State of SaaS with Altimeter Capital

Hi everyone, welcome, welcome. Hello Workshop Wednesday community, thank you all so much for joining. Just giving folks a few minutes to get settled here in the room. We have a great turnout, a really great session today. Hello, hello everyone. As always, we are so happy to see you at Workshop Wednesday. We are thrilled today to be joined by Jamin Bell, partner at Altimeter Capital. If you guys haven't followed Jamin already, he is always sharing really insightful data on the SaaS ecosystem. So if you don't follow him now, you should go and do that right now on LinkedIn and on Twitter, because he's always putting out a lot of amazing data. and we're really excited to have him share some of that and dive into some of the things that he's seeing in the market right now and what he's looking ahead to for 2024. So we're really thrilled to have him. It's going to be an awesome session. As always, yes, please tell us where you're tuning in from. We're thrilled to have Jason M. Lemkin joining us today from Menlo Park. Welcome.

Great. I'm excited to be here. Thanks for, thanks for having me and looking forward to chatting all things SaaS.

Awesome. Um, well, just to get us kicked off, we're going to dive into our quickfire questions just to get to know you a little bit better and to kind of hear your perspective on some of the top topics. So, um, would love to hear, in the past year, what has been the favorite investment that you've made?

Oh, it's a good question. Um, and it's easy for me to pick favorites because I, um, hasn't been like a heavy investing period. Lots of meeting with companies, not, not tons of actually investing over the last year, but We recently partnered with a business called Tabular, which is in the data infrastructure space, building a data lakehouse solution around the open source project Apache Iceberg. And that one has been quite fun to work with, with the team, Ryan and folks over there. So in general, very excited about the data infrastructure theme more broadly. And this business feels like it's kind of at the center of a number of really exciting trends. And so looking forward to our partnership with them for the long term there.

Awesome. Sounds great. Um, and then what has surprised you the most about venture capital this year? You know, this is a loaded question. You probably talk a lot about it. Yeah, probably talk about it in your presentation.

Very loaded question. Uh, you know, I would say 2021, lots of learnings from 2021, just around the pace of deployment, the kind of the entry valuations. Um, and I'd say just like lots of self-reflections in general from kind of the whole venture community over lessons learned from 2021. I would say what's maybe— maybe it's a hot take— what surprised me a bit about the venture community is what appears to be just a lot of the same exuberance that existed in 2021 kind of showing itself again in 2023, which I would've envisioned maybe a little bit more of like either PTSD or muscle memory from, from 2021, but we've kind of reverted back, uh, quicker than, than I maybe would have, would have anticipated.

Yeah, but we, we love a hot take, and we also love to hear that things are kind of, um, more active than what people are maybe thinking and perceiving, uh, based on some of the new stuff. What about, uh, the next 12 months? What are you most excited about?

Yeah, I mean, I'm really excited about Getting, you know, what I would call like back to basics. I would say over the last few years, there was just, it was really hard to get signal on A, do you truly have product-market fit, you know, or B, like how differentiated are you really from your competitors? And I'd say it led to just a lot of harder and tougher strategic decisions where when you had this huge period of exuberance, there was like lots of Everyone was buying software. Everyone wasn't thinking about, is this a point solution or should I get this functionality from this other vendor who offers it as part of a bundle? And I think it in general was harder for companies to have clarity on like, are we making the right decisions? Are we being rewarded for those decisions? Or are we kind of just like caught up in this big wave of SaaS and software buying? And I think on one hand, like it'll get harder going forward. But I think it will lead to more clarity on which products are differentiated, which markets are big, which companies truly have product-market fit versus need to kind of keep tweaking to find it. And I think while that clarity can be good or bad, you can get clarity and it's negative clarity, I think ultimately that's going to lead to more efficient businesses being built and ultimately less noise. In, in the market in general. So I think, you know, the next year, 2 years are going to be an amazing time to, to build businesses, uh, the, the right way. And I definitely hesitated and did not want to say I'm excited about it. I'm very excited about AI, but it felt like too easy.

Yeah, no, well, we love to hear, again, an optimistic view. So excited to hear more— you dive more into this, uh, in the next few minutes. But last question before I give it over to you fully is Who is one of your favorite co-investors?

Hmm. Oh man. So I have like 3 little— I have 3 daughters and it feels like it's like asking like, who's your favorite?

A lot of people are always like, oh, this question. Yeah.

You know, so before I can get into a little more of my background as well, but before I joined Altimeter, I was over at Redpoint Ventures for about 5 years and I still have a ton of respect for the team over there. I'm actually hanging out with some of those folks, um, later this weekend. One of the guys on their team was a groomsman in my wedding, and so I kind of— lots of shared history with the Redpoint folks. And so I always love getting, getting an opportunity to, to spend, you know, excuses to spend more time and work together with them.

Yeah, it's a great, great connection. We love the Redpoint team too over here at Zaster. So, um, well, thanks so much for those quick answers, and I know you have a lot more information for us, so Without further ado, I'll let you dive right in. Thanks, everyone, and make sure to get your questions ready.

Perfect, perfect. Let me pop over here. Just a couple disclaimers I have to start with.

Oops.

Is there a— is there someone writing on the slide, or is that— I don't know if that just shows up on mine. Okay, well, if it's— does anyone see a green line down the middle, or is that just on me?

Yeah, I am seeing that, uh, but I don't see anyone that's written that, so, um, yeah.

Okay, I'm not sure how to erase it. Um, either— let me—

I'll work on that, but you keep going.

