The State of Venture Capital and Getting to $100M ARR with Byron Deeter, Bessemer Venture Partners

We're trying to shift attention away from this unicorn notion of value and a point in time multiple on something to actual business metrics. And the term that we're emphasizing is Centaur, which is about the 150 cloud companies that are over 100 million of ARR today and are building great real businesses that will ultimately be valued with the very best over time, but independent of current market fluctuations, are building fantastic companies. If that's the focus you get to great monetary outcomes ultimately. Ultimately as well.

I need some traction. You need some traction.

Let's get some traction.

Hey what's up innovators, entrepreneurs, visionaries and disruptors. This is your Traction Podcast host Lloyd Lobo. We're a community of over 100,000 people just like yourself, on a mission to help you get the methods, the money and the madness to explode your business growth. Featuring stories and tactical advice straight from those who've done it before, like Shopify, Twilio, Asana, and many more, this episode is brought to you by Boast AI. Each year the US and Canadian governments give out billions of dollars in R and D tax credits and innovation incentives to fund businesses like yours, but the application process is cumbersome, prone to frustrating audits, and receiving the money can take up to 16 months. Boast AI gets you access to research and development tax credits and innovation funding opportunities without the headache and red tape. Join thousands of North American companies leveraging Boast AI software to maximize cashback. Check out B oast. This episode is also brought to you by Launch Academy, an international tech hub that provides mentorship, resources, network and the environment for entrepreneurs to launch, fund and grow their startups. Since 2012, Launch Academy has incubated over 6,000 entrepreneurs, of which 300 have grown their startups past Seed and Series A and have collectively raised over $1.2 billion in funding. To learn more about Launch Academy's programs, check out LaunchAcademy CA. Special thanks to our Podcast partner, Content Allies from Podcast Production and Promotion content allies helps B2B companies build revenue generating podcast. We recommend them to any B2B company that's looking to launch or streamline their podcast production. Learn more@contentallies.com as everyone knows, massive shifts.

And uncertainty in the markets right now. Founders, CEOs, CFOs, board members alike want to know what are the new rules to play by and couldn't find a better speaker on the topic. Byron started his career as a SaaS CEO and has invested in probably more SaaS, IPOs and unicorns than any other VC Twilio Canva, DocuSign, HashiCorp, Box, Intercom, dozens others. And Byron also co authors The Bessemer's iconic 10 Laws of Cloud Computing. He puts together the annual State of the Cloud report. He was behind the BBP NASDAQ Emerging Cloud Index. So who better to educate us on what's going on in the market today? Byron, welcome to Traction. Welcome back. Thanks for joining us.

Thank you so much for having me. I should also add that I was a CEO years ago, buried in my bio and actually weathered one of the pullbacks many years ago. So I have some deep empathy and some battle scars and experience going through a market pullback in the CEO seat as well, which unfortunately may be increasingly relevant these days. Also awesome to see the broad range of people coming in. I'm watching the chat light up here from Dubai and Florida, all across the western us Toronto, et cetera, uk, France. Super exciting to see this broad community coming together here.

Byron seen our journey when we were doing pizza nights and then the first conference and so he's seen that journey. And I had the privilege of working with Byron in a company he incubated out of Bessemer's office. I was there for two years and I would say hands down, if you're raising money, Byron is the best VC on the planet, the most helpful VC and somebody that if you have Byron on your board, I still remember I'd ask him at a board meeting, byron, make these intros please, if you can, if you have time. And next morning those intros were in my inbox. Byron's probably the most helpful VC I've ever met.

That's high praise given how much experience you have in and around this world, Lloyd, but absolutely always fun to work with and around you. And you never cease to amaze both the progress with boast as well as the community you've built up in around Traction. And so generally when you call or text or send me an email, I'm happy to oblige. Yet again, a great excuse to reconnect.

Thank you so much. So we went from last year, unicorns being minted every day, sky high valuations, to a ton of uncertainty in the markets. Interest rates are up, SaaS stocks have taken a beating, valuations are down, layoffs galore. I guess Elon Musk is buying Coca Cola next. Give us your analysis of the public and private markets. What's happening?

