The NetSuite SaaS Valuation Outlier

May 28, 2012 2 Comments

Looking at the last round of Publicly Traded SaaS Company Valuations there’s one outlier that needs more discussion: NetSuite. NetSuite is a strong Software-as-a-Service (SaaS) company with a powerful enterprise resource planning and accounting package along with a host of other tools like CRM. Whereas ExactTarget deserves to be in the 8x revenue club due to growth rate, NetSuite with a market cap of $3.2B (NYSE:N) and a run rate of $280M, is trading at north of 11x revenue, but only has a one-year revenue growth rate of 22% (source: thestreet.com).

A 22% year-over-year growth rate is solid but a 11x revenue multiple seems like a stretch. What gives? After asking around I found a plausible answer:

Oracle has to buy NetSuite at some point to be competitive in the cloud and investors have baked that into the valuation.

Since there’s a suitor with deep pockets in waiting, investors have taken that into account and paid much higher than expected prices, knowing that for Oracle to acquire NetSuite they’ll have to pay a premium on the public valuation, thus there’s still money to be made for investors. The next time an entrepreneur points to the NetSuite valuation as a good example for SaaS multiplies, that outlier needs to be thrown out the window.

What else? What are some other reasons NetSuite is a valuation outlier for SaaS companies?

Filed under Entrepreneurship, SaaS

SaaS Recurring Profit Margin Metric

May 20, 2012 Leave a comment

The CEO of Zuora has a nice slide deck online titled The Only 3 SaaS Metrics that Matter where he talks about the subscription economy, gives the three metrics, and provides benchmarks from publicly traded companies. The three metrics are straightforward and make sense:

  • Retention Rate – How much of your Annual Recurring Revenue (ARR) you keep each year
  • Recurring Profit Margin – ARR less churn less non-growth spend (growth spend is money spent on sales and marketing)
  • Growth Efficiency – How much does it cost to acquire $1 of annual contract value?

Retention rate is a common one as is growth efficiency in the form of the SaaS Magic Number, although I like that growth efficiency is much easier to understand than the ratio of sales and marketing spend from one quarter compared to recurring revenue growth in the next quarter.

The middle metric, recurring profit margin, is a great idea and not mentioned enough. One of the reasons successful SaaS companies have such great valuations relative to other companies with similar revenues and profits is that many SaaS companies could be much more profitable and still retain their revenues if they cut back on sales and marketing — recurring profit margin represents this number.

Here’s a quick SaaS startup example for recurring profit margin:

  • $1 million in annual recurring revenue
  • 85% renewal rate
  • $50,000 profits (so, $950,000 in annual expense)
  • $300,000 spent annually on sales and marketing
  • Recurring profit margin: 1,000,000 times .85 minus the difference between total expenses and sales and marketing expense (950,000 – 300,000) = $200,000 or 20%

Another way to calculate recurring profit margin is by taking away the sales and marketing expense (e.g. $300k), subtracting out the annual recurring revenue amount from customers that leave based on the churn rate (e.g. $150k), and adding in existing profits (e.g. $50k). Startups that spend an unusually large amount on sales and marketing, have high renewal rates, and still break even, will have excellent recurring profit margin metrics.

What else? What are your thoughts on SaaS recurring profit margin metric?

Filed under Entrepreneurship, Operations, SaaS

Scaling a B2B SaaS Startup is Expensive

May 10, 2012 3 Comments

Software-as-a-Service (SaaS) is an amazing model with great recurring revenue, high gross margins, and strong industry growth. That said, scaling a SaaS startup is expensive. Very expensive.

Once you’ve crossed the desert and reached profitability, you can control you own destiny, especially if profitable, however modest, is true profitability paying market wages, and not just ramen profitable. Now, break-even or slightly profitable is great, but scaling the business and staying ahead of the market requires significantly more investment. The real challenge is when the law of large numbers kicks in based on the size of the customer base and the renewal rate. In order to grow, the number of new customers signed monthly has to keep growing because the number of customers leaving keeps growing.

