You might not have heard about Domo, but it’s an important analogy to follow as several software companies in the brick and mortar ecosystem raise money at sky-high valuations.
Domo is a me-too software startup in the very crowded and undifferentiated field of business intelligence SaaS. We might even dare to say the field of offerings is commoditized too, much like POS and payments. In our opinion Domo raised the money it did on the celebrity status of its founder, Josh James, who has a respectable past. From Crunchbase,
Before founding Domo, Josh was the CEO of web analytics firm Omniture, Inc., which he co-founded in 1996 and took public in 2006; and from 2006-2009, he was the youngest CEO running a publicly traded company.
Omniture was the number one returning venture investment out of 1,008 venture capital investments in 2004, as well as the number two performing technology IPO of 2006. Omniture was also the fastest or second fastest-growing public company for three consecutive years. Josh later facilitated Adobe’s $1.8B acquisition of Omniture in October 2009.
https://www.crunchbase.com/person/josh-james#section-overview
Domo raised $690M over six and a half years with the last round trumpeting a $2.3B post-money valuation. Once companies reach valuations in the billions it’s harder to keep raising capital in the private markets unless growth is absolutely ridiculous. Uber, for example, raised $3.5B in the summer of 2016 at a $63B valuation. How? Because it was growing more than 100% on an annual basis. And it was achieving that growth on billions of dollars, not tens of millions or hundreds of millions. Billions. This is an absurd amount of revenue accretion: every hundred million dollars in recurring revenue is basically a public company in itself.
Suffice it to say Domo was growing comparatively slowly yet still needed capital to support their burn. According to the S-1 Domo later filed for its IPO, they were burning $176.6M a year after $108.5M of revenue. Yes, the company was burning through nearly $200M a year with $130M of that coming via marketing. Despite raising nearly $700M Domo had already chewed through $800M ($100M was from debt) and had $70M in the bank at the time of IPO. One of the biggest risks Domo stated in its S-1 was its likelihood of needing more capital to sustain its burn.
Yet the public markets weren’t as forgiving when Domo did IPO in summer 2018.
Domo Technologies is no longer on the coveted list of unicorns, with the business intelligence company recently filing to go public at a valuation of roughly half a billion dollars. The company, which intends to list its stock on NASDAQ under the ticker DOMO, is offering 9.2 million shares to public investors at a price range of $19 to $22. Considering the fact that the company will have just under 25 million in outstanding shares after an IPO (without the impact of an over-allotment option of 1.38 million), this works out to a valuation in the range of $475 million to $550 million – less than a quarter of the $2.3 billion valuation at its last round of funding in April 2017.
https://www.forbes.com/sites/greatspeculations/2018/06/21/why-domos-ipo-valuation-is-down-over-75-from-its-last-funding-round/#2ae3377e58fd
When down rounds like these happen employees get shellacked; employees who were granted options at $50 per share to coincide with the $2.3B valuation are underwater when the shares are trading at half that figure. It’s the same dynamic that we initially assumed happened at Revel though their executives later clarified that their investors offered some reprieve to keep morale high.
What’s the learning here? Public markets deal with profit and loss much differently than private funds who must deploy capital or lose it. Barring extreme levels of growth on billions of dollars (i.e. Amazon), you need to show a clear path to profitability.
Toast has raised money at a $2.7B valuation. Unlike Uber, Toast is not multiplying billions of dollars in revenue annually. While they’re growing revenue at 150% annually, they’re also losing a lot of money according to inside sources (Toast wouldn’t comment on the matter). And as Domo has showed us, the public markets don’t like companies losing lots of money unless you’re growing at ridiculous rates. Even the market reaction to the recent IPOs of Lyft and Uber make this clear.
For Toast to earn a profit, we can see some pretty drastic scenarios:
- Toast cuts a lot of their engineers. Engineers are expensive and once you’ve built a stable set of features supporting those features is dramatically easier. Thus the math says you can whack a good number of your engineers and not lose customers
- Toast tightens their marketing belt: say good bye to free hardware, reduced software prices, and all other gimmicks to win customer accounts. Toast, via their investor dollars, has perversely disrupted the economics of the POS industry. Merchants have grown accustomed to Free POS and respectable industry competitors who lack large balance sheets have been marginalized. Capital can be a business strategy but it should be used to advance the industry to the next business stage, not to win market share so you have the potential to abuse customers in a locked-in model. More specifically, we don’t think suppressing prices just to make back the money hand-over-fist on processing at an effective APR of 65% (which Toast has demonstrated) is an admirable business aim. Collectively the payments industry has done some real harm to the customers that pay their bills. #Irony
- Toast increases pricing – likely in their processing rates. Because Toast gives themselves optionality in their processing language we think if they were to seek profitability through revenue increases it would come from the payments part of their business.
Even though Toast has pocketed $250M in their latest round, they likely have no more than 18 months of runway left by our estimation. They must either raise more money in the private markets – which could be very challenging, per the below paragraph – or make a run at an IPO before cash on hand becomes a problem.
Toast CEO’s has gone on record saying they’re in no rush to go public. That makes for a good soundbite but it’s getting harder to believe. To stay private Toast will need to do one of two things:
- Maintain a growth rate of at least 150%. As DoorDash’s recent fundraise has shown, there’s private venture money sufficiently large for companies growing fast: in DoorDash’s case their growth went from 250% to 325% in 2018, though on revenues much larger than those of Toast per our sources
- Find EBITDA so private equity can use debt to afford a transaction
As Uber and Lyft have demonstrated, going public today might mean that Toast’s burn rate becomes an issue. Uber was losing $1.8B on $11.3B of revenue, or -16% EBITDA. Insiders have shared that Toast is burning ~$60M on $200M of projected revenue, or -30% EBITDA.
Toast’s management is not inept, and they’ll surely have a path to profitability laid out in their S-1. If you’re a Toast customer, don’t be shocked if your bill goes up as Toast gets closer to an IPO. And if you’re a Toast employee, don’t be surprised if you’re called to a “team meeting” at 4:45 PM on a Friday.
Godspeed.