You were actually too conservative. 1 1/2 unicorns a day were minted last year. Over 500 were created, which almost doubled the unicorn count in one year alone, the good times were cranking. Certainly there were some fabulous businesses in that process, but the valuation environment certainly got ahead of ourselves and we're paying for it a bit now. The public markets, which we can talk about, you see it for and foremost, the pullback there has been aggressive. We're down over 50% year to date alone and down over that from the highs which were late October for most cloud companies. On the private side, we haven't seen it fully roll through yet, but unfortunately it's coming. Ultimately, the public marks are the exit environment that people need to underwrite to. And so we're slowly starting to see that ripple through into the private markets. And we can talk more about how and when and in what forms that's going to appear, but it's absolutely coming.

Why do you think this is happening? What is the macro learning here for founders and investors alike?

So a number of variables. The CNBC crowd is hyper focused on interest rates, and there is this fundamental idea that people value current income much more than future income in a higher interest rate environment. So there's certainly some causation there, although I think it's overblown. There's a combination of other factors here as well. At the highest level, let's accept that probably 25x revenue run rate multiples that we saw at some point in the public markets averages certainly in the high teens for a broad basket of companies late last year was probably overheated. And then you add in all the macro effects that have started rolling through here where people do have concern that we're entering a recessionary period that may impact buying behavior. So the forecast for these companies may be overstated. The interest rate environment causes people to be very disinclined to, you know, invest in money, losing businesses for many years at the hopes of future income. And then there's immense geopolitical instability, whether the what's happening with Ukraine or the supply chain crisis or the China dynamics, even some of our own domestic issues. And so people are putting these in a blender and going for safe havens. I think we're oversold. I think the public markets are going to look extremely cheap at these multiples. When we reflect back three years from now, three days and three weeks from now, who knows? I'm not even comfortable calling bottom yet. Despite how far we', fallen, given the uncertainty out there and the flight to anything with cash flow that the market's going through.

You said the private markets are coming. What does that mean? How should founders brace themselves? Valuations are already going down. Last year at high I've seen 40 to 80 x valuations multiples, I guess it was supply and demand and it seems like business fundamentals and profitability is coming back in style. Tell us more.

Yeah, private markets, obviously early stage businesses, you have near infinite multiples on zero or little revenue. But for businesses that had some scale, there were deals that cleared north of 100x ARR at some points over the last year plus and these were super high quality hyper growth businesses going after massive markets. But certainly it takes a long time to grow into that multiple. When you look at the current exit environment and so the underwriting that we're seeing first from the late stage crossover investors into these hyper growth rounds is the simple math that you can't buy at 50x when you're selling into a 7x revenue multiple environment in the public markets. The business needs to grow 10x plus just to eke out approaching a 2x return in that environment. And so just the math isn't sustainable. And so what we're seeing is this slow roll through and it's starting first with those very late stage rounds because they're benchmarking almost immediately off of the IPO outcomes and they have real financials to underwrite against. And when you're looking at a business, a fantastic high growth business at 100 million in ARR growing 100%, hopefully that'll exit for more than 7x ARR. But in the current market that's maybe a 10x and you look at that and if you want to make a 2 or 3x on your investment, you need to, you can't underwrite even over many years to much more than a 20x ARR multiple or you're going to, you're going to be left out in the cold on that. And so they've pulled back meaningfully from what used to be 30, 40, 50 xs now to 15, 20, 25 x for the very, very businesses and that's probably coming in from there. Then you start to see the pressure up the value chain and these mid stage growth rounds are starting to see the pressure and it will ultimately roll all the way through to the seeds and A's. Historically in my mind that was a six to nine month lag. But when you look at the data it's actually one to three years. When you look at peak to trough. So if we call October of 2021 the peak, we're now a little over six months into it, but it may be through the end of this year. Until the private markets start to adjust or possibly rolling you into next year. And so for founders out there, we can talk about a lot of things to potentially do when you see this coming, but certainly one of them is raise money fast if you are likely to be in market in the coming months. I would not wait for a better picture because when you look at the public markets, I think it's much likely to get worse than better. For the private financing valuations in the.

Coming months, a lot of companies are raising at that 4,000 plus X on revenue multiple and that's a Ford multiple. What I saw a lot of the times for 12. What are you seeing at series A, B and C in terms of multiples today? Because founders got valuation obsessed and capital obsessed.