Scaling a SaaS business is expensive because the primary expense of the business is people, and people need to be hired and trained in advance of customer acquisition. With the SaaS model, customers don’t pay a large sum of money up-front, rather they pay monthly or quarterly, often with an annual contract. The lifetime value of the customer is great but payment is spread out over years, with a decent chunk of the first year’s revenue going towards sales and marketing costs for customer acquisition, leaving little left over to staff up engineering, support, services, and back-office functions.

To recap: first year customer revenue almost all goes to sales and marketing, payments are spread out over years, and people are the largest expense, which need to be hired and trained in advance of delivering value. To scale a SaaS startup, sales has to get out in front of churn, which is always growing on an absolute basis assuming the the churn percentage stays constant and the business is growing. Along with significant investment in sales and marketing, all other core aspects of the business need investment in advance of customer growth.

What else? What are some other reasons scaling a B2B SaaS startup is expensive?

Filed under Entrepreneurship, SaaS

Look Out for Harvest Mode SaaS Startups

May 3, 2012 1 Comment

Software-as-a-Service (SaaS) startups should have great revenue growth with companies buying more cloud-based tools, the layering of recurring revenue on top of recurring revenue, and the strong investor appetite to fund money-losing businesses. Unfortunately, things aren’t always so rosy. In fact, when a SaaS company’s growth stalls, and has outside investors with a timeline on the business, there’s a serious chance the company will be sold to a non-strategic buyer and put into harvest mode.

What is harvest mode you ask? Good question. Harvest mode is when a significant percentage of staff is cut, typically 30-80%+, for the purposes of maximizing profitability and milking the recurring revenue.

Here’s a simple example harvest mode scenario:

  • SaaS company is break-even on $10M in revenue and 70 employees
  • Growth stalls and investors, controlling the company, decide to sell to highest bidder
  • Company is bought for $30M and 50% of the 70 employees are immediately laid off
  • Employee costs represent 80% of the expenses, so a 50% staff reduction results in $4M in annual profits
  • Company continues to improve the product and sign up new customers, while revenues and profits slowly shrink
  • The financial buyer of the company is able to fund the acquisition with the $4M/year profits

This is a hypothetical example of a harvest mode SaaS startup. I’ve personally seen it happen a few times and it’s important to look out for them, especially if you’re a potential customer thinking about choosing a vendor.

What else? What other thoughts do you have on harvest mode SaaS startups?

Filed under Entrepreneurship, SaaS

Gathering User Feedback For An Established Product

April 24, 2012 Leave a comment

User feedback is critical for building a successful software product. As the product matures and becomes established, user feedback is easier to get, but can also become overwhelming with requests from so many different constituents. Here are some ideas for gathering user feedback for an established product:

  • Quarterly check-in calls by a client advocate or account manager to find out how things are going
  • Idea exchange with single sign-on so that customers can post ideas and vote on other ideas
  • In-app net promoter score where you ask once per quarter how likely they are to recommend the product
  • Regional user groups with a company team member facilitating
  • Annual users conference with significant customer interaction
  • Customer advisory board that does a quarterly conference call with the VP of Product Management

Gathering user feedback with these methods is the easy part. The real challenge is organizing the information and combining it with your own vision and opinion for the product. Then, clearly communicating the direction and future functionality with the key stakeholders.

What else? What are some other ways to gather user feedback for an established product?

