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Only a little related to this, in recent months I've spoken to ~60 growth stage equity funds and found out that essentially all transformed to be SAAS focused i
by doh 7y ago
Only a little related to this, in recent months I've spoken to ~60 growth stage equity funds and found out that essentially all transformed to be SAAS focused investors.
That means they abandoned 1/3 portfolio strategy they used to have (1/3 loses money, 1/3 returns exactly 1, 1/3 returns fund) but instead are focusing on steady returns by SAAS companies at 2-3x of the investment.
There are a few major implications:
- for the founders; if you don't fit their narrative, for example you have big chunk of revenue coming from services or you have only few enterprise clients, then you are out of luck
- for the funds; the deals are overly competitive driving up the price and diminishing the returns
- for the market; up until the economy is up to the right, things will be fine. Once things start changing, the first things to go will be a lot of these "nice to have" SAAS companies. In turn they will take down growth equity and freeze funding at the later stage (Series B, C, D, ...).
The last point applies to also to the the article. You can build bootstrapped $1M ARR business, but can you defend it? I think that's the biggest question.
- deleted 7y ago[deleted]
- deyan 7y agoMind clarifying what funds you spoke to (VC or PE, which geographies)? Curious whether your sample size is Bay Area or elsewhere.
- doh 7y agoBoth VC (70%) and PE (30%). 90% in US, 17% in EU and 3% in Canada. 31% in the Bay Area (many growth stage funds are now in NYC).
- DenverR 7y agoFormer GE investor here - everything you've said is spot on. Our modus operandi was that a growth equity investment should _never_ go to zero. The new portfolio thinking has shifted to the right: 1/3 make 1-2x, 1/3 make 2-3x, 1/3 make 3x or more.
- doh 7y agoThanks for clarifying it.
- hogFeast 7y agoJust as the shrewd investors who have been printing cash here for decades are moving out. Always right on time.
- rcarrigan87 7y agoSeems like this trend is only starting to begin... https://earnestcapital.com/investment-memo-fund-2/ https://earnestcapital.com/investment-memo-fund-2/
- hogFeast 7y agoYep, that is what everyone thinks at the top. The smart money is in cash and will buy out the "long-term/trend to infinity" crowd at the bottom.
- pklee 7y agoVery interesting article on earnest and very well done. The author seems to argue that there is a bond like investment instrument that SaaS are starting to become. The S curve the author talks about is a continuum in my limited observation. There are companies at EVERY ONE OF THOSE points i.e. in the past as well as in the future there are commodity companies. It is not clear to me why he target SaaS to be that.
- czbond 7y agoIt seems like the investor profiles and expectations are different. Prior decades of VC / high growth and exit investors are now seeing those exits are no longer as common in SaaS. For many reasons, easier to start a company - more competition, more startups. The area is moving to lower returns, which still can be good for smaller independent teams that can grow or bootstrap. They'll make a similar return to founders, since VC's cash was needed to fund large teams or infrastructure
- reggieband 7y ago> if you don't fit their narrative, for example you have large service revenue or you have only few enterprise clients, then you are out of luck Can you clarify this? What do you mean by "large service revenue" and why does that mean the founders are out of luck?
- doh 7y agoIt was poorly phrased so I changed it. I meant that if a big chunk of your revenue comes from services, they are not going to be very enthusiastic about your business.
- reggieband 7y agoThank you for the clarification. I hope I can ask another. What is the alternative that would make them enthusiastic? That is, if I am bootstrapping a business and want to attract these kind of investors then what sources of revenue would they like to see other than revenue from services?
- andrewmutz 7y agoProduct subscription revenue
- doh 7y agoWell, SAAS. That means subscription revenue, preferably in a market with large TAM that has simple CAC/LTV and churn calculations. Everything else is essentially a hassle.
- reggieband 7y agoI know Customer Acquisition Cost and LifeTime Value from working in free to play games. Total Available Market is a new acronymn/initialism for me. Funny how I don't know if it is pronounced "tam" or "tee, ay, em".
- 7y ago
- whoisnnamdi 7y agoThe re-focus on SaaS as the only class of investment that can reliably generate returns and avoid zeros or capital loss is a very real trend. Would emphasize your point around services - SaaS investors are generally allergic to this stuff and prefer services to make up as little of revenue as possible. It's typical low margin and not seen to be very "strategic" (though this could be debated). SaaS is also much easier to analyze and diligence than the typical non-SaaS software company or consumer internet business. I won't say it's dead simple, but it's very much not rocket science. In combination with excess capital, this leads to prices getting bid up as such ease of diligence leads many investors to throw in a term sheet. It's just so easy to get comfortable with this stuff. One caveat to all this that ties to your last point around the market / economy is volatility. You can see in the data that companies that generate a higher amount of the their growth from SaaS-like retention/upsell see higher valuation volatility when the market turns for any reason. [1] The "best" SaaS companies in the eyes of later-stage investors are typically those with high net revenue retention - but these are also the ones that get whacked the most in corrections. As far as a downturn taking down growth equity - time will tell. [1] https://whoisnnamdi.com/high-retention-high-volatility/ https://whoisnnamdi.com/high-retention-high-volatility/
- tomkubik 7y agoRisk / return trade-off still holds - great insight! Performance through-the-cycle is a big question. One can point to Salesforce (founded 1999, IPO 2004), which has been around for 20+ years... However, big sample bias here (ditto for my article, with sample n = 1). Salesforce, a big-category-defining company - may not be representative of moderately-sized businesses. Whoisnnamdi - per your post, revenue retention looks like a key metric driving valuations!
- doh 7y agoMy point wasn't that all SAAS business are going to be in trouble, rather than the growth equity is going to be impacted because they are funding only SAAS businesses. There is no hedging and as such, once business stop paying for certain SAAS services, they will in turn stop paying for others and so on and so on.
- tunesmith 7y agoWhat does "up until the economy is up to the right" mean? up to the right sounds like a good growth path to me.
- sombremesa 7y agoI believe GP means that as long as everyone has more money than they know what to do with, SaaS companies will more reliably find business (partly because other new companies, SaaS or not, are popping up and using them). However, if the economy took a downturn, these same SaaS companies would be some of the first to bite the dust. Many modern consumer companies are able to hedge against this through the fact that they are more or less "free" and people will not outright drop them, e.g. Google, Gmail, Instagram, Facebook, Fortnite BR - they are more likely to weather a downturn. Of course, these things are not true for all consumer companies nor all SaaS companies, but you can see the rationale.
- doh 7y agoThis is exactly it.
- louisv 7y agoWho are the biggest "nice to have" SAAS companies you think could go under in the next crisis?
- doh 7y agoThat is very hard to judge. We will need to wait and see.