Yes. And I think that's the unfortunate part of just the unicorn branding is that people became very focused on these private marks, often at the expense of deal terms, investor quality, other business metrics, and the growth at all costs had the financing at all costs implication, which then had a lot of downstream implications on the business. And two answers to that. One, what we're seeing is a massive range right now. There are still some investors out there that when falling in love with the business, will pay a market clearing price that still looks more like October than it does summer 2022. And that's where the comment of Speed matters here is trying to give some guidance. Because venture investors, we're all optimists, we all want to believe, we all fall in love with the companies that we invest in and we're not value investors. So we're trying to just get the deal done and pay what is reasonable and fair at the moment. And so the deals that we're doing right now still have some of those elements where the pricing still reflects back more on those times. But I certainly would take that money, put it in a drawer and do your best to change the mindset in terms of deploying it and to come at this with an efficiency mindset where you really are trying to get that cash on cash payback from that capital within two years, which hopefully is within your cash cushion window, so that you can actually compound the value of that even at the expense of some growth rate, because your cost of capital is likely to go up in the coming months. And so the ability to turn that and have the balance sheet strength when maybe some of your competitors don't will.

Be an asset at the growth stages. The valuations are more in line with the public market earlier stages. It's still probably October 21st what is driving decision making in VC at say, seed and Series A versus growth rounds?

Very different answers based on firm background and firm structures. So if we start with the late stage growth rounds, there were a lot of new entrants into the market over the last couple of years that from an entrepreneurial perspective, created a broad range of new capital sources and really distorted the market in good and bad ways. Certainly not all bad ways, but created a flood of capital. And so you saw the public hedge funds that were coming over and part of the context is that these companies weren't going public at 500 million or a billion anymore. They're going public at 5 billion or 10 billion. And so the hedge funds are saying, look, we can't get that hypergrowth phase of the early billions. And so they're coming over. They also had raised piles of capital and so they want to cross over. They're now looking at their public tech books, 30, 40, 50%. They've been just pounded and they're reeling. Understandably, they're tapping the brakes on this market. And so their decisioning process is very different. Depending if you have a dedicated private pool of capital or a single commingled pool of capital. If you've got a commingled pool of capital, you're looking at your marks that have been crushed. And these are the names you liked, mind you, that you think are now on sale. So the last thing you want to do is sell those names to buy other. Sell a company at a 7 to 10x to buy a private company at a 20x right now when the public is at scale, already liquidated. And so a lot of those investors have very tough decisions with capital allocation and they're pulling out of the market for those with dedicated pools of capital. And this extends into the institutional funds on the venture side, it's going to become a fairly attractive time to invest. There are vintage year dynamics. If you go back and look at the 2009 and 10 vintages for us at Bessemer, that was Pinterest, Twilio, Shopify, were all companies we got to work with starting in those years, great companies when the market was in complete chaos, where strong partnerships were formed and again at what seemed reasonable valuations to us, to the entrepreneurs were fair in the climate and yet they built great businesses coming out of that. And so the capital allocation for the mid stage institutions are going to be volatile, but you'll see that those with capital are, I think, going to start leaning into things by the back half of this year. And then for the Solo gps and for the super angels and seed funds, very different dynamics based on their own capital sources and frankly net worths for folks that have single threaded stocks that they were funding it with, that were wealthy founders, entrepreneurs from successful companies, they've seen that pressure for folks that were funded by a collection of those individuals, they're likely going to have a lot less capital to play with in the coming months. And so I do think unfortunately that you'll see a large number of those investors exit the seed market and it will add some pressure in terms of less capital and fewer funding providers in that ecosystem a year from now, by necessity.

And how does this environment flow through the exit and acquisition market? You think?

