A look under the hood as Klaviyo heads for IPO

It’s been a bit of a dry spell for tech IPOs since the COVID boom of 2021.

The mood has been dampened by a correction of tech valuations driven by aggressive interest rate hikes from the central banks.

But that’s about to change. Klaviyo has made its intentions clear – it’s just filed to go public.

Now, if you don’t happen to play in the e-commerce neighbourhood, Klaviyo might not ring a bell. But in e-commerce circles, it’s a titan of B2B MarTech (or business-to-business marketing technology, if you’re not up on the lingo).

At SBO Financial, we manage the financial matters of more than 50 e-commerce businesses. I’ve reviewed the “subscriptions” P&L account and can confirm that pretty much all of them are loyal Klaviyo users.

Out of curiosity, I decided to delve into Klaviyo’s S-1 filing – and let me tell you, there are some pretty impressive things going on under the hood. Here’s my financial teardown.

What is Klaviyo?

At its core, Klaviyo is a SaaS platform designed to assist e-commerce brands in collecting customer data for targeted marketing communication across email, SMS, and push notifications.

You know those annoying random text messages from direct-to-consumer (DTC) companies? Well, there’s a good chance Klaviyo played a role in sending those. Essentially, Klaviyo is a tool used by brands to spam customers to buy more shit.

Klaviyo’s platform consists of three key layers.

Data layer: This layer connects with complementary retail, customer service and shipping platforms to provide a unified view of a customer’s journey. It aggregates this data, allowing users to generate detailed customer profiles and identify customer cohorts.

Application layer: Positioned atop the data layer, this layer comprises analytical tools that assist users in interpreting and leveraging the collected data. These tools aid in decision-making, such as crafting targeted marketing campaigns, monitoring customer behavior and, ultimately, driving revenue growth.

Messaging infrastructure: These tools allow brands to engage with (read: spam) their customers through email, SMS, and push notifications.

What sets Klaviyo apart from other email marketing competitors like Mailchimp or Drip is its origin. Klaviyo didn’t initially set out as an email automation platform. Instead, it began as a database solution designed to store and unify disparate data from various e-commerce platforms. Its primary goal was to comprehensively track the customer journey.

Why Klaviyo is essential: the importance of first-party data

In the pre-iOS 14 era, a lot of DTC brands emerged and expanded their reach through paid customer acquisition, leveraging third-party data platforms such as Instagram and Facebook ads.

It was a golden age when a substantial advertising investment could effortlessly translate into hundreds of thousands, and sometimes millions, in revenue.

But that all shifted when Apple introduced changes to its privacy settings in the iOS 14 update. Apple’s changes impacted advertisers’ ability to effectively reach, understand and engage people on mobile devices and across the web. They disrupted the capacity to gauge performance, control ad visibility, and make informed decisions regarding advertising budgets.

The impact was severe – an overall decline in ad performance and a significant increase in the cost per action (CPA).

In a nutshell, it became more expensive, and in some cases no longer economical, for brands to generate sales solely through paid advertising channels. To mitigate this dependency on paid advertising, brands pivoted towards retention marketing.

Rather than spending boatloads of money on acquiring new customers, they redirected their efforts toward nurturing and upselling to their existing customer base. This is precisely where Klaviyo emerged as a critical component of the marketing technology infrastructure.

At the time, it was the only native tool that seamlessly enabled brands to deliver targeted marketing messages to their existing customer base.

In other words, Klaviyo pioneered the market by enabling e-commerce brands to collect first-party data – data obtained directly from their customers.

With the increasing emphasis on data privacy, the importance of collecting first-party data is only set to grow.

The pick-and-shovel strategy

Tobi Lütke, the CEO of Shopify, famously quipped that the company aims to empower individuals and businesses to compete with the big guys by “arming the rebels”.

Through its ecosystem of apps and services, Shopify provides entrepreneurs with the tools they need to swiftly and affordably establish and grow their businesses. This levels out the playing field, enabling them to compete effectively with colossal legacy brands like Amazon.

Like Shopify, Klaviyo has built a successful business around one of my favourite investment strategies: the pick-and-shovel strategy.

The concept of the “pick and shovel” investment strategy draws its roots from the gold rush era of the 19th century. In essence, it involves investing in the tools, products, or services that are essential to an industry or trend, rather than directly in the industry or trend itself.

The name comes from the idea that during a gold rush, those who sold picks, shovels, and mining equipment often made more consistent and reliable profits than individual gold prospectors.

So, how does this strategy work?

Identifying a growing industry or trend: Investors begin by identifying an industry or trend poised for significant growth. This could be anything from a new technology sector (e.g. blockchain, electric vehicles) to a broader economic trend, such as the rise of e-commerce.

Determining essential tools or services: Next, investors identify the tools, products, or services essential for businesses or individuals to participate in or benefit from the industry or trend. These are the modern-day “picks and shovels”. In Klaviyo’s case, this translates to the universal need for businesses to capture customer emails and execute effective remarketing strategies.

Investing in suppliers or enablers: Instead of directly investing in or launching companies within the industry or trend, investors allocate their capital to firms that supply these essential tools or services. These suppliers or enablers often generate consistent revenue streams because they are not overly reliant on the success of any single player within the industry. In other words, instead of starting an e-commerce business, they create tools for e-commerce operators to grow their business.

Reduced risk: The pick-and-shovel strategy is a lower-risk approach as it mitigates exposure to the inherent volatility and uncertainties associated with specific companies or assets within the industry or trend. Even if certain companies within the industry fail, the suppliers of essential tools or services continue to thrive.

Long-term potential: The strategy is often considered to have long-term potential since the demand for these essential tools or services remains in demand even as the industry evolves or undergoes cycles – particularly relevant in our current economic downcycle.