Eraser.

There we go.

Oh, there you go. There's still a dot, but that's fine. Um, great. Uh, just a quick background on myself. I'm over at Altimeter Capital. Uh, we do both public and private investing, although I spend all of my time on, um, our private— most of my time on our private team. There's lots of shared learning between both our public and private teams, but most of my day-to-day is, is around the private side. Generally, from a stage perspective, it's what I would call early growth. So lots of Series B, Series C, Series D, kind of right when companies are hitting the earlier phases of product market fit, you know, have something built and are now, you know, maybe have a couple early customers and are really getting into that, how do we scale that go-to-market org? How do we scale the go-to-market operation and turn this thing that we've built into a growing business? Lots of the companies I work with tend to be more in the infrastructure, kind of cloud infrastructure umbrella. So lots of DevOps, DevTools, data infrastructure. Some of the companies that I work with the closest with are companies like dbt Labs, Tabular, Airbyte, Prisma, ClickHouse. So you can sense a trend, lots of open source, lots of data infrastructure. I write a blog called Clouded Judgment, which generally talks about themes and trends more on the public side, but kind of like broadly in software markets. And so I wanted to kind of take some of what I write about and package it into what I would call kind of like the state of SaaS and, you know, a series of 10 or so charts to really dig into what's going on in the world of software valuations, business performance, like how does macro and interest rates kind of like all like wrap together into the state of SaaS. And so I wanted to start with, this is a chart that I share pretty regularly. The darker blue line shows shows the median revenue multiple of a basket of about, you know, close to 100 software companies. The lighter blue line shows the 10-year interest rate, and the horizontal gray line shows what I would call the long-term average multiple. And so just, you know, I know there's probably like a wide range of experience here, kind of on more of like the financial public market multiple side. So I'll try and give a high-level enough overview, but also enough detail so it kind of, it makes sense to a wide range of listeners here. But when I think about, you know, for those who aren't familiar with what a revenue multiple is, it's— this is a valuation methodology for kind of comparing relative valuations of businesses. And so what, you know, what it actually means in practice is you'll take a valuation of a business and divide it by some metric to get to a multiple. And for software companies, the most common metric that is used is your forward revenue. So your next 12 months, NTM stands for next 12 months revenue. Generally folks will look at a forward metric, not a lagging metric, you know, because ultimately how, you know, how the market perceives companies will perform over the, you know, a future period is more relevant than what they have done. And most, you know, all, most, yeah, all public software companies have revenue. So it's an equalizer in terms of what you can look at. There are other metrics that you can use to value companies. You can use a profitability metric like free cash flow or net income. Not all public software companies have that, right? And so their multiple would be a negative multiple. And so a revenue multiple is just a great way of level setting kind of relative valuations of public software companies. And I like to call it this chart because if you look at kind of that COVID period, the April 2020 to kind of the start of 2022, you can really just see how anomalous that was when it comes to public valuations relative to basically like the history of software valuations that preceded it. A lot of software valuations, and I'll talk to you, are kind of tied to interest rates, right? As you can see, interest rates, that light blue line, really, you know, kind of went to near zero, um, in that COVID period and have been steadily climbing. Uh, and there's usually an inverse relationship with interest rates and software valuations. And so if you, you know, look at kind of that end of 2021 to today, we've kind of seen this steady decrease of valuations, um, with an increase in interest rates. Um, And so I think a lot of people look at this chart and say, okay, hey, well, the median multiple now is 6 times, right? That, that longer-term average, that longer-term steady state is closer to 8 times. You know, it feels like we're due for a bounce back. And I think I want to talk today a little bit of like, well, can we get that bounce back? Like, how do we think about the 6x median multiple today, which is, you know, about 25% lower than the long-term average, in relation to a number of other factors, interest rates, growth rates, profitability. 'Cause I think it's easy to look at this chart and say, wow, like, you know, software companies are undervalued, like we're going to bounce back. But, you know, I hope at the end of this to provide just a bit more context to everything that goes into a software valuation. So this chart, similar chart to the last chart that I just showed, except I've removed, that the line that had the 10-year rate, and I've added a light blue line that shows for that same basket of businesses what the median kind of consensus next 12 months growth rate is for that same basket. And I think this is a real interesting chart because like what you can see here is, yes, the median multiple is down about 25%. I think it's actually 22%. But at the same time, the median growth rate for the basket of public software companies today, this is forward growth rate, is 13%. When we compare that to what the median growth rate was for businesses from that kind of 2015 to 2020 period, it was 27%, right? And so on one hand, we can look at this data and say, sure, the median multiple is 22% lower than its long-term average, but at the same time, the median growth rate has almost halved. It's down about 50% from what it was from its long-term average. At the same time, the 10-year, which is like a benchmark interest rate, that has gone from about 2.2% on average from that 2015 to 2020 period to 4.3% today. So the 10-year is up. It's almost doubled in that period. And so Looking at that data, it might give a different takeaway, which is growth rates have almost halved, interest rates have about doubled, yet the median multiple is down 22%. I think that's a very credible argument to say it feels like maybe the median should be lower than that, given where we are in terms of the interest rate environment, as well as the business performance environment. I guess I jumped into— I don't want to assume that there's a broad knowledge around the group of