Filed under Entrepreneurship, Product Mgmt, SaaS

Notes from SaaS Growth and the Cost of Capital

April 21, 2012 Leave a comment

SaaS Capital has some great resources for Software-as-a-Service (SaaS) companies with one of them being a white paper titled SaaS Growth and the Cost of Capital. ExactTarget in the 8x revenue club is a great example of the SaaS business model, which is one of my favorites. Here are some notes from SaaS Growth and the Cost of Capital:

  • 13 public SaaS companies tracked by Pacific Crest Securities have increased 40% in value from the beginning of 2008 to the beginning of 2011
  • Best valuations come from SaaS companies growing more than 25% annually in a large market
  • Main driver for valuations comes from revenue growth rate (not profit growth)
  • Three of the four fastest growing SaaS companies are spending more than 40% of revenue on sales and marketing
  • When today’s market leading SaaS companies were in expansion stage before going public they spent 60 – 70% of revenue of sales and marketing and took on outside investment
  • Cloud technologies are contributing to higher incremental gross margin for SaaS companies (along with Moore’s Law)
  • High-growth SaaS businesses are worth three to five times more than slow growth ones

The author of the white paper really drives home the point that growth for SaaS companies results in a huge premium and should be seriously pursued.

What else? What are your thoughts on SaaS growth and thd cost of capital?

Filed under Entrepreneurship, SaaS

Large Customers as Edge Cases with SaaS Products

April 8, 2012 Leave a comment

Software-as-a-Service (SaaS) is an extremely efficient model for product development since the delivery components and upgrade cycles are controlled by the vendor (an inordinate amount of time is spent supporting configuration environments with installed applications). There’s one edge case with SaaS product that isn’t talked about much: unusually large customers.

In the installed software world, unusually large customers typically require more expensive or exotic hardware and the problem is somewhat solved. With SaaS it isn’t as easy because SaaS applications are often sharded whereby clusters of customers are grouped on the same database, but individually delineated. As the customer base of the product grows, the SaaS company adds more and more shards. This breaks down with an unusually large customer when the customer is so large as to not fit in an isolated shard or with the standardized hardware used to power the other shards is not powerful enough.

Modern technologies like Cassandra and HBase provide amazing scalability across a cluster of machines and solve the scale problem. Unfortunately, the tools to develop against them aren’t as simple and powerful as tools for standard databases like MySQL and PostgreSQL, but they are rapidly improving.

Some ideas to deal with the unusually large customer edge cases with SaaS products include the following:

  • Data size allotments with fees for additional storage
  • Setting upper-bound limits for certain categories of data and not allowing overages
  • Isolating the account to a dedicated shard

My recommendation is to think through scalability limits early on and address them in advance of customers reaching them.

What else? What thoughts do you have on large customers as edge cases with SaaS products?

Filed under Entrepreneurship, SaaS, Tech

Publicly Traded SaaS Company Valuations

April 5, 2012 2 Comments

In December of 2010 I wrote a post titled Publicly Traded SaaS Companies detailing the companies, market cap, quarterly revenues, and number of employees. Since that post the numbers have moved upwards nicely along with a couple being acquired (SuccessFactors and Taleo) and a few new ones going public (Responsys, ExactTarget, and Demandware). Let’s take a look at the current numbers:

  • salesforce.com (NYSE:CRM) – customer relationship management SaaS company.
    Market cap: $21.52 billion
    Last reported quarter’s revenues: $631.9 million
    Employees: 7,785
  • NetSuite (NYSE:N) – enterprise resource planning (accounting, inventory, etc) SaaS company.
    Market cap: $3.45 billion
    Last reported quarter’s revenues: $64.09 million
    Employees:  1,265
  • Constant Contact (NASDAQ:CTCT) – email marketing for small business SaaS company.
    Market cap: $873.79 million
    Last reported quarter’s revenues: $57.53 million
    Employees: 926
  • SuccessFactors – human resources SaaS company.
    Bought by SAP for $3.4 billion
  • Taleo – human resources SaaS company.
    Bought by Oracle for $1.9 billion
  • LogMeIn (NASDAQ:LOGM) – remote machine access SaaS company.
    Market cap: $846.84 million
    Last reported quarter’s revenues: $32.32 million
    Employees: 482
  • LivePerson (NASDAQ:LPSN) – live chat SaaS company.
    Market cap: $899.43 million
    Last reported quarter’s revenues: $36.51 million
    Employees: 524
  • Responsys (NASDAQ:MKTG) – email marketing SaaS company.
    Market cap: $587.27 million
    Last reported quarter’s revenues: $37.24 million
    Employees: 693
  • Demandware (NYSE:DWRE) – ecommerce SaaS company.
    Market cap: $774.98 million
    Last reported quarter’s revenues: ~$15 million
    Employees:  215
  • ExactTarget (NASDAQ:ET) – email marketing SaaS company.
    Market cap: $1.62 billion
    Last reported quarter’s revenues: ~$50 million
    Employees: ~1,100