So the MA market is the most interesting because when you look back on 2016 where we had a pullback in the end of Q1 there at Splunk and LinkedIn and some others missed earnings, tech market pulled back, cloud market pulled back, about 20 to 25% of memory serves and then the M and A environment heated up because you had the big incumbents that still had their shiny market caps to play with. They'd been looking for it opportunity to buy the hot new cloud companies with a little bit of multiple pullback. And so there's this alignment where they there was an arbitrage, a time based arbitrage of sorts to come in. The issue right now is that there's not much of an arbitrage. The fang stocks have been hit hard. Mount SaaS with the cloud leaders have been hit hard. The legacy software companies that are generating free cash flow have held up much better for the reasons we talked about at the opening. So I definitely expect them to go shopping here. And what you'll see is that MA becomes a more liquid and compelling part of the exit environment landscape for a lot of these companies. And companies that seemed disinterested and unbiable just a couple of quarters ago are suddenly going to be open minded to engage in discussions when MA looks meaningfully more compelling potentially to short term IPO dynamics. With that said, I absolutely believe that the best companies that think long term are going to put their heads down, they're going to build great businesses. Many of them will actually still choose to IPO into this depressed multiple environment and not this month. Given the volatility, it's hard to do it when investors are just trying to find value. But roll forward a couple of months and I absolutely hope that some of the best companies do choose to still go public. There will be headlines that say Company X rate goes Public at a down round. And it'll imply all sorts of bad things, which is crap and unfortunate because what the journalists in most cases will not capture is the fact that their public peers are off over 50%. So if they're only down 30% from their last round private financing when they go public, that's actually a really good outcome. But that'll be a couple of days, it'll be noise in the market and then fundamentally, these companies will roll forward and it will be the very strongest that go public, not weakened companies, which unfortunately some of the headlines may suggest in the short term.

Now, you're still very bullish on the cloud. Why? And how long do you see this phase lasting?

The transition to cloud is permanent and real. It is probably the single biggest macro technological trend of my investing career and of the coming years in front of us. And it's certainly the biggest trend in software in our lifetimes. And so this transition is real, permanent and massive. The execution on these businesses is still spectacular. You look at the pure business metrics of these companies, even the public ones that we're talking about that are trading in single digits now, they're growing well north of 30% on average. They're generating positive free cash flow and they are driving this replatforming in the industry. And I think we're still in the early innings. We're at 10% global penetration of IT spend by cloud and there's a lot more ahead. This is a valuation question first, second and third. This is all about investor substitutes and a need for cash, anxiety about current income and a rotation, in my view, an over rotation into cash flow, generative safety stocks. When you step back, the metrics that we still care about most, and we actually have just released our 2022 State of the Cloud report, we're trying to shift attention away from this unicorn notion of value and a point in time multip something to actual business metrics. And the term that we're emphasizing this year is Centaur, which is about the 150 cloud companies that are over 100 million of ARR today and are building great real businesses that will ultimately be valued with the very best over time, but independent of current market fluctuations, are building fantastic companies. And as entrepreneurs and as board members and investors, if that's the focus, you get to great monetary outcomes ultimately as well.

I love that Centaur with the ARR at the end. I think if I caught that versus unicorn.

Indeed. Couldn't avoid the pun and the fun with it. And yes, it's this idea of A massive scaled entity.

Now you sit on a variety of boards, from seed through IPO boards, at the seed series A stages versus growth stages. What is driving conversations? Is it still triple, triple, double? Is it rule of 40? What advice are you sharing with founders?

Every single board meeting I've been in year to date, public and private, the discussion has been around this growth versus profitability trade off and how aggressive to lean into the growth plan. And without exception, the discussion has been should we tap the brakes a bit on hiring to generate more cash flow or to burn less? In most cases, as most of my companies are still very much in investment phase, that conversation is being replicated across my partnership, it's being replicated across the venture industry and it's being replicated across the public and private boardrooms, across this full community that our chat group represents here. That's a question of the day and it makes logical sense. As cost of capital is starting to go up for these businesses, you need to be more pragmatic about cash stewardship and also rate and pace investment. And at a high level, absolutely. The growth goals remain primary. And to the extent that a business can compound value over many years, that's the most exciting and compelling way to build value. But you have to be super focused on those payback periods. And my advice is twofold. It's be very return oriented and think about the CAC to CLTV payback ratios and then the CAC payback ratios within months, not multiple years. And then to think about financing and cash management with a big window ahead of you. And I'll tell you, years ago, as an entrepreneur coming through one of the prior recessions, I always had the zero outside capital plan where always knew what would we do internally if we couldn't raise another penny and we needed to coast into break even. Where would we tap the brakes on hiring or spending? Where would we actually do some cutbacks starting with outside vendors, discretionary spending on marketing or other things. And the beauty of these businesses, especially those with high NRR rates and upsell rates, is that when you get above a certain scale, and for some businesses it can be in low single digit millions of ARR. You can survive forever like you are self sustaining. And that's why I do believe that the subscription cloud business model with these renewal rates could be the single best business model we've seen in technology. And there's a lot of effort to get there, a lot of expense, a lot of four loaded things. But when you get that flywheel spinning, you have ball control in a way that very few other business models do. So don't lose that, don't give that up because of being overly aggressive, counting on a financing that's not yet baked and being in a position potentially where you have to do some really painful things to survive if you get out of sync with timing.

