Category: SaaS

State of the Cloud 2018

Byron Deeter of Bessemer Venture Partners has an excellent slide deck titled State of the Cloud Report 2018. Byron and his team do an excellent job reviewing trends in the industry and predicting the next big areas for cloud-enabled B2B software.

Some notes:

  • Five largest companies in the world by market cap are tech companies
  • IPOs are sill below historical norm
  • Public cloud companies outperform the overall market
  • Many private companies are getting premiums compared to public companies due to faster growth rates
  • VC-backed startups exits have gone down the last three years
  • ARR growth rate from $1M to $10M is a major indicator (best is doing it in two years)
  • ARR Multiple divided by Year-over-Year (YoY) annual growth has stayed constant
  • Example: 10x ARR multiple divided by 150% YoY growth would be an ARRG value of 6.7x
  • Best valuations for SaaS startups as follows:
    • CARR revenue growth of 200% (e.g. tripled ARR in last 12 months)
    • CAC payback < 12 months
    • Churn is net negative
    • Cash flow efficiency > 1
  • Predictions:
    • Rise of serverless computing
    • API’s drive innovation
    • Blockchains finds a home in the enterprise
    • Payments-as-a-service
    • The move from system of record to system of results
    • The screenless software movement
    • Values create value
    • The cloud is flat; innovation outside the Valley

Interested in SaaS? Head over and read State of the Cloud Report 2018.

The Winner Effect in SaaS

One important component of SaaS that isn’t talked about enough is the “Winner Effect.” Simply put, the Winner Effect is all the benefits that accrue to the winner in a specific market that ultimately results in a significantly more valuable company. SaaS is well known for its high quality business model: substantial recurring revenue, high gross margin, and tremendous predictability. The Winner Effect makes the model even more profound.

Here are a few elements of the Winner Effect:

  • Sales Opportunities – Instead of hunting to find the potential deals in the market, the Winner Effect results in being in almost all the sales opportunities by default. Every prospect brings the winner in and it’s up to the upstarts to try and unseat the leader.
  • Public Relations – The #1 in a market gets 10x the number of media mentions than the #2. This PR results in even more separation between first place and second place, which compounds over time.
  • Third-Party Integrations – Even with all the middleware tools out there, integrating products is still a challenge, especially for the deep, more comprehensive integrations. As the winner in the market, more third-parties write integrations back into the platform creating an even larger moat for the next set of challengers.
  • Valuations – Ultimately, category winners get a valuation premium both when raising money from investors and when going public or selling to a strategic. Look at the some of the high end SaaS valuations to see investors that believe they’re betting on winners.

Another way to put it is that SaaS has a real network effect that snowballs as the business gets larger and larger and becomes the de facto winner in the market.

The Winner Effect is real. Entrepreneurs would do well to understand it and seek it for their business.

What else? What are some more thoughts on the Winner Effect?

Co-Founder Complement: Go-To-Market + Product Experts

Earlier this week I was talking to one of the top SaaS entrepreneurs in town about his experience from a simple start at the Atlanta Tech Village five years ago to raising $75 million last year. We got into a discussion about team, stream, and not a meme and I realized my previous definition of the team element was incorrect. Before, I characterized it as a heroic sales person and a heroic product person.

The heroic sales person brings in deals with lots of passion and vision, yet has an incomplete product. The heroic product person builds the product on the fly while delighting customers all the while. My phrasing it as the heroic sales person was wrong.

What’s the right way to describe this person? They’re the amazing go-to-market leader. Acquiring customers happens through a variety of channels. What matters, especially early on, is finding one channel that works. The go-to-market leader could be great at selling directly, generating demand through road shows, or generating quality leads through search marketing. In the end, the result is  a steady flow of people that want to buy the product.

Pair the amazing go-to-market person with the amazing product person and you have the most successful founding team combination. The ultimate co-founder complement is combining someone who can attract customers with someone who can delight them.

What else? What are some more thoughts on the best co-founder combination being a go-to-market person and a product person?

Build A Startup Around the Ideal First Customer

We started Pardot in 2007 building a marketing automation platform around the ideal first customer: Hannon Hill. Hannon Hill, my first company, was a small, fast-growing content management software company focused on colleges and universities. As marketing automation was a new concept, there wasn’t an existing set of expected modules. First, we built form capture and CRM integration followed by lead tracking, automation rules, and email marketing. Every new feature evolved directly from feedback and ideation with Hannon Hill.