like, well, why do interest rates increasing have an inverse relationship with software valuations? So why does an increase in rates lead to a decrease in valuations? On one hand, there's probably two quick reasons. On one hand, you can look at a business and say, the best way to think about the intrinsic value of a software company is looking at the future values of its cash flows and discounting them back to present value. Um, the reality with a lot of software companies is a lot of those free cash flows are more heavily weighted towards the outer years. You know, maybe you're not generating free cash flow today, or you're generating a small amount of it, and over time that your margins expand and, and those, those figures grow. But the reality is, is for software companies A lot of the value or a lot of the free cash flow that will be generated over a company's lifespan are more heavily weighted towards the outer years. And so when the interest rate goes up, the discount rate goes up. So you're discounting those future cash flows higher. I'd say another reason is when you think about big asset managers, they're thinking about how do we allocate our own capital across a wide span of asset classes, real estate, credit, debt, equities. Software businesses are generally thought of as further out on the risk curve. They're more risky investments. And when interest rates go to zero, you essentially have an asset class that you won't really get a return on. You can invest in a security bearing like a 25 bps or 0% interest rates, but you're not really going to make much return. And so you're really not going to allocate much capital to a risk-free investment that has a super low interest rate. You're going to put that capital in high-risk assets like software stocks. As interest rates have gone up and as everyone, myself included, everyone listening, can park their money in treasuries that gets you a 5% kind of guaranteed rate per year, maybe you start to take some capital out of the high-risk assets and allocate it to this risk-free. And so you just get big flows of capital moving from high risk to risk-free. And when that happens, it generally has a— it pulls down multiples. And so just wanted to quickly level set on me, well, why is there a relationship between interest rates and software valuations? And then also frame this slide, which says, look, the current median multiple, while yes, it is lower, and a decent amount lower than its long-term average, there's also other factors like growth rates have really significantly slowed and interest rates have significantly increased. So you would expect the median multiple to be lower than its long-term average. And until either or both of those factors reverse, I don't think we should expect to go back at the median or above it. Uh, and this kind of wraps all that up, right, into, well, what if we looked at a growth-adjusted multiple? Let's take your revenue multiple and divide it by your growth rate. Um, and this is the, the light blue line is, is showing the median growth-adjusted software multiple. And I think this chart is, is really the most telling, um, because what it shows is the median, you know, the long-term average kind of growth-adjusted multiple was right around 0.3 times, right? But where we are today is we're about 60% higher than that, even in an interest rate environment that is quite a bit higher. And so the takeaway from this slide is really on a growth-adjusted basis, like the software universe actually really isn't that cheap today. I think you could actually say it's actually relatively expensive, relative to the long-term average. And so I think a very fair question is, "Well, why is that? Is that because business quality has gone up? Are these businesses just more profitable? Do they have higher free cash flow margins? Are there expectations that rates are going to go down and this is the market moving ahead of that?" Are there expectations that growth will start to reaccelerate as we kind of like make it through this, you know, software and SaaS recession that we've had in kind of 2022 and 2023? And I think those are very fair questions that I hope to kind of maybe not answer, but maybe, you know, give you some data that helps you make your own informed decision. But before jumping into that, one final chart here is I've shown you revenue multiples. I also wanted to show free cash flow multiples. And so this looks at the universe of software companies that are free cash flow positive, that have some level of meaningful free cash flow. So if you had $1 million of free cash flow, your multiple might be something crazy, crazy high because you're just dividing by a really small number. So I've removed companies that have a negative multiple, removed companies that have a greater than 100x multiple, —because neither of those baskets are really relevant at looking at kind of the relative performance—to basically say, okay, let's look at a profitability metric. We've looked at a revenue multiple, we've looked at a growth-adjusted revenue multiple. What if we kind of boiled it back down to ground truth and said, well, how have free cash flow multiples trended over the last few years? And I think one takeaway from this chart is you're going to see a lot less volatility. You didn't see kind of the huge crazy spikes like you did in 2020 to 2022, or to 2021, of revenue multiples, you definitely see a spike, but not as dramatic of a spike. And today, the median free cash flow multiple, it's about 10% lower than the long-term average. And so for businesses that are free cash flow positive, who are quote unquote like good businesses generating cash, They're closer to their long-term average. They're still below it, but again, you'd probably expect that given the interest rate environment. So quick recap, I know I've kind of— of what we've talked about so far. I know there's just been a lot of numbers and data, but the median revenue multiple is down about 22% from its long-term average, while the median growth rate or projected growth rate of that same basket is down about 50%. The median growth-adjusted multiple, however, is up about 60% versus its long-term average, while interest rates are up almost 100%, and free cash flow multiples are kind of about steady with where they have traded on a historical basis. And one other context, a lot of the long-term average I'll talk about excludes everything that basically went from COVID forward. Which was a little bit of like an anomalous period where valuations went crazy. But what about other performance? Like how can we look at business performance of public companies to try and gain insights from that? The chart on the left, so public companies will report quarterly earnings where we get a glimpse into how they performed that quarter and a little bit of like what they expect in the immediate short term. Every