So in this market now, to continue to raise, as you said earlier founders, if you're raising, raise now, raise fast. Don't wait for times to get better. What does best in class metrics look like versus acceptable?

Yeah, so we have, if you look back through some of our prior state of the cloud reports, we have good, better best frameworks for metrics by size which because they're different for different stages and I will also acknowledge that they're different by business model types. A low friction product led growth business can look different in the customer acquisition cost side, whereas an enterprise direct selling motion can have much less favorable CAC but could have a more compelling CLTV for instance. And part of this is understanding where your business model fits on these grids as well as understanding what the aspirational metrics are that you want to go after. And so at a high level, some things that I would share certainly growth rate and I do love the this notion of trying to still be in a hypergrowth world while being cash efficient and that the triple double type mindset definitely should be the aspirational North Star in the early days where possible. The CAC payback period, what we like to see is sub two years and for PLG businesses or SMB businesses ideally sub one year. And we go further and we gross margin adjust that because we want to see the actual kind of cash optionality payback of that. And so a gross margin adjusted payback period within those timeframes. And then from a renewal rate standpoint we definitely are looking for businesses north of 100% net renewal rates, inclusive upsells and the most compelling businesses early are at 130, 140, 150 NRS plus and that's where you see especially the land and expand businesses where you can build through users and consumption and departments. But even the enterprise businesses where you have other modules or other seats to sell, we want to see that. And I'll tell you in a recessionary environment, those renewal rates are the single most important metric of customer love of business health. And over time, as you go towards public markets, that's the biggest driver of future free cash flow is the renewal rate dynamic with the upsells because it's the cheapest way to Sell net new business obviously in the process. And then there are a bunch of other submetrics we talk about in the report around ratios of CAC to cltv. We talk about gross churn rates, we talk about some absolute benchmarks for representative CACs and those things. And you can tune the dials for your business. And obviously part of the experimentation of that early stage teams go through is finding out what is your business model going to be. And we have a lot of companies that aspire to be product led growth businesses and for a variety of reasons their product just doesn't get there. But they can still do a direct selling motion outbound and make those unit economics work. And that's perfectly acceptable. You've just got to find whatever your path is to get to market in a rational way.

You said focus on CAC payback, period, focus on ARR. And in the report it says ARR is the new valuation. I call this unicorn porn. The media has done a phenomenal job over the last 10 years spreading the addiction to this unicorn porn. And now it's time to focus on ARR. Let's dive into that a little bit. Building 100 million ARR business is extremely difficult and it feels like last year when there were over 500 unicorns born, they were just handing out valuations and not a lot of companies had that 100 million ARR. So what are some things founders can do to get to that growth rate in this market? Because now capital is not as readily available, it's getting expensive, you have to pull back on growth. What are some levers the best in class companies are pulling or focusing on to drive that sustained growth to 100 million?