In hindsight, there were a number of benefits of building the business around an engaged, and ideal, first customer:

  • Quality Feedback – One of the hardest things about a new company is getting quality feedback from customers regarding all aspects of the relationship: product, service, support, etc. Having one ideal customer from the beginning that meets the desired profile is hugely valuable.
  • Informed Iterations – Customer usage is oxygen for new products. Too often entrepreneurs build new products in a vacuum and come up for a beta customer when it’s too late. Product iteration speed is critical, yet a customer is required to go with it.
  • Demonstrated Usage – With SaaS software, it’s easy to know if people are using the product with tools like FullStory and simple tracking of items like number of sign ins. Being able to sit next to a person using the product and watching it live, face-to-face makes for an even stronger process.
  • Marketing Stories – As the product gets used by the ideal first customer, more marketing stories emerge as well. These stories about how the customer benefit are then incorporated into the website, emails, sales collateral, webinars, and more. The better the stories, the better the message reaches the market.

Starting a startup? Start with an ideal first customer that fits the long term vision and make that customer successful and happy as quickly as possible.

What else? What are some more thoughts around building a startup around an ideal first customer?

Private Equity as the SaaS Savior

Several years ago if you were to ask me about SaaS startups and their likely acquirers, I would have rattled off the usual suspects: big software companies that want to get in the space, non software companies that recognize software is eating the world, and the occasional out-of-left-field company that’s making a move. Nowhere on that list is private equity. Now, when people ask who a likely acquirer is for so-and-so startup, private equity is the first thought.

Historically, private equity was known for acquiring profitable companies and either combining them with other similar companies to create more scale or aggressively cutting costs to increase profitability. Regardless, high growth SaaS businesses that burn lots of capital and are rarely profitable in the early years wasn’t the target.

Just in the last few weeks, two high growth Atlanta SaaS startups were recapped (code for new investors coming in and buying out existing investors, ideally at a much higher price than the last round.) The two startups:

  • Gather ($55 million valuation) – Venue management software to manage event spaces and private dining rooms in restaurants.
  • CallRail ($160 million valuation) – Call tracking software for marketers to understand the ROI of different campaigns.

Previously, these types of startups would have raised large growth equity rounds and continued marching towards a massive exit, ideally being acquired by a strategic or going public. Instead, they decided to put money in their pocket (de-risking their position is the lingo) and bring in new partners to help grow the business. And, as part of growing the business, the goal is to make 3-5x their money in 3-5 years, as different from venture capitalists that shoot for 10x+ returns.

When SaaS startups reach modest scale (at least $5-10M+) with a strong growth rate (>80%), private equity firms will compete aggressively to buy the company.

High End SaaS Valuations Using the 2017 Inc. 5000 Data

Every year I love pouring over the Inc. 500 (now Inc. 5000). When I first read Inc. magazine in high school in the late 90s, I made it a personal goal to win the award. As a founder/CEO, I first succeeded with Hannon Hill (#247 on the 2007 Inc. 500) and then with Pardot (#172 on the 2012 Inc. 500). And, now, as a co-founder/chairman, succeeded with Rigor this year (#430 on the 2017 Inc. 500).

When looking through this year’s list, a number of well funded SaaS startups appeared:

  • Gainsight – $23.1M, 3,843% growth, #102
  • Bizible – $3.4M, 2,405% growth, #179
  • Domo – $79.9M, 2,250% growth, #192
  • GuideSpark – $24.8M, 525% growth, #856
  • Smartsheet – $64.3M, 425% growth, #1021

Let’s take Gainsight as it has the highest growth rate and look at some high end SaaS valuations from their funding rounds.

Gainsight Notes

  • Funding rounds listed in Crunchbase:
    • May, 2017 – $52M Series E
    • Nov, 2015 – $50M Series D
    • Oct, 2014 – $25M Series C
    • Nov, 2013 – $20M Series B
  • Recognized revenue by year:
  • Estimated end of year run rate (run rate is always ahead of recognized revenue for fast growing companies):
    • 2016 – $30M
    • 2015 – $17M
    • 2014 – $8.5M
    • 2013 – $3.5M
  • Published valuations:
    • Nov, 2015 – $348M post-money (source)
  • Estimated valuation as a multiple of run rate:
    • Nov, 2015 – $16M run rate with a $298M pre-money valuation making a valuation multiple of 18.6 times run rate
    • Nov, 2013 – $3M run rate with an estimated $80M pre-money valuation making a valuation multiple of 26.7 times run rate

SaaS valuations are typically in the range of 3-5x run rate and can go as high as 10x run rate for the fastest growing startups (see SaaS Funding Valuations Based on a Forward Multiple). When valuations are 18 and 26 times run rate, it’s a bet on building the category winner and a different game compared to 99% of the venture capitalists out there.

