Homecoming: Customer Profitability In Adverse Market ConditionsBy Nur Malek Pascha | Wed, 09/14/2022 - 10:00
Although public markets are starting to show positive upward momentum – in the technology space, in particular – the downturn and valuation adjustment that took place in the first half of 2022 forced strategic, VC and private equity players to rethink their investments and risk profiles. This resulted in a flight to quality toward companies that can show consistent profitability or break-even levels and a deeper resolution to reach customer-level profitability after demonstrating product market fit.
According to Crunchbase, Latin American startups raised US$2.3 billion during the second quarter of 2022, representing around a 66 percent reduction from the same quarter last year. Having said that, the region has shown its strength in early stage and Series A investments with average rounds of US$15 million, with some exceptions, of course. This tighter funding environment has been mainly driven by tightening global market conditions and a generalized increase in interest rates, which boosts an investor’s cost of capital, which in turn increases its quality expectations for the assets it is funding or acquiring.
It is very important to note that even though the amount of VC investment shrank in 2022 in Latin America, there are still deals to be made. Also, this doesn’t mean that the region is no longer “hot.” Latin America is still a hub of great companies and founders and some big deals have been made this year, such as the US$200 million Series C for Habi.
The important question is what investors are looking for in this complex scenario and also what makes great entrepreneurs thrive in this market, which is far from that experienced during the pandemic. Aside from the fact that interest rates were almost zero during 2021, there was also a great deal of optimism and euphoria that positively impacted every segment of the tech industry and, of course, valuations.
Now, the times have changed and we can assure that winter is here. The investment recalibration is already a reality and it seems that in this market, the secret to making it through is not only a matter of growth but sustainability for the next 24 months at least. It is very clear that without ambitious growth targets, investors won’t get their profits. But there is an important question in the air: Is it possible to build great companies with amazing revenues on solid unit economics and financials?
I think it’s challenging but not impossible. For example, at Enviopack, we pride ourselves on the quality of our platform and the services we provide to our customers but also on a business model that was profitable from day one. With no initial outside investment, we were always fanatical about customer profitability and the efficient use of our cash and resources growing by double digits year over year.
Looking back at our history and even forward into our future, we believe that the long hours spent designing and structuring our business, ensuring we delivered quality services with clear upward monetization paths for all our customers while delivering increasing amounts of value at each step, was the key for our success. We wanted to make sure that we had a sustainable, long-term opportunity and were not hostages to trying to reach an ephemeral “at scale” future, so we decided to be cash-efficient at scale at every step. We are thankful for the experience and for the advisers who have helped us along the way and are still part of this exciting story.
Having said that, there’s no right or wrong on how each entrepreneur decides how to scale its business. Whether to fold or double down will depend on each funding team and board members. For me, it is mandatory to read the market timing, especially if the startup requires funding. What is certain is that in this turbulent and unpredictable context, you have to make sure to raise money when your numbers are great.
As a parting thought, I always remind myself of the basic concept in McKinsey’s Tim Koller’s valuation masterpiece: if a business is profitable, you need to fund growth; but unprofitable growth destroys value.