As specialists in e-commerce accounting, we have witnessed firsthand the challenges faced by brands in the industry. Soaring inflation, interest rate hikes, and high CPA are making it increasingly difficult for brands to stay alive. Meanwhile, your monthly SaaS bill paid to platforms like Shopify, Klaviyo, and Gorgias continues to climb.

If Shopify is the ‘pick’, Klaviyo is undoubtedly one of the many ‘shovels’ in the ongoing e-commerce gold rush.

The Klaviyo-Shopify relationship

Over the years, Klaviyo has cultivated partnerships with several big players in the e-commerce arena, including BigCommerce, WooCommerce, and Wix. However, it’s undeniable that the company shares significant common ground with Shopify.

According to their S-1 filing, “approximately 77.5% of total Annual Recurring Revenue (ARR) as of December 31, 2022, came from customers who also use the Shopify platform”.

Now, usually, heavy platform dependency is a huge red flag for investors. But, in my humble opinion, this concern may not be as pressing for a few key reasons:

Customer acquisition channels: Klaviyo has reported that the vast majority of its customers come from inbound channels, particularly through marketing agency partners. Only around 10.6% of new ARR stems from customers acquired via the Shopify App Store.

Shopify’s investment and strategic partnership: It’s worth noting that Shopify holds a substantial stake in Klaviyo, owning 11.2% of its shares. Beyond ownership, there’s a strategic partnership in place, involving a revenue-sharing agreement and a stock purchase agreement.

The financial teardown

Outside of the business model and strategic risks, there’s a lot to admire about the headline financials.

• Total revenue for the 12 months ending June 30, 2023, stood at $585.1 million.
• Achieving a 56.6% growth rate within the current challenging macroeconomic climate is truly awesome.
• Klaviyo stands out among SaaS companies, as it is essentially break-even, a rarity in the industry. 
• The healthy gross margins of 73% align well with the typical range for SaaS businesses (between 70% and 90%). Although there’s limited detail on the breakdown of Cost of Sales (COS) in the S-1, it’s notable that a portion of wages, presumably for customer support, is allocated to COS.

Now, let’s delve into some core metrics.

• High net dollar revenue retention standing at 119% – this is great, considering that most of Klaviyo’s customers are SMEs.
• An impressive customer base of 130,000, with an average contract value (ACV) of approximately $5,000.
• 1,458 customers with an ARR of more than $50,000 as of June 30, 2023, representing growth of 94% year-over-year.
• Customer Acquisition Cost (CAC) payback period is just 14 months for the quarter ending June 30, 2023.
• The Rule of 40 score, calculated at 65%, further underscores the company’s strong performance.

These numbers are great, but what I love most about Klaviyo is its capital efficiency.

Capital Efficiency

Despite securing substantial funding of $775 million, Klaviyo’s story is far from the typical Silicon Valley narrative. Here’s a brief overview of their capital journey.

• In 2012, CEO Andrew Biaklecki and Ed Hallan founded the business and bootstrapped it to profitability.
• 2015 saw the company raising a seed and Series A round from Astral Capital.
• In 2019, it secured $150 million in a Series B round from Summit Partners.
• 2020 brought a $200 million Series C round from Summit Partners and Accel.
• A $320 million Series D round led by Sands Capital followed in 2021.
• 2022 saw a $100 million injection of strategic capital from Shopify.

Despite raising all this money, Klaviyo maintains a healthy cash balance of $439.8 million as of June. Basically, the company has not burned through the capital it’s raised over the past two years, pointing to very high capital efficiency.

And here’s the real kicker: Klaviyo’s most recent valuation stands at a staggering $9.5 billion.

Such high valuations often signal founder dilution. But this isn’t the case for Klaviyo. The founders have scaled the business with high capital efficiency, commanding higher valuations while keeping founder dilution minimal.

As it stands, the largest shareholder remains CEO Andrew Bialecki, who controls 38.1% of the Class B shares prior to the IPO. Collectively, co-founders Andrew and Ed hold a 52% ownership stake in the company.

According to SaaS legend Jason Lemkin, Klaviyo is on the cusp of breaking a new record for founder ownership at IPO, with only the Aussies Scott Farquar and Mike Cannon-Brookes at Atlassian surpassing them.

Valuation considerations

It’s currently not clear how much Klaviyo will be priced at IPO, but let’s attempt a back-of-the-envelope estimate.

The last reported valuation in 2021 stood at $9.5 billion, led by Sands Capital. It’s worth noting that private company valuations were quite exuberant back then due to very frothy capital markets. For Sands Capital to secure a decent return, they’d be eyeing at least a 1.5x return, equivalent to approximately a 14% Internal Rate of Return (IRR), which is a fairly standard figure.

In this scenario, Sands Capital would be seeking a valuation of approximately $14 billion at IPO.

Considering Klaviyo’s ARR of $585 million, the IPO target would need to be priced at approximately 23 times revenue. The question arises: is this a realistic figure?

For context, Klaviyo’s best buddy and partner in life, Shopify, is currently trading at a multiple of 12.8 times the Last Twelve Months (LTM) revenue.

If we were to apply this same multiple to Klaviyo, the company would be valued at $7.5 billion, which is $2 billion less than what Sands Capital paid in 2021. This scenario hints at the possibility of a down round.

However, it’s essential to note that Klaviyo has been growing faster than Shopify. Consequently, Klaviyo will need to convince the coffers it can sustain its growth trajectory and mature into its valuation.

Only time will tell!

In summary, my overall take on Klaviyo is that while it may not be in the same league as generational companies like Stripe, AirBnB, or even Shopify, there’s a lot to love about the profitability and capital efficiency of the business – a characteristic that resonates well with the current market sentiment.

This article was first published by SBO Financial.