How to think about your next 3 years in pro-tech if you want to raise or sell.
I wrote this blog in the hope that I can help some of the emerging prop-tech companies understand the current cycle of real estate and how they might want to think about their business over the next 3 years.
This article is especially relevant for entrepreneurs looking to raise funding or secure an exit (ie, sell) their prop tech businesses in the next few years.
The real estate market SUCKS right now!
Sales volume and units sold are down pretty much everywhere. High-interest rates and no inventory are creating the perfect storm of terrible for Realtors® and this is leading to many agents leaving the business. For those that remain, (agents, teams, and brokerages) they are battening down the hatches to weather the storm.
What this means for prop-tech companies is that right now it is going to be EXTREMELY hard to demonstrate much growth since the spending profile of Realtors® on tech tends to almost perfectly match the market.
When times are good, they spend! When times are bad, they look for cheaper solutions and stop spending on anything but critical infrastructure.
In short, now is a really bad time to be a start-up or struggling company in prop tech, as things are only going to get harder for the next 1-2 years.
The rule of 40 - a must-hit metric to maximize your exit or fundraise.
Anyone who is at all serious about raising funds or existing their business needs to understand the rule of 40. It's where you need to get to if you want to sell your business or raise money at a good valuation. I'm placing this first since not everyone is familiar, and for those that are, it's a reminder that if you're not there, you should not be thinking of selling or raising funds.
Simply put, the rule of 40 states that the combination of your growth rate and profit margin (typically we use EBITDA).
Investors in prop tech will look for companies who can achieve this metric as it indicates a healthy and sustainable business that is well run and has achieved product/market fit.
If you're small (say under $5M in revenue) then the rule of 40 should be much easier to hit (since any growth will show us a much higher % of revenue) but you may be re-investing all your profits into that growth. My recommendation is to have a small operating profit ie 5-10%, show that you can pay yourself, and then crank the growth as high as possible % wise since this is what investors or acquirers will look for.
If you're starting to build up some size/scale (let's say $5-$10M which is a decent size for a non-funded prop-tech company) then growth can be a bit harder. When I say growth I mean organic growth, not growth through acquisition. So maybe you're able to get 25-50% top-line growth YOY. In this case, if you're over 40% growth, it's fine if your EBITDA is low to nothing since the reason for it will be obvious: you're re-investing those profits to drive the growth. Perfectly natural. But if you're not well north of 40% growth, you better be showing a profit that makes up for it.
Now if you're larger (north of $10M annual revenue) like my company Real Estate Webmasters Inc, the numbers get a bit trickier. At this size, adding what would be considered a large amount of net new revenue (let's say $1-$2M in net new after churn revenue) might only amount to a 5-10% lift in growth. So at this level, you really need to be able to demonstrate that you are running a strong business that has a healthy margin established. It's the inverse of the small scenario - you need to make up the vast majority of the rule of 40 in profits.
My advice: Tank your revenue now and stabilize profits
Tank your revenue? Sounds crazy right? Not if you think it through. Let me explain.
If we can agree that prop tech spending follows the trend line in real estate AND that real estate is going to continue to suffer through 2024 then it makes sense that we adopt a strategy that not only allows us to survive a down market, but also that we look towards the future and work towards where we want to be 3-4 years down the line when the market has recovered.
And where is that? We want to be at the rule of 40!
Here are the steps I think prop-tech companies should take:
These are the actual steps I'm going to take with my own business, so hopefully you know I'm right here with you. I've thought a lot about this (and spent a lot of time speaking with our own leadership, other leaders, and advisers.
Tank (BAD) Revenue:
I know, I know I said "tank revenue" but I think we all know that's not what I meant. What I really meant was tanking "bad revenue" which I will define here as revenue that was gained at low to no profit (or worse actually "costs" you money to have on the books).
We all have bad revenue: Sometimes it's a partnership with too high of a rev share. Sometimes it's a quid pro quo advertising deal or sometimes it's a high profile customer who promised to promote the heck of you and help you grow (and they haven't) and they have such a discount and are such a drain on resources that they actually cost you money. LET THEM GO!
You need to get rid of any bad revenue. Now is the time. If it's not profitable then it should go. Full stop.
There is actually an important reason I'm suggesting this and it's not just because it's a smart idea to make sure you get paid for your work.
Think about it. The goal here is to intelligently get rid of as much revenue in 2023 as you can so that your revenue is as LOW as possible as a "starting point" for the next cycle. You want 2025 or 2026 to show "high growth" right? It's a lot easier percentage-wise to pull it off if you start with a lower number. That's just math.
