Let's talk about SaaS, high-growth, not-yet-profitable companies.

These companies were at the peak of the hype in 2021, and by 2022 most of them had lost -60% from the top price, and some bad cases got to -90% and more.

The immediate suspect is inflation. But inflation alone, in a world of free money, has no effect. By October 2021, inflation was already rising fast and got to 6.2%. Yet we hadn't seen the peak of the bubble for a few more months - with capitulation starting only when the FED announced rate hikes were coming.

The NASDAQ didn't fear inflation until interest rates came up.

Unprofitable companies were just as unprofitable before the rate hikes - and that's why some are confused about their drawdown. But looking at revenues, margins, and profitability is not as useful when talking about high-growth subscription-based companies.

Delayed profitability with subscriptions

There are many great articles about SaaS metrics like CAC (Customer acquisition cost) and LTV (Lifetime value). This post isn't it - I recommend getting familiar with the terms by the articles I linked if you're interested.

One important quirk of subscription-based companies is that they initially lose money on each customer - until sometime down the line when his accumulated monthly payments cover his cost.

Let's say the CAC, the cost of acquiring an average customer through ads/marketing/whatever, is $300. The subscription cost is $10 a month. At this price, for this cohort of customers, the average customer stays for 3 years. That means a lifetime value (LTV) of $360.

In this case, an average customer will turn out a profit 30 months after he joins. Making the company seem unprofitable for 30 months. And since this process is continuous, with more marketing and sales spent to get the next cohort of customers that will turn a profit 30 months down the line - the company may seem like it's never profitable, while in reality, their ROIC may be amazing, depending on the numbers.

This example is simplistic, ignoring operations cost, assuming the company has a perfect model to predict churn and LTV, etc. But it is useful for the point I'm making.

The cost of money

For years now, money has been free for growth companies. Unlike the poor, mature companies that had to raise bonds for 1%-2%, high-growth, tech, SaaS companies could raise as much as they wanted for a percentage of ownership, which would grow by multiples of the invested money by models - making it even cheaper than free.

When money is free, the time element, and thus inflation - has no effect. Multiply anything by 0, and you'll still get 0. As long as the average LTV is larger than the CAC, you're golden. You can offset any inflation effect over time by getting more free money into the machine.

But now money has a price. People stopped buying random bored monkeys JPEGs. It's now limited and harder to come by. Large investors winding down their leverage. The formula now has a non-zero value assigned - and that changes things.


Inflation didn't matter (much) for the model, while money was free. But now it does. Since the time element matters now, so does the depreciation of money through it.

And since that already changes the model, as we'll see - it will force more fundamental changes by the companies, throwing the models all over the place.

Changes like raising prices to account for inflation are not that simple. Higher prices can lead to higher CAC and higher churn. The total gap between the CAC and LTV may be thrown all over the place - unpredictable and risky. Investors hate this.

Visualize the change

We have 4 players in this simplified model:

  • CAC - Customer Acquisition Cost, how much does it cost on average to bring a customer
  • Real CAC - How much does the CAC cost when considering the cost of the money to the enterprise
  • LTV - Lifetime Value, how much would an average customer in the same cohort will earn the company before he leaves (churn)
  • Real LTV - As the earnings are going through time, how much will depreciate with inflation

We'll start with a base case, which we had for the past ~10 years - A world where money is free, and thus inflation doesn't count. The CAC and the Real CAC are the same, too.

Every year the income goes down as some customers churn.

In this base case, the company hits parity in the 3rd year and, from then on, is profitable for the same customer cohort.

For the next case, let's assume the cost of money is 6%. This is extremely generous and may be applicable only to the biggest VCs. Companies raising funds in the public market through bonds, for example, will have a much higher cost of money. But it's good enough to make the point:

That alone moves the parity point to the end of year 3.

But here's the real kicker - let's apply inflation through the years to get the real earnings.

P.S - play with the figures to get how the picture changes.

This gets ugly quickly.

Since the typical high-growth non-profitable company is very, very future dependent - once inflation kicks into the model, all the numbers are getting ugly.

That's ignoring weaker sales, higher churn, and many other issues facing a high-growth company in a recession. But in a classic chicken-and-egg case, the recession kicks in because money has a price, which makes inflation count in many industries - not only SaaS. Making it all the cause and the effect of itself.