The 10+ year period of near-zero interest rates caused a lot of investors and leaders to deemphasize the fundamentals of valuing companies. As I’ve written many times, we know that a company’s value is equal to the present value of the amount of cash you can take out of it over time. That is, the amount of cash you can take out of the company over time discounted to present-day dollars. When you’re in a zero-interest environment, there is no discount rate. When there’s no discount rate (or no risk-free way to make money), investors take more risk to find a return, thus the overflow of money into venture capital and other high-risk investment vehicles during that period. When there’s no risk-free bar to clear to find a return, an investor is more open to non-traditional investments. When interest rates are high and low-risk treasury bills are paying out 6%, in order to invest in something risky, the investor has to be comfortable that any investment will exceed 6%, causing money to flow out of venture capital and other high-risk investments.

When the risk-free rate is very low, investing gets hard because there are no guarantees, so you start to use proxies and benchmarks for future returns. This was particularly true in SaaS which really emerged in a big way during the 10+ year period. Things like Rule of 40 and 35% EBITDA margins and 70% gross margins became solidified as proxies for investable software companies. We needed those proxies because they provided guidance for what to invest in in a world where almost anything “could” be a good investment.

Now that investors have raised the bar on what they’ll invest in and there are real questions about the future of SaaS margins due to the emergence of new pricing models and pricing pressure from AI duplicating SaaS products at a far lower cost, it’s time to return to the fundamentals of valuation. Remember:

Growth is just a proxy for future cash flows.
Gross margins are just a proxy for future cash flows.
Operating margins are just a proxy for future cash flows.
Net income is just a proxy for future cash flows.

None of them alone can tell an investor the amount of cash they can take out of the company over time.

Now that we’re back to desirable risk-free rates, and CIO budgets have tightened, and high interest rates have squeezed company margins, it’s time to be more flexible and get back to the fundamentals of valuation. There are numerous ways to get there that might not fit with the traditional SaaS benchmarks we’ve used as a reliable guide over the last decade.