quarter, there's what's called a consensus estimate, which is just the median estimate from a number of banks that put out research notes. And two metrics that folks like tracking is, well, how did the company's quarterly performance compare to that consensus estimate? Did they beat it or did they miss it? And by what margin? At the same time, they'll provide guidance for one quarter out, which is basically just saying, next quarter, we think we will do X million in revenue. And similarly, folks like to look at, well, how does that compare to consensus estimates for one quarter out? Is it higher? Is it lower? And by what margin? And so that's what these two charts here show. The bar charts is the binary yes/no. Did you beat or miss consensus estimates? The left-hand side for the current quarter, the right-hand side for the guidance one quarter out. And then the gray line is that margin of beat or miss. So how much Or what, by what margin did you come in above or below those consensus estimates? I just wanted to show these charts to highlight a couple things, right? One, generally software companies are beating current quarter estimates, you know, at kind of 95% or more. We've kind of dipped down to call it 90% over the last few quarters, right? And it's kind of stabled out there. Usually companies beat by about 4%. That number's about half that, it's about 2%. So companies have definitely been beater by beating by smaller margins and less companies are beating. And that same trend holds when we look at consensus estimates. So usually you'll have companies guiding about 2%, 1 to 2% above the next quarter. Maybe you have, call it, 80% of companies beating guidance. Right now it's almost a 50/50. Half the companies are missing guidance, half the companies are beating it. The average guide is basically flat with consensus, which kind of makes sense given that 50/50 figure. And so We're not getting a ton of— I think the leading indicator here is, okay, well, when are those guidance beats going to start getting back to historical figures? And when is the guidance raise is going to be, you know, closer to that 1 to 2% versus, you know, kind of flat what it is today? That'll be a good leading indicator, at least that companies are more confident in the short-term outlook. Um, I'd say here's a positive chart, um, that I put together, which looks at every quarter Net new ARR added. And net new ARR basically just says from one quarter to the next, how much incremental ARR was added to your business. That looks at ARR being generated from new customers that you've signed, as well as existing customers that have either expanded or contracted, or existing customers who have churned and left altogether. So it's more of a quarterly metric. How did your ARR change one quarter to the next? And I think what we've seen is for a few years now, like that figure, that growth rate has started to slow, right? And has shrunk every quarter with the exception of the last few quarters, right? So this, I would say, is a good potential leading indicator that maybe the tide's starting to turn a little bit. Maybe companies are starting to kind of like add more net new ARR, 2024 could be an exciting year for that reacceleration. When I think back to those first few charts, looking at growth-adjusted multiples and interest rates, I think there is an element of an expectation that performance will reaccelerate into 2024, and we'll see those growth-adjusted multiples normalize a bit as the growth rate goes up. And as the growth rate goes up, the multiple will go down. Um, but I wanted to show this chart because I thought it was kind of an interesting— you know, we'll see if the trend continues in, in Q4 and Q1 of next year, but so far the last two quarters have at least been a positive signal that, you know, growth is starting to, um, to rebound a bit. Lots of data on this slide, um, but really just wanted to present some metrics here. Um, I think I've repeated one slide, um, realizing that now, but The net retention is one of my favorite metrics. I think one of those charts was supposed to be growth rates, so sorry about that. But we've talked a bit about growth. And I think it's like seeing that retention fall from 120%, which is where it's been for a while, down to closer to 110% over the last few quarters. I mean, I think that's very indicative of what I see in private companies, what all these public companies are seeing, which is there's a lot more pressure. Your existing companies are just expanding less. Than they have. They're right-sizing their contracts, they're right-sizing their consumption, they're right-sizing their number of seats, and it's a lot harder and there's a lot more pressure to grow from your existing customer base than, than there has been in the past. You know, on the bright side, if we look at the bottom left chart, we've seen a really big change in the profitability profile of the universe of software companies, right? In that 2021 period, you can, you can really see where the emphasis shifted from profitability to growth at all costs. And then businesses across the board really just started focusing on growth and on generating more revenue and a lot less on let's generate profitable revenue. And so free cash flow margins dropped across the board. And in the last few quarters, you've seen that rebound back to right around 10% median free cash flow margins for the software universe, which again, I think it tells a story of, hey, it's time to get fit. It's time to focus more on profitability versus just simply growth. This chart is also, you know, it kind of tells a similar story. And I know it's hard to see, but what each dot is labeled doesn't matter quite as much. These are regressions that show your revenue multiple and your growth rate, right? And if we rewind the clock back to September of 2021, you can see the correlation between revenue multiple and growth rate was quite high. That's the left-hand side. The right-hand side, you can see that that correlation has broke down, right? It's not all just about revenue growth. There's other factors that matter here. In the color coding, I know you can't see the— or maybe you can, I can't read it, see the labels, but the blue dots show businesses that have greater than 20% free cash flow margins. The yellow dots and the red dots are companies that have less than negative 20% free cash flow margins. And the yellow dots are companies that are in between, so -20% to 20% margin. The reason that the labels on the dots don't matter is that the takeaway on this slide is if you look at who's above the line, who's trading above the regression, it's a very high concentration of blue dots. So if you are generating real free cash flow, kind of above 20% free cash flow margins, odds are you will be rewarded with a higher valuation relative to your growth rate to peers with similar