The first thing is certainly break it up into phases and understand the different plateaus or horizons of business model excellence. And for round numbers, let's think of it in that one, the 10 and then ultimately the hundred and takeaway one is you have to get to the one in the 10 to have a shot at getting to a hundred. They build on each other obviously, but at different phases. I think of that first phase and that first million of ARR is just understanding what's the product that you're building and what's the community want from it. And this is that aspirational product market fit that people talk about. But it's more than that. It's understanding exactly what the entry point is going to be, what the product vision is. Oftentimes our founders even at that stage will know what their second and third acts may be. They may have a vision for an application that they're going to layer on a payments product to over time or a marketplace element to. And it's far in the future and it's aspirational but at least that's coming together. And they have something that's awesome, something that important people are willing to pay for that's valuable being used. And you see the engagement and the effectively the NRR dynamics but around the product usage and consumption and value starting to build, build from that one to 10 stage. It's all about figuring out a go to market motion that works. It's this idea that we have something valuable here, can it be repeated? And most companies can muscle their way to a million. It's hard to muscle at least efficiently your way to 10 million. What you need to do there is have your first sales reps in a repeatable way or have a really tight funnel in a PLG motion, often with the sales assist through it where you can start to get some repeatability and build up this idea of what unit economics look look like. And obviously we found a lot of companies that don't have a penny of revenue, that are just concepts or that have early revenue. And that point it's all theoretical. You're on a whiteboard with five different models and ideas and you're constantly testing and iterating, working through it. When you start to get into the millions of revenue, you've got some hypotheses, you've got some pods of selling units that are starting to get their legs and ramp up. And that's usually when the business is funded to get into scale mode. When you're going from 10 to 100, it's absolutely replicate and hyperscale that first model. And you're probably starting to think about your second act. And we talked about this two years ago in the State of the Cloud report extensively because we think people underestimate and in some cases are slow to think about that next phase. And the beauty of these cloud businesses is how the adjacencies from a product side can compound. And one of the most compelling examples we give over the last years have been the emergence of fintech within application tech. And this comes from our work with Shopify. Early on a toast in the restaurant, it has payments embedded deeply within it. On the private side, ServiceTitanr Portfolio, which sells mobile and cloud software to plumbers, H Vac, electricians, pest control, lawn control, roofing, et cetera. You go down those industries and now a field technician, a field ops person in your house can not only give you an estimate, but can take a credit card payment and it's a better experience. It's a much better integrated closed loop app experience. Just like a Shopify checkout at in your cart or toast paying for your restaurant order in the moment. And these are massive business extensions, often doubling net tams for these businesses and thinking about those early in that 10 to 100 million ARR range so that you're starting to lay the seeds so that then you can build on it. And I think when the markets stabilize, we're going to see businesses that are going public again as they cross that 100 million ARR mark. And you want to have that investment in that next horizon starting to take place while you're still private, because that's messy, that's entrepreneurial, that's iterative and you much rather do that in the private markets than the public markets. And I think it's one of the most compelling reasons why many of these companies have chosen to wait a bit longer to go public so that they can start to get really the platform part of their business nailed and that next horizon. And for companies that are thinking Centaur and beyond, that's where you want to just get your team and your product and your processes in place so that you have that next part of the business and hopefully you can still grow in the high double digits in some cases into the triple digits at scale in a repeatable way if your market allows it.

What are some best examples of second acts you've seen? I love that second act and it's a good framework. As you're approaching 10 million and you're trying to make this journey to Centaur. Think of a second act. Does the second act need to be bigger than the first act? Because if it's just incremental then it's a feature, it's not really a second act. So does it need to be significantly bigger than the first act? And what are some good examples of second acts you've seen in your portfolio?

It varies a lot by company and market. The payments examples I think apply to some of these application side, but I'll go to Twilio. Back in the early days we were fortunate to be seed investors in them, worked with them from the very early days and they went broad to multiple acts pretty quickly, from SMS to voice to video, to push messaging, acquired SendGrid into Twilio, added email. And so this idea of there was value in having multiple communication channels that were integrated in a single platform so that then they could provide the multi channel capabilities and that meta of orchestration and quality of service and things. And so their conclusion was they needed to go to multiple acts very quickly because the sum of the parts was much better, much more valuable to their customers than any single channel. And so in their case, they took it as not necessarily that the scale needed to compound, but what they want to do strategically is decide what's the easiest entry point, what's the most logical, lowest friction offering upfront, and then walk down the path where they incrementally build on each other. And so the same analogy with apps and payments. I think it would have been very hard for service Titan to start with a payments app in the field, but when you already have the shop owners running on your software and you have then the mobile technicians, when they add the mobile app as one of their second acts in the field, with this on an Android phone, an iPhone and a tablet, what have you, then you've earned the right to layer in payments. And the same thing I think is true with Toast. When they added the mobile takeout as one of their second acts and then connected that with payments which already existed, you had this compounding effect. And they need to be large enough and strategically important enough to be worth the effort. And so in that regard, your opportunity cost is hugely valuable and the distraction risk of misplaced second and third acts can be damaging. I think in that regard it needs to be big enough to be worthwhile. But if you've bet right on your entry point market, you can scale that up hopefully deep into the hundreds of millions of ARR, if not billions, and therefore your second act can draft on that and be a subset of it, as long as it's a complementary addition. And obviously the other segment I would mention is in the application side. Adjacencies are often very powerful. And what you see from early leaders like Salesforce themselves is they will start with essentially a sales cloud, a subset of sales capabilities, build into a more complete sales cloud, then have a marketing cloud, a services cloud and walk down the adjacencies. And that's a fairly typical older school way of doing it as well, but also correct and valuable.