Now is the time (you have an excuse, the market took a dive, and so did your revenue). It's a good story.
But when you look at my planning graph below, you'll see why this makes sense. I want to reach the rule of 40 when it's realistic (3-4 years from now) and if I start at a much lower number, then it is much easier to show steady increases in revenue over the period. (BTW investors will really only be looking at 2023-2026 by the time 2026 rolls around.
(screenshot of my actual forecast graph)
Eliminate bad vendor contracts/partnerships:
Do you have any contracts that you can cancel (without penalty) or that have expired that are not generating a positive ROI both financially and from your time? I know I do.
These often come about because we entrepreneurs are mad scientists and we want to "try everything"! We also don't always pay attention to every dollar when times are good (does this sound like you?).
The net effect of this can sometimes mean a lot of partnerships or platforms that we're paying for (in either time or money) that we aren't even using, let alone profiting from.
Start from the top (the most expensive) and work your way down.
Software is a great place to start. For me, this was salesforce.com - it sucks (we had big ideas for it, but once we started using it, we realized it was just a big, expensive, complicated POS and our own CRM is actually better for our needs). Our contract is up this summer, we served notice and did not renew. #boom! $50k+ straight to the bottom line. And I save on all the salary (programmers, sales admins, etc that I needed to have on staff just to run the damned thing. So overall, I'm likely putting $150k in pure profit back to the EBITDA line.
I am willing to bet there are a bunch of small, medium (and large) software expenses that you're not leveraging well and could easily be replaced by something cheaper (or don't need to be replaced at all). Get into the weeds! (And do it now, monthly savings compound).
Another example? Rent!
Do you have too much space for your business? Do you even need an office at all?
We own our own buildings (and almost everyone now works from home), yet my company is still paying rent and expenses for these buildings (at one point around 25,000 square feet). Sure it's me paying me (kind of a passthrough). But you know what would be MUCH better? If a third party was actually renting the space and they were actually paying the expenses and we realized a net profit on rents in my other company AND removed an expense on REW's P & L.
I already completely leased out one of our buildings (reducing REW's expenses by over $300k per year AND generating a net profit of over $225,000 for our real estate company) and I'm about to put another one up for least in order to do the same thing again.
We still need "some" space since we have staff who really do love to put on the suit and come to work. But if I'm honest with myself (and I check my ego at the door) we only need 1 floor of 1 of our buildings since only 8 or so people really ever come in anymore. So we'll go down to around 5000 sq ft which on the books should save REW another $175,000 per year AND generate that same $175,000 for our real estate company in actual revenue.
Did I just "increase" Real Estate Webmasters profits by $475,000 AND increase true net profits for my commercial real estate company by that same amount? You bet I did!
Don't lose your great people (trade-in advertising instead)
A huge mistake many companies make is they automatically start looking at their staff costs as the first place to cut. Now I am all for cutting "non-productive" people who are not engaged (that should always be done, regardless of the market conditions) but if you have amazing staff that know your business inside and out and they work hard - no matter what you need to protect them! They are your best asset and you will need them more than ever now. They are also critical to taking advantage of the upswing once the market turns around.
So my advice is to cover their salaries with advertising/marketing dollars.
Advertising is easy to get back. You can always write a cheque and get exposure/leads. Great people are irreplaceable. So right now, if there is no one spending money anyways (because let's face it there isn't) then cut the advertising spend! That will free up the budget for you to be able to retain your awesome people AND it will also increase your EBITDA since you are now saving on your P & L.
Less advertising does mean less business though, and so it's important to have a conversation with your leaders and individual contributors about why you're doing this, and that you're going to need to lean on them and their talents to help generate new business (or new revenue from existing business) by using sweat equity and relationship building.
If you do it right and are transparent with the current state and what the plan is (show them a post like this perhaps) they will be excited to be a part of a well-thought-out plan, and they can end up generating as much (or more) revenue than the advertising spend that was cut.
It's critical not to scare your people though. They need to feel safe and that these changes are part of a well-thought-out plan, not because the company is in trouble and their jobs are on the line. < If they think that, no matter how much they love you and working for you, they have to start looking for a new role out of self-preservation. So make sure you let them in on the plan.
Lean into ROI: DOUBLE SPEND, QUADROUPLE TIME!