growth rates. So the market is really rewarding profitable growth now versus just growth. Quick chart on rates. I'm not a macro expert, but we've talked a little bit about, okay, how do rates impact software valuations? And so I think then the big question is, well, what's going to happen to rates? You know, rates can rise or fall for, I'd say, two different reasons, right? One is around inflation and one is around economic growth. A big reason, right, one of them, the main reason we rose rates was because inflation, uh, when I say we, I mean we, one reason the Fed rose rates, um, is because inflation started to rise out of control. And one way they combat that is by increasing interest rates. If rates are higher, the cost to borrow is higher, and in general, kind of like spending will go down. Leading to downward pressure on inflation. One reason you'd cut rates is the exact opposite. Hey, if inflation is no longer high, you don't need to keep rates super high. You can slowly start to bring them down as inflation comes down. And we've seen inflation come down over the last few months and quarters. And kind of the question is, does that trend continue or do we see a rebound in inflation? Another reason you could decrease rates is not a positive one. But it is if the economy starts to slow, if we start to head into a recession. Decreasing rates, in the same way increasing rates can lead to, hey, a pullback on spend and a pullback on inflation, taking rates down, it does the opposite. It can lead to an increase in spending and it's a form of stimulus. And so rates could come down because the Fed is projecting the economy slowing and they want to stimulate it. Obviously, that's not great. That would mean, hey, there's an impending recession. But when we look at this chart, this is the implied Fed funds rate projections as of 2 months ago, 1 month ago, and today. As you can see, the projections for interest rates have pretty meaningfully come down over the last few months, and that's a result of inflation coming in line, but also some leading indicators that, you know, maybe, um, maybe the economy is, is heading to more of a slowdown than people think, um, right? Jobs numbers, you know, and unemployment are kind of surprising to the downside, which, you know, many are, uh, are, are reading into as leading indicators of a slowing economy, right? So I would say rates and rate expectations are coming down, but if it's because inflation's coming down, that's great. If it's because there's an expectation of a recession, not so great. The reality is it's probably some combo of both, you know, and that's what makes 2024 fun is we'll, we'll kind of, we'll get more data on, hey, is it more of the former or the latter? And maybe this is just kind of like a final chart, which is, you know, one thing I love is looking for kind of like dispersion, right? So this compares the top quartile multiple versus kind of the median. Not all software is created equal. I think from that 2015 to 2019, 2020, everyone was really starting to understand software, but companies traded in a tighter band. In 2021, it was this crazy COVID anomaly, but what we're seeing now is maybe settling out to, is there a new normal in dispersion? Are the best of the best companies, do they deserve to be valued higher on a relative basis to the median software company compared to historical standards. I think what we've seen in the software world, which gets me so excited, is just a number of companies that are able to operate in growth mode profitably, right? So companies that can maintain high growth rates and high free cash flow margins. Generally in software, the prevailing view is you're in one or the other, right? Your high growth, low profitability, and over time growth slows, profitability picks up. And then your high profitability, low growth. I think seeing a lot of businesses today that can do both, um, is a really exciting, I think, proposition for software and why we're maybe settling out to this— you know, I always hesitate to use the term new normal, um, but just like a different level of dispersion than, than we've seen in the past. Um, To wrap all this up, and I'll end my monologue and we can open it up to some Q&A, but as I've talked about, valuations today probably appear expensive relative to growth and profitability and interest rates. I think there are a lot of folks expecting a quick bounce back in valuations. My whole point here is being like, maybe I don't expect them as sharp as a bounce back. Because we need rates to change, we need growth rates to change, and those things tend to take time and not be kind of bounce-back-type recoveries. We don't see interest rates bounce, you know, or I don't expect them, right, to bounce down. You know, don't really expect growth to have that V-shaped recovery. But I think what's exciting and why I'm excited about 2024 is when we headed, you know, heading into 2022, heading into 2023, we were in a rate-hiking environment, right? It was very clear that rates were going up and they were going to continue to go up, and we really know where they were going to top out. What we did know is as they continue to rise, it would continue to be a headwind to software valuations. I think now, just my opinion, it appears more clear that we're no longer in a rate hiking cycle, we're actually more likely to be in a rate cutting cycle. I think that's very constructive to software valuations in general, And I think one of the reasons I'm kind of constructive and optimistic about the world ahead, right? And then finally, like the current debate is really like, well, do we have a hard or soft landing? You know, I tend to be a, you know, people label me like a perpetual optimist. So I'm always in the, you know, hey, I'm gonna be excited and optimistic until it's, you know, slapped me in the face that it's not. So I'm pretty constructive heading into 2024. I think rates are no longer a headwind and they're more likely a tailwind. Excited about the possibility for not a hard landing, but a slowing of economic growth, but not necessarily a deep recession. And I caveat all that with— I can't remember who said it, but I listened to some presentation where someone once commented, when it comes to macro, you're either wrong or you're lucky. It's really hard to be right and smart. You're either right and lucky or you're wrong. And so all of these is obviously just you know, my own, my own opinions versus any kind of, any kind of like expert opinion. But I think that's, yeah, that's my last slide. And so happy to, happy to answer any questions, or if there's things I mentioned that didn't make sense that folks want me to double-click on, or acronyms I've used that everyone's like, what the heck does that 3-letter thing stand for? Yeah, happy to go in any direction, and I'll stop sharing so you can you know, see me. Awesome.