Want to explore more? Check out the 2017 Inc. 5000 and Crunchbase.

When Customer Expansion Outpaces Churn

One of the holy grails of successful SaaS businesses is having the expansion of existing customers outweigh customer churn. Meaning, if the business didn’t sign any new customers in a year, the upgrades from existing customers would be more money than the lost revenue from customers that leave, resulting in growth for the company. A business that doesn’t have to sell anything new, but still grows, is in an enviable position.

Here are a few benefits when customer expansion outpaces churn:

  • More Money to Acquire Customers – When customers regularly grow their account, more money can be spent to acquire the initial account, providing additional options for customer acquisition.
  • Faster Growth Rates – The law of large numbers starts to kick in making it hard to grow fast at greater scale. When customer expansion is more than churn, it makes it easier to grow faster as there’s a built-in growth engine.
  • Raising Money – Investors look for unit economics that show the fundamentals of the business are strong, and excellent customer expansion, along with customer renewals, and gross margins are three of the most important metrics making it easier to raise money.

Customer expansion outpacing customer churn is the hallmark of a successful SaaS company.

What else? What are some more thoughts on the importance of customer expansion being larger than customer churn?

SaaS 1,000 for Researching SaaS Startups

Tom Blue and his company published a cool little micro-site today called SaaS 1000. From the site:

The SaaS 1000 is a list of the top SaaS companies according to employee size growth. We have created a simple algorithm that tracks a SaaS company’s 6 month employee size growth and overall employee size to come up with the SaaS 1000 ranking.

One of my recommendations for entrepreneurs researching competitors, prospects, etc. is to go on LinkedIn and check out the respective employee count for the company. This SaaS 1000 list has that data and goes one step further showing the six month employee growth rate, which is great for understanding how fast the business is growing.

For entrepreneurs researching potential business ideas, this is a great way to understand companies that are hiring fast, and thus potential markets to build a competitor.

For entrepreneurs looking for peer groups of other entrepreneurs in their city, this is an excellent starting point (e.g. it lists 25 startups in Atlanta).

Interested in Software-as-a-Service? Check out SaaS 1000.

Build a Competing Company, Internally

Forbes has an excellent article titled Starting Over: How FreshBooks Reinvented Its Online Accounting Service On The Fly. FreshBooks is a popular online accounting app (think major competitor to QuickBooks and Xero, but more focused on micro and small businesses) that’s been around for over 15 years. After 10+ years with the original application, it was clear that the product architecture and user experience wasn’t going to scale for the next 10 years.

We all know that the a full product rewrite is the kiss of death. What to do?

FreshBooks created a separate company, with a separate team, in a separate office, to build a new competitor called BillSpring. BillSpring’s goal was to build a real business with it’s own customer base, that if successful, would replace the original FreshBooks product. After two years, BillSpring was working well and customers loved it. FreshBooks made the BillSpring product the new FreshBooks product while maintaining the legacy product and not forcing customers to switch. Now, FreshBooks has a platform for the future.

Need to reinvent your company? Consider building a competing company, internally.

What else? What are some more thoughts on building a competing company to reinvent the business?

$136,000 Median SaaS Revenue Per Employee

Once the startup begins scaling, leaders from each team start asking for more resources (e.g. we just signed 10 more customers, let’s hire another person to do ‘X’). Only, outside the budget, it’s difficult to assess the overall efficiency. One of the best metrics to track efficiency is revenue per employee.

According to the 2016 Pacific Crest SaaS Company Survey Benchmarks, the median SaaS revenue per employee is $136,000:

Over time, the revenue per employee changes as the startup scales from pre-revenue through to seed stage and beyond. Each milestone often has a higher revenue per employee with ones at the expansion stage typically having $200,000 or more in revenue per employee.

Entrepreneurs would do well to track their own revenue per employee and benchmark it against other startups of similar size and scale.

What else? What are some more thoughts on using revenue per employee to evaluate the efficiency of the startup?