What Kind of Value Generator is Your Company?
The question often posed to the software industry is how do privately owned software companies achieve high valuations whilst simultaneously loosing huge sums of money?
This week CEO Today hears from Ken Stillwell, Chief Financial Officer at Pegasystems, who has the answers on unicorn valuation, growth in the sector and the definition of a ‘ship in the desert’.
Often known as “unicorns,” bearing similarities to magical creatures, they represent the future of disruptive technologies with fiery tendencies. These Unicorn valuations have been a talking point in the tech industry, with the aim of every software start-up to become one. Investors should be looking for other types of start-ups apart from Unicorns, hence generating shareholder value in the software sector can be done using a different method. So, what are the different business models that can truly help drive ROI?
The Golden Goose
Firstly, software companies can create shareholder value to become consistent cash-flow producer companies, such as CA Technologies. A reliable company such as this experiences low year-on-year revenue growth because the markets that it works in are established and have low growth.
Specifically, a Golden Goose company will seek to encourage operational efficiency to lower costs and improve profitability to generate huge cash flows annually. Thus, shareholder value is delivered via predictable cash flows in dividends and share buybacks to investors every year.
A key risk associated with this method is that cash generators have an expiry date and can be limited to this investment. A piece of advice could be that hiring and keeping innovators or growth-drive managers engaged in this business is challenging, so operational managers that flourish in a Golden Goose business risk the culture being less innovative and too “stable.”
Hiring and keeping innovators or growth-drive managers engaged in this business is challenging, so operational managers that flourish in a Golden Goose business risk the culture being less innovative and too “stable.”
The Unicorn: Driving Hypergrowth
Secondly, an alternative way to create shareholder value is by producing hyper annual revenue growth. Those businesses that fall under the Unicorn model category are said to grow 40% or more annually and aim to secure market share rapidly in emerging, disruptive markets. Unicorn companies can create shareholder value because their revenue growth rates are quickly accelerating, which suggests to investors that the organisation will (one day!) make a profit to deliver cash flows.
Furthermore, venture capitalists often say that an early-stage company that makes money is not executing. Some venture capital firms may expect that more of their investments will lose money than will make money, but the gamble is that those very few “home-run” investments will make up for the losers. This model does not work for the executives and employees of those companies that perform less than exceptionally. Imagine 36 people placing bets on a roulette wheel; one winner gets a 35 to 1 return and is covered; the other 35 losers go home broke.
In times of economic crisis, the hyper growth business can come up against obstacles. Furthermore, due to the hyper growth’s tendency to develop a culture around rapid revenue growth and rapid spending increases with no concept of profitability, establishing the rules to maximise profitability is challenging. The fast growth and spending can make Unicorns too focused on driving growth at any cost and cause its decisions to be fiscally irrational.
The culture of Unicorns is mainly focused on growth, beer, fun and candy, thus typically employees switch roles a lot and aren’t worried about the long-term strategies of these moves. In reality, most of these companies will not survive long-term as standalone entities. Executives are expecting a sale and will be pleased with the outcome, financially. What happens to their customers and employees? This differs depending on the buyer, the price and the number of people and products displaced as part of the buyout.
The “Ship of the Desert”
A ship of the desert is comparable to a camel based on its strength, resilience, and brilliant design for its environment. Similarly, companies that create value for shareholders by delivering scalable and predictable growth are a “ship of the desert” in economic terms. These companies increase their revenue rates at consistent rates (annually 10% to 20%). Typically, they aim to work within large growing markets that are sustainable. As they balance revenue growth, these companies can face challenges due to profitability. Therefore, these companies are a good choice for shareholders who require a predictable and ongoing return on their investments.
Overall, when balancing growth and profitability, ensure rational decision-making and objective risk assessments throughout all management levels. Most companies will be able to achieve levels of balance, but few maintain longevity in this category. The challenge is to incorporate a mix of personality profiles, including innovators, process deployers, orchestrators, and optimizers. It seems that only perfectly created creatures will flourish in the economic realities that we face today.