the business fundamentals at the core of tech-enabled companies and the out-of-touch software-sized valuations they’re being emblazoned with. It’s proving a weighty thing for these tech-enabled companies to carry.

In March, Shyp, the so-called “Uber of shipping,” announced it was shutting down after failing to live up to the hype of the $250 million valuation it was tacked with in 2015. Shyp raised $50 million on the valuation. And CEO Kevin Gibbon ran with it.

“At the time, I approached everything I did as an engineer,” wrote the founder in a blog post announcing the end of Shyp. “Rather than change direction, I tasked the team with expanding geographically and dreaming up innovative features and growth tactics to further penetrate the consumer market. To this day, I’m in awe of the vigor the team possessed in tackling a 200-year-old industry. But, growth at all costs is a dangerous trap that many startups fall into, mine included.”

In a lot of ways, Shyp was being valued as a software-as-a-service (SaaS) company, when it was, at its core, a shipping company. It didn’t take long for its “one-size-fits-all” delivery model (Shyp’s business model was to make up the cost of delivery via cheaper bulk costs for those deliveries) to evolve into new fees for returns and changing prices for bulk shipments in order to drive revenue.

The problem is, unlike its SaaS peers, non-SaaS companies tend to be short on sticky revenue. And given that these sorts of companies are valued based on revenue multiples, it can be challenging to make it work in the on-demand sphere.

“Software companies – the first “S” in SaaS – command high multiples because, at scale, their operating margins can be 30-40 percent and contribution margins on revenue are usually 80-95 percent,” says Joel Lessem, CEO of Firmex, a Toronto-based SaaS company and leading virtual data room provider. “Not so for shipping companies, and having their revenue valued the same way simply does not make sense.”

In a lot of ways, 2015 was the year of hype for businesses like Shyp – delivery startups DoorDash (valued at $600 million that year), Postmates (valued at $450 million), and meal kit Blue Apron (valued at $2 billion) dominated. By the third quarter of 2015, the on-demand category peaked at 115 deals, according to data from CB Insights. By 2016, the category had fallen out of favor with deals slipping by 35 percent.

Tech-company or tech-enabled company in tech clothing?

Blue Apron springs to mind as a prime example of the misalignment going on. In April 2014, the meal kit company was valued at $500 million following its Series C. By June 2017, it had a proposed $3 billion IPO valuation. The final IPO valuation sat closer to 1.9 billion (by April of 2018, its share price had fallen by 80 percent.)

In an editorial last July, Alex Wilhelm, Crunchbase News’ editor in chief called the discrepancy between proposed and final IPO valuation a reclassification of the company as opposed to a repricing:

“If Blue Apron is being revalued not due to changing financial performance, but a changing categorization of its business, it’s something that could impact other firms that we tend to count under the technology unicorn aegis,” says Wilhelm, citing peer-to-peer Lending Club and Jessica Alba’s much-hyped e-commerce platform Honest as examples of businesses that the market “has not, or may not, award a traditional tech price-revenue multiple.”

“And if you can’t get to a SaaS price-revenue multiple, for most unicorns at least, you are underwater,” wrote Wilhelm.

The bandwagon effect

A study by Firmex and Mergermarket interviewed 25 dealmakers in North America to get their take on the challenges of valuation. 68 percent of those surveyed called the bandwagon effect – a bias where buyers are willing to pay more for a target in a hot sector – a “frequent problem faced in any M&A deal.”

“Hot sector syndrome affects most of the valuations,” said a VP for corporate development at a consumer company with more than 50,000 employees worldwide. “We usually assess the cycle, trajectory, duration and the spread of this hotness in the sector and the level of impact it is showing. Many times, brands ride short-term demand in the market, after which the valuation subsides.”

Amidst the newness (the on-demand valuation gold rush was only three years ago), the lines are apt to stay blurred between SaaS businesses, and their tech-enabled, non-SaaS counterparts. After all, at a high level, both are targeting a large market. And who wouldn’t want to see their company wear a SaaS valuation?

As Shyp founder Gibbons pointed out in his candid goodbye letter, it didn’t take long for the shipping company’s explosive growth and success to earn it comparisons to Uber.

“From a growth standpoint, who wouldn’t want to be compared to Uber? In a handful of years, Uber had transformed the way consumers thought about transportation,” wrote Gibbons. “We could do the same, I was told. And I believed it. The numbers told a story and I became fixated on that story.”

Andrew Seale

Andrew Seale is a Toronto-based business writer who contributes frequently to Yahoo Canada Finance, The Globe and Mail's Report on Business and The Toronto Star.