Jamin, I appreciate your acknowledgement that SBC needs to be considered, but I believe your treatment is overly generous. Let's use your Box example.

Last year SBC was $185m. To roughly account for dilution, let's divide that by the current share price of ~$31 to get ~6m shares. That would equate to ~4% dilution, or 4x your gold standard.

I think you're also missing a step. Box's diluted share count has declined from 155.8m at end-FY21 to 150.2m at end-FY23. However, to achieve this Box spent $987m on share buybacks. That works out to $176/sh. That's a lot of shareholder cash flow out the door.

A more reasonable accounting for SBC, in my opinion, is to view it as a source of financing - you're borrowing cash from your employees in exchange for your shares. So, move the SBC impact out of operating cash flow and into financing cash flow (where the cash outflow from buybacks resides, by the way).

Now you've got a more reasonable representation of cash flow to shareholders. Under this treatment, Box's FCF margin is ~10%. And now you have a Rule of 20-25 company, which is where I believe enterprise software truly resides in maturity (maybe Rule of 30, and excepting the few exceptions with true network effects).

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Jamin, one of your best articles to date IMO!

“ I’ll end with a takeaway - every software company should plan to hit terminal FCF margins (~30%) by the time revenue growth slows to ~10%. If you can’t, or this isn’t possible, your multiple today should be dinged meaningfully (think trading at1-2x revenue)”

You have noted that a number of software companies are not likely to meet this FCF margin hurdle so what predictive criteria would you suggest that identifies the failures BEFORE the market punished then with 2X revenue multiples??

Also, care to opine on the generative AI threat to software (SaaS) when coding can be accomplished with voice requests? Some 60%+ of GitHub software is generative AI created so what does this mean to the whole SaaS sector?

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One of your best writings, Jamin. Thanks.

“every software company should plan to hit terminal FCF margins (~30%) by the time revenue growth slows to ~10%.”

I recommend adding one more goal in this statement. Companies should bring their SBC down to 10% of revenues by the time they hit the other two metrics.

I recently wrote about how growth investors are getting fooled by supposedly high FCF while SBC is being “hidden” in plain sight on the cash flow statement.

Some of the worst offenders: CFLT, S, MDB and SNOW. Three of these companies feature on your top 10 valued (ahem…overvalued?) list above.

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Cool. FCF/share is truth. Why don't you track it then?

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Jamin, great article. Hard to take the SPAC King very seriously on any topic related to how people should invest their money. Just sayin . . .

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Two SBC related questions

1) If you include SBC in trailing (LTM) free cash flow margin the median decreases from 5% to what?

2) "In the last 3 quarters software companies have drastically improved their margins" Is there any data on increased SBC during this period? Would it not be a negative indicator if SBC meaningfully increased during this same period?

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