Thank you so much, Darren. Uh, great content. Uh, we have a lot of chat going on, uh, and a lot of questions, so we'll just dive right in, uh, in a few minutes we have left with you. But, um, first up is Addie. He has a couple questions for you.

Hey, Jeremy, go ahead. Thanks so much for joining. I, I read your newsletter religiously, follow you on Twitter, so appreciate, uh, seeing you in the flesh, I guess, uh, over Zoom.

Thank you. Couple of inside—

one inside baseball sort of finance question and then one more broader question. The inside baseball question is, have you ever looked at this stuff on a market cap weighted basis since there's all this— like these, you got a few SaaS companies like Adobe that are so big and trading at huge multiples, it might be skewing things. And you can take that offline if you want to answer that, but messes with the— how different it is from the median.

Yeah, yeah, I would say we, you know, a good representation of this is, you know, what everyone's calling like the Magnificent Seven, um, where, you know, you can look at the big index, you know, like the S&P, and I can't remember exactly, you know, Netflix, is it Facebook, Amazon, I remember the specific names, Microsoft, but like there's 7 companies that if you look at their performance over the last year versus if you took them out of the index, you know, the index is basically flat But with those companies in it, the index is up whatever it is, 10%, 15%, and those companies themselves are up 40%, 50%. There we go in the chat. And so that, I think, leads back to this dispersion point, which is there are a few companies that are really holding indexes and averages up that probably make the picture seem a little bit more rosy than it actually is. Because if you actually looked at the percentage of companies who are performing well versus the basket, it's not going to paint quite as rosy of a picture. You have a lot of these companies that have massively benefited from some of these big trends, Microsoft around, and Nvidia around AI, huge beneficiaries, Amazon as well. The answer is, I guess I haven't really answered your question. Yes, it's very relevant to look at all of that on a kind of like market cap adjusted basis, because the large companies tend to trade a little bit differently. I just didn't for this presentation. I think most of the businesses in that index that I've shown like are not the huge— there are some, right? Like Salesforce and ServiceNow and Workday and others, but like the vast majority are kind of more of your not mega caps, like in Microsoft and Apple and Amazon. Like I don't have those. They're not in that software. They are software companies, but I've taken them out of the index that I track just to try and avoid some of that. But good question.

Yeah. Yeah, Adobe is probably the biggest of the players that trade huge multiple too. So it may be the one skewing it the most. That's right. Second question is on most of us, I think on this call are more involved at smaller private companies. Yeah. How should we best, you know, if we, If we accept that growth really matters, growth and profitability matter, how much do you think things like management, you know, like to be public, you're the cream of the crop, you're the best of the best, it's proven you can sort of forecast hopefully and hit your numbers. There's a great, there's a bigger management team. How much do those other factors outside of growth and profitability matter? And how do you tend to think of like, what should a private company think it's worth relative to a public company? Because it, I would think it'd be some discount. That's typically the way it works. [Speaker:JASON M. LEMKIN] Yeah.

I would say, I mean, all those factors really do matter, right? Looking at your net retention or your payback periods or these other factors that would overall help me answer the question of really fundamentally, A, is this a good business? And then B, is it a durable business? And all wrapped up into that is, is the market big? Is the team good? Are they executing well? Is there differentiation with competitors? I think that all matters. And when it comes to private companies, I think at the end of the day, I think about public multiples as kind of ground truth. A lot of startups are thinking about, hey, well, what could I be worth one day in a liquidity event or in an exit, either an acquisition or in the public markets? And usually in both of those scenarios, your metric, like what you're valued on, either you're going public and it is, you will get a public public market multiple, or you're getting acquired, and maybe it's a, it's a slight premium to that because it's a strategic takeout, but it will be very close to a, to a public market multiple. Um, so I think what we see is like, over time, as companies get later and later stage, the, the multiples that they're given in the private markets really start to converge with, um, the multiples that investors expect the business to trade at in the public markets. Because if I'm an investor and I am paying 50x or 100x, I'll just walk through some math. And again, I don't mean to talk out of both sides of our mouth. We did our fair share of overpaying for businesses in 2021, but I think there's lots of lessons to be learned. If you pay 100x for a business, 100x ARR, and I think that was— I used that number because it was the flashy headline number in 2021. I mean, we saw it all the time, but you expect the business to exit at 10 times revenue or a 10 times multiple. You're going to have a little bit of dilution along the way. Maybe there's 20% dilution from future fundraisers, from options being granted to employees. Maybe you go public and there's dilution in an IPO. Call that 25%. The reality is, is just to break even on an investment, that business needs to 12 or 13x its top line. And if I want to— I'm not looking to break even. We're looking to have a portfolio that returns a 3 to 5x. To get that, by entering at 100x, the businesses need to grow top line 40x just to get back to our base level return. That math is really hard, and all done in a window, maybe call it a 6, 7, 8, 9, 10-year window. There's not that many businesses that can grow top line 40x in a 7, 8-year window, right? And I think that's why the math for investors around these 100x ARR rounds get really tricky. But I'd also say that there are a lot of dangers too, and for founders thinking about, well, how, you know, if I am given this type of offer, like, how should I think about it? It really sad— always sounds good in practice, but the advice that I always give to folks is, you know, raise around at a valuation where you feel like you can hit 1 or 2 key milestones before raising the next round at an up round. I think the challenge of the 2021 period is what the implicit thing that companies were taking on is, well, if we want to raise an up round, if we exit this period of crazy exuberance, the reality is, is we're going to need to hit 7 or 8 or 9 milestones before we can raise that up round. I mean, and everyone on this call knows, like, startups are hard. Like, it's really hard. It's, it's never a straight line. It's really bumpy. You'll, you'll think a milestone is going to happen at X period in time and it happens a year later. It's— it gets really hard. And when you have just this crazy pressure to live up this valuation, you know, with a lot of cash in the bank, you know, it can lead to ill-informed decisions. Um, it can make hiring hard. And so You know, I've always said like the safest, not the best, but like the safest way is raise capital in regular increments, right? Raising smaller amounts of capital, maybe more frequently to kind of make the cap table not a risk to your business is a helpful approach. Again, like I'm a venture capitalist, so I'm sure there's lots of folks who say, well, aren't you just, you know, kind of like trying to negotiate lower valuations and I would say, look, that's just my genuine views on the valuation environment, how it can be dangerous. But I would say, look, early on, I'd say private investors are usually willing to pay a slight premium because we know, hey, these companies are growing a lot faster, they're much earlier in their S-curves, and we're willing to pay a little bit forward. But at the same time, the question of how much and what is that premium depends. As much as everyone wanted to look at that 2021, 2022 period and say, "Wow, well, look at these public market multiples," that was always the anomaly. Really, the purpose of the newsletter that I started and why I started talking about public market multiples was because I don't really think it's something that a lot of people really pay attention to at a granular level. So maybe when you start paying attention to it, it happens in an anomalous period one way or another, but you don't really have the frame of reference to know, Is it anomalous or is it normal? And so a lot of the metrics that I post on Twitter, on my blog, are really just meant to be a drip feed of what's enough content where I can pay attention to what's going on in the public markets, don't need to be an expert, but can get a sense for what's normal and where are we today relative to what's normal. I don't even know if I've really answered your question. I just rambled. But hopefully that was somewhat helpful. And if I didn't answer it, just shoot me a note and I'll put more coherent thoughts together.