The companies that get the largest premium are the leaders in their space and have the fastest growth rates. In almost all cases market cap, quarterly revenues, and employees have grown since the last report 16 months ago. Software-as-a-Service continues to be hot.

What else? What are your thoughts on publicly traded SaaS company valuations?

Filed under Entrepreneurship, SaaS

Successful SaaS Startups Grow Slower Than a Hockey Stick Curve

April 1, 2012 1 Comment

The proverbial hockey stick-like growth curve for startups has been talked about many times, including yesterday. That growth curve is rare, and even more rare over extended periods of time. In reality, startups that experience the hockey stick growth curve often do so for a limited period of time, while the market adoption is at it’s peak, and then the growth abruptly slows down or goes away. So, instead of a hockey stick over a short period of time (< 7 years) it is really an ‘S’ like curve slanted to the right where there’s slow growth, hyper growth, and finally slow/no growth.

Crazy hockey stick-like growth is more often attributed to companies with truly revolutionary products or strong network effects where the value of the system keeps building on itself indefinitely (e.g. Facebook). Software-as-a-Service (SaaS) or cloud-based software products that are successful have growth curves flatter than a hockey stick. Here are a few reasons why:

  • SaaS revenue layers on itself year after year which makes it easier to keep growing but harder to keep accelerating growth due to the law of large numbers.
  • SaaS contracts are often annual with the payments made quarterly, making payments of the lifetime value of the customer stretch out over several years whereas installed software products get most of the value up-front, and thus installed software products can have a sharper revenue growth curve, everything else being equal.
  • Customer churn for SaaS companies (read about the leaky bucket number) eats away at growth and even if the renewal rate stays constant, the number of new customers needed to grow at the same rate continues to increase.

SaaS companies that break out are likely to have a growth curve flatter than a hockey stick but continue to grow as a business for longer periods of time due to the layering of recurring revenue.

What else? What are your thoughts on successful SaaS startups growing slower than a hockey stick curve?

Filed under Entrepreneurship, SaaS

Sales Reps Without Territories for SaaS

February 29, 2012 2 Comments

One of the more common strategies associated with sales reps is assigned geographic territories. Territories make sense when field sales are involved but with the growth of Software-as-a-Service (SaaS), more and more sales are done over the phone and internet. A major downfall of territories is that in a fast-growing startup every additional sales rep that’s hired  shrinks someone’s territory, and shrinking territories is tough on morale. With a modern marketing automation system or CRM system there’s a better way.

Here’s one way to have sales reps without territories for SaaS-type sales teams:

  • Score and grade all inbound leads automatically and route them to a market response rep
  • Route sales qualified leads to a queue that distributes leads in a round robin fashion to the account executives
  • If there’s a particular source of lead that is sales qualified but even more valuable, like from a test drive, route those to a second queue of the same account executives (the idea is to have equitable distribution of the regular qualified leads and the best leads)

With one or more round robin lead queues, reps are assigned leads in a straightforward manner that is minimally dilutive when an additional sales person is added.

What else? What are some other ideas around sales reps without territories for SaaS?

Filed under Entrepreneurship, SaaS, Sales and Marketing

← Older posts

Follow

Get every new post delivered to your Inbox.

Join 2,160 other followers