The Premium of Platforms

Valuation Insights from the Bessemer Cloud Index

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At Equal, we’ve been long time admirers of the power of platforms and their role in creating long-term value.

We’re not investing in platforms just for the sake of it - our obsession with these businesses lies within the superior cash flow potential they have with scale. To illustrate this, we leveraged data from the Bessemer Cloud Index, the leading benchmark of public cloud companies to categorize companies into two buckets: “Platform” and “General SaaS”. The results show resounding differences in how the public market treats these companies given the efficiency and cash flow propensity of the different models.

Before digging into the findings, it’s worth aligning on how we define a ‘platform’ (especially given the amorphous nature of the term, and how often it is flung around in venture/startup rhetoric). At Equal, we’ve defined tech platforms as software systems that generate increasing returns to scale via proprietary Data, Distribution or Development (the 3Ds).

Leveraging the definition above, multiple investors on our team went through each company in the cloud index and categorized each business into one of the two buckets. We then consolidated the results to come up with our final list. Companies such as Shopify, Snowflake, and Salesforce slotted into the platform category while companies like Sprinklr, Freshworks, and Toast fall into the traditional SaaS category.

Our findings showed that the platforms in the index commanded significantly higher EV/revenue multiples and significantly higher overall market caps. While traditional SaaS  companies averaged a 3.9x EV/revenue multiple, platform companies commanded an 8.2x revenue multiple, demonstrating a >2x premium. The median market cap for a traditional SaaS company in the index is $4.1B, while the median market cap for a platform company is $26.4B! Platforms are not only valued more for each dollar of revenue, but they can also become significantly larger businesses. This is due to their ability to dominate market share within their category and expand into new categories from a highly defensible position. In the chart below, we’ve shared the data to showcase how companies that we had categorized as platforms are performing and being valued in comparison with those that are traditional SaaS.

One of the reasons platform businesses can become so big and so valuable is they are far more efficient at growing. You can see this in the data below by the superior Rule of X (explained below) and efficiency (FCF margin of ARR + ARR YoY growth rate). Platform businesses demonstrated an average of 70.5% when looking at the Rule of X whereas traditional SaaS showed an average of 42.4%. Similarly, platform companies outperformed SaaS companies 45.4% to 28.7% in efficiency, demonstrating the ability to grow in a more FCF effective manner than their SaaS counterparts.

This data helps explain why investors value platforms so favorably to SaaS companies. While their gross margin, FCF and even growth may be similar upon initial investment, over time platforms grow more efficiently than SaaS companies, thus providing a pathway to far greater FCF potential in the future. For those who believe in DCF as the root of valuation, it becomes clear that platform companies will produce far greater FCF as they mature. As you look at the graph below, there is an incredibly strong correlation between Rule of X and EV/Revenue multiple, showing how favorably investors consider that metric (while also showing how the prevalence of platform companies in the upper-right quadrant).

The Long-Term Value of Platforms

Platforms are NOT just a cool term to throw around in startup circles. They are incredibly hard to build, but hugely valuable once established. Whether it's establishing data network effects within/across customers, enabling a thriving 3rd party developer ecosystem, or maintaining a multi-sided marketplace of stakeholders, these businesses establish dominance over their category, enabling them to focus on their customers > competition. As AI makes it easier and easier to achieve product parity, we believe the value of platform companies will diverge even further from traditional SaaS companies as the increased competition further erodes SaaS multiples. SaaS companies were once lauded (and valued as such) for their defensibility given their recurring revenue, but as competitive forces attack the software category, it’s increasingly clear that recurring revenue alone will not enable you to achieve sustainable FCF as a business.

Whether you’re a founder or an investor, it’s never been more important to recognize that “not all revenue is created equally”. While many companies may call themselves platforms during a pitch,the data will ultimately show the truth, making it more important than ever to build platform capabilities into the company as early as you can. If not, you might be stuck with a company far less valuable than what you previously thought.