No, thanks, Jim. And a lot of people had questions about your take on effects on private companies. So I definitely think that that was helpful. I have some questions, follow-up questions for you too if we run out of time. But Jason's on the line and has a couple of questions for you as well. I'll let him jump in.

Maybe I'll just simplify to the second one. I'll tell you what I've just been thinking about lately, and I'm sure you've thought about a lot more than I have, so curious your thoughts. Um, you know, it's just, it's crazy how much more efficient so many B2B companies got in the last 5 quarters. Like, it's crazy, it's crazy. You look at Monday, like, growing 60% with the same headcount, um, all across the board, right? I mean, I, my jaw just drops every time I write up a 5 interesting learnings and I look, and I look back 5 quarters and I'm like Oh my God. So I think everybody, with a few exceptions, got fit, right? Even Salesforce got fit. So the question on all the metrics and everything is, what's after fit? And I think so at first fit seemed to work, right? And the companies with some sort of sweet spot, uh, decent growth and fit and at least non-GAAP, uh, you know, profitability, seem to be the ones that were trading at the 8 to 10x or above, right? Um, but I'm not so sure now that's what the markets want, and I'm not sure the markets are like perfectly efficient or perfect. Of course. So, of course, um, well, I'll give you— I, I, the, um, if they did, then I think Klaviyo should have traded perfectly in sync with Shopify this year, uh, because they're the same company. But what's after this? Now that we are fit, now that we've all bulked, gotten, gotten shredded at the gym in SaaS, not start, but what is next? Yeah. Right. And, um, is, is it, is it— and I don't know, I don't know the answer, that's why I asked.

I think that's a great question. And I look, I would say there were a lot of questions, you know. I think in hindsight we can look back and be like, wow, look at how quickly these really large companies were able to turn the knob and go from like really inefficient to really efficient. I think that was a big question mark of like— and it was also 15 years, it was a question mark.

Could anybody do it, right?

Yeah. And it was a little bit of like, hey, there was always this promise of SaaS recurring revenues are just like cash flow annuities, right? And you can stop hiring salespeople and just farm these annuities forever. And so that belief in that mindset was look like the reason companies aren't profitable is because we're investing in growth. We're hiring new sales rep. All those reps are not efficient. They haven't ramped yet. We're paying them money, but they're not bringing in new business, right? There's money going out the door, but not coming in. And when you're in growth mode, you just have like a high percentage of unrammed, unprofitable reps, right? And you have a lot of new marketing people and you, you have a lot of R&D projects you're working on, you know, the second, third, fourth wave of the business, maybe you're Datadog and you've nailed kind of infrastructure monitoring, but you want to move into application monitoring and logging and So you have a lot of people in R&D who are building product 2 and building product 3. And again, engineers are expensive. Um, they're building products that aren't finished yet, so they're not bringing in revenue. And so for many reasons, companies operating in growth mode, whether on the product side or on the go-to-market side, it's just hard to be really efficient because you just have inefficient headcount. And there was just kind of this question of, well, can you even reverse that? Like I don't believe you can. And sorry, this is also just more context to the question for the rest of the group. What's been amazing over the last few quarters is just to see how quickly companies can just turn that knob and say, well, we can be profitable, or if not profitable, we can greatly expand our margins very quickly. And I think that was a really important thing to show for the investment community, for markets more broadly, Because I think, I think, um, it kind of does validate companies' decisions to operate in growth mode. Um, and so what I would say is, I think as we head to 2024, 2025, like, I think everyone can look at this supercycle, right, that we are entering into around AI with foundation models, text, video, image models, how those are going to kind of create the next leg of growth For software companies, are incumbents going to benefit? Are startups going to benefit? And I think there's going to be a little bit more of a willingness to accept, you know, some less profitable actions, right? As companies look to capture and be winners of that supercycle, there's going to be a little bit more leash to say, hey, we are trying to acquire market share, and to do that, we had to operate maybe a little bit more inefficiently. Um, because look, like, I always joke, you know, my, my business, my— doesn't exist if every company is profitable. Like, every company's profitable, you don't need any— you don't need venture capital. Um, so like, in many ways, venture capital is kind of dependent on burn. Um, it's much easier to start companies today than it was 15, 20 years ago. Um, there's a lot more competition, and so there really is kind of like a race to get market share. Um, and once you have it, once you are the market leader, then you can start to farm it and, and operate more efficiently. But the race to get to that market share is very real, um, because again, there's just so many more competitors now. It's easier to start competitors. Um, and so I would say, to answer your question, I think there's going to be a little bit more leash, um, to operate not perfectly efficient, with the understanding of, well, Is this a business that we think can actually turn the knob, or is this a business that if they turn the knob, all of a sudden Microsoft is offering some competing product in a bundle and the business is just going to get bundled away? So I think, yeah, that's kind of my high-level thoughts/ramble.