This post is not just about cost-cutting. There are things you absolutely should NOT cut. And that is anything that gives you a minimum of your target ROI. Let's say you are targeting a 20-25% EBITDA margin (like my example below). If you have anything that has that ROI or better, you really should be doing "more" of it. (not less).
Examples of this for me are things like:
PPC (Pay Per Click): We get a great ROI on Adwords (I'm going to double our budget)
SEO (Search Engine Optimization): < Here is where I use my people since we're an SEO company, so we don't have a third-party cost AND our talented people can be contributing to our success as per my recommendation above.
(screenshot of REW's SEO report for tracked keywords)
Social (not paid social): Once again, my people are awesome and so having them help promote the business on social gets us a great return with regard to exposure and new business.
Events: (Only certain ones) - there are a few really great events that are a must-attend for us that give us great exposure and ROI. But do not (I repeat do NOT buy their sponsorship packages). There is not a single event in real estate right now that provides a high enough ROI right now to justify their ridiculous sponsorship costs. Let the big companies buy the sponsorships (and waste their money), you should be spending to bring 1-2 of your very best people (best networkers, outgoing connectors, salespeople whomever that is for you). Get cheap flights, look for hotel deals and spend as little as possible.
Some additional tips on events:
- Don't spend on dinner when coffee with a client is just as effective.
- Commit to 12-16 hour "work days" (and have that talk with your staff). Conferences are not paid vacations and every person there must understand it's a marathon and you must take every opportunity you can. If they aren't "default positive" about making the most of an event, and they take off for "me time" during the conference, you have the wrong person on the team. Conferences are expenses and you need to get an ROI. Besides, there is plenty of fun to be had "in conference" (the prospects and clients are already wicked fun).
- Stay away from other vendors: there is nothing worse than your staff having all their time taken being "pitched" on partnerships by other vendors. Train them to politely say "I'm here to generate x client opportunities. I'm sure your product is amazing but I hope you can understand I'm required to go work the room. Feel free to email me details on your product, here's my card".
- Get creative (on a budget): At Inman Las Vegas, the team went to Target and for less than $100 we were able to create our own photo booth that clients and prospects loved. We received many likes, social shares, and comments and we also are tagged along with very influential people in the business. Fun right? It showed effort and cost almost nothing. Try to think along these lines.
(Stacie Staub and Greg Fischer at REW Homemade Photo Booth)
What happens when you lean into ROI with the double spend / quadruple time method?
You'll actually find that this process ends up completely replacing any of the value and revenue you were worried about losing by canceling bad contracts and reducing low ROI advertising. That's how you are going to stabilize your growth for 2024, and create enough cash on the balance sheet to re-invest in 2025.
That takes care of 2023-2024 (tank the revenue, strengthen the profits)
Now let's talk about recovery and growth.
If you've done as I've suggested above and you continue that process throughout 2023 and 2024 (while the real estate market is down) then you should be sitting on a healthy pile of cash (from EBITDA).
Sure, you're growth has flatlined, but remember, that was intentional and is as per the model. You did that in order to be able to make it through the downturn and be in the position you are going into 2025.
And what is that position? A company that retained all its great people, accumulated cash, eliminated any waste or non-ROI relationships and patiently waited for greener pastures.
All while building a much stronger business based on best-in-class fundamentals and discipline.
So where are we in 2025?
There is likely a LOT less competition for your product as many companies will have failed in your space (they didn't read this blog and take this advice) AND since it's not a start-up / investor-friendly market, new startups are likely not much of an issue. You've survived and continued to build your name and your brand.
The real estate market is shifting in the right direction. Now that the downturn is shifting, there will be an automatic lift to your business since Realtors® will once again be on the hunt for positive ROI services of their own in order to take advantage of the changing tides.
Now is the time for you to start leaning back in!
Remember that process of identifying the best ROI advertising. We're going to double down again!
The next step (at the same time really) is slowly, but methodically adding to your sales force so that you can not only handle all the additional inquiries that are coming from the market shift, but also you need to go back through your database that you have been slowly building during the downturn. Those that were "great product, but not right now". Go close them!
Bit of a brain dump I know (I will probably come back and clean it up later).
But I do hope it's helped some of the up-and-coming prop tech folks (or maybe even the veterans out there) think through the coming market.
If you saw this on social somewhere, by all means, share your thoughts (and the post while you're at it).
And if you're in prop-tech and needing some advice (or looking to sell) I'm always up for a quite chat on social, or perhaps a call schedules permitting.
Just let me know :)Posted by Morgan Carey on