[Speaker:BRAD_STONE] Yeah. I mean, I'll let someone else ask a question. When I talk to public company CEOs, and I've done a lot of that lately, most of them think the current efficiency metrics are here to stay. That's what they've internalized, and they've told their teams, yeah, um, you're gonna have to do the same with this amount of headcount for this amount of bookings and this amount of things. Um, I just don't know. I, I don't know that where— if things are even as multiples reflate even a smidge. Yeah. Or, or, or maybe, maybe I don't know that that's what Wall Street and the rest of the world will want, right? I don't know. I, I literally just don't know. Um, but I I— my gut is that we've slightly overcorrected and that we're hiding— we're hiding inefficiency. We're hiding— we're— we— everyone gets a pass. Even this true of startups. We get a pass on mediocre growth in startups, not just public companies, if you got wildly efficient. Yeah, right. I mean, Datadog is one of the best of our lifetimes, right? But Datadog has gotten both more efficient and seen its growth slow, right? There's a million like that. And so I just— I don't know, I ramble, but I think founders are confused because founders get bad advice that it's okay, that efficiency, efficiency, efficiency justifies buys slower growth, and it doesn't— especially for startups, it doesn't. It doesn't for startups, right?

Yeah, I think about it, right, which is I want to have a good point of view when spending time with startups of, is your growth real? I mean, the macro question is, is your growth real or is it fake, right? It sounds kind of basic, um, but let's take an extreme example. Let's say you're adding $1 million of net new ARR a quarter, but you're burning $10. You know, I'm gonna say I don't really think that grows real, right? Like, I think you're just, you know, hiring an army of folks and like, that's just not sustainable. Um, if there's a permanent increase in attention on efficiency, um, you know, we're not going back to this 2021, like, oh, like no one cares about how much you burn or this or that. Um, there's a permanent, you know, change and we are always going to be thinking about it now. The level of that, I think, just naturally will ebb and flow. As much as we say it shouldn't, I think public markets are very reflexive and it will ebb and flow. But I think everyone's now thinking of, look, hey, the triple, triple, double, double, or whatever it is, it's like those aren't all created equal. And doing it efficiently versus doing it very inefficiently is going to lead to just different valuations, different binary outcomes. Do funds want to even invest in you, yes or no? Um, so there's a very real attention on how real do I think and how sustainable do I think this growth is. And, and a lot of that brings me to look at how much are you burning, what's the efficiency of your ramp reps, how many reps are hitting quota, is everyone under— you know, like, there's, there is a lot more attention on that from the investment community that, um, that, that I think is is here to stay for, for a little while. Um, you know, there's an AI bubble separately.

Um, the one, um, the one metric that you track, which is great, and I think you calculate it maybe slightly differently than others do, is what's the CAC for all these public companies, right? And I think it doesn't really matter exactly how you calculate as long as it's consistent. But I think one of your conclusions is that they ain't get even— we're more efficient today, mainly by freezing hiring. I mean, that's the simple answer, right? Yeah. But our CACs aren't coming down. And in fact, in many cases, our CACs are getting worse. It's costing more to acquire customers, and we're masking that with the combination of higher NRR and lower growth, right? Because we're masking it in retention. And that's, that's my worry, is that we think we're getting better and more efficient, like, but, but if our CACs are going up, we're actually not getting any better at selling and marketing this, this B2B software, are we?

That's right. I mean, yeah, and efficiency goes up or down. And that's really a function too of like, it's just, I mean, I'm sure everyone on this call, but it's a really hard environment to sell software. Like deal cycles have elongated and slowed. And so, you know, your marginal person is less efficient, but you have a lot less of them. So then the basket is maybe more efficient from a spend standpoint. But yeah, it's not an easy environment to sell software, like, right? It's harder to get revenue. From your existing customers. It takes longer to close new business. Enterprises are thoughtful about like, do we need another vendor to do this? Or can we get 80% of that functionality from Microsoft, from Salesforce, you know, for free? And so all of that has just made it harder to be efficient on a unit economic basis. But on an aggregate basis, you're maybe spending less. Yeah. Yeah. Cool.

Thank you so much for all the commentary, Jamin, and Jason, thanks so much for the great questions. Love seeing everyone's chats. Jamin, we know you have to go, so thank you so much for the time. We have more questions than we could get to, so I'm gonna follow up, and everyone that's in the chat and had your questions, we're gonna make sure Jamin gets these. Hopefully he can even do some future posts about them. So keep an eye, again, make sure to subscribe to Cloud of Judgment. You may even see some of your questions answered there. Jamin, thank you so much for making sense of all the madness right now in the market. And it's always great to hear some optimism going into 2024. So we really appreciate you. Um, and everything else you do it. Yeah. Thanks so much, Jamin. And then everyone else, um, as always, we will see you next week, 10:00 AM Pacific time. We have Alessio Artufo. He's the president and COO at DSOBO. He's gonna be sharing his lessons, um, and successes and setbacks on their road to $1 billion valuation. So it's gonna be a great, um, scaling journey session with him. And we're really excited. To hear from him. So thanks again, Jason M. Lemkin, and thanks everyone for joining. We'll see you next week.

Bye.