I was just checking out Service Titan's website and ARA and the team have come a long way. It seems like now they were going towards this journey of building the operating system for that industry, and then it was just a natural fit to add payroll processing and payments and maybe lending down the road. Is it crucial though, to be an operating system like Honeybook for your customer to be able to squeeze this out or you become that operating system for your customer as a virtue of adding it. It's like a chicken and egg thing.

That's an interesting point. And I think there are multiple ways to approach it. And I would tell you, for the vertical SaaS, founders and CEOs and teams out there listening, I think that this is one of the most exciting areas of cloud computing and software on the planet today. We had five vertical SaaS IPOs last year alone and have probably a dozen and a half really compelling private vertical SaaS companies in our portfolio right now at considerable scale. And here's why it's so interesting and around about more complex answer to your specific question is these industries desperately need tech. They've been underserved by tech for years because licensed on prem traditional software wasn't flexible enough to serve their needs. And the unit economics of selling and delivering into those verticals was just less compelling. And so you had a lot of mom and pop shops, you had a lot of legacy vendors that were stretching and bending crappy software products to work for these markets, et cetera. For the first time, you're seeing awesome software delivered for these customers. That's unlocking massive value. And the personal stories are so inspiring. When on the service titan example, several come to mind, but where you talk to these shop owners and you'll talk to folks who used to spend hours on their kitchen table at home going through paperwork every night. And when you get the stuff automated, that goes away. And these people are, they're healthier, they're happier. These user conference stories of, you know, people losing 100 pounds because they can work out and eat better, they've got their kids running up and saying, I don't know what the service type thing is, but I love it because I'm getting to spend time with you again. Or you get entrepreneurs that are opening more stores because they can be back on offense strategically. And so that's the power of vertical software when applied to these markets. Markets, that's more in the operating system sense when you start to take on the back office of paperwork, those things. But there are multiple layers in it. And in the simplest sense, one of the models that I love when thinking about these vertical software markets is really owning the application, owning the payments rails within that market segment, and then the marketplace of connection, matching customer, vendor or even suppliers and partners to you, your vendors and your end customers. And that's in some ways the trifecta is if you can provide all of those capabilities, you're really dominating a value chain in Important industries and oftentimes outside in people look at these segments and say, I'm just not sure the TAM there is big enough. I'll admit embarrassingly, that both with Procore and with ServiceTitan, early on we had TAM concerns. We looked at construction, which is one of the largest segments of GDP globally for procore, and said, I'm not sure that the software piece is big enough because historically those companies hadn't spent much on software. But what we didn't appreciate is when you unlock the capabilities of technology and you give them more of these capabilities, they'll pay more for it because they're saving money, they're growing their businesses, there's a large ROI and the TAM's actually massive when you look at it bottoms up. The same is completely true for these field automation businesses and field ops that folks like surge tightener in or toast with restaurants. When you provide these adjacencies and you say, look, we can help you source customers better with marketing capabilities or marketplace capabilities or both, we can drive fast, efficient, completed payments in an instantaneous way instead of these technicians going home at night and generating an invoice and emailing it over and hoping that a check comes in the mail days or weeks later. And those things are just immensely powerful. And so for entrepreneurs out there in and around these markets, think about not only what's your entry strategy, and it could be any one of those three. Typically it's from one of the ends, the marketplace or the application, how you come in and then how you take advantage of that position to deliver more value in the stack.

I love this framework because second acts and becoming a platform company, all of this can get really messy. And if it's incremental then it can also be a distraction. And so this framework of start with the application, large total addressable market that is underserved, manual broken processes and recurring need. Then as you get to 10 million, start seeing if you can do the payments and then eventually become that marketplace. When is the right time to have that platform mindset and become a platform company? Because nobody's interested in throwing their apps in your marketplace or getting connections when you have no customers.

Totally valid. And you need to be at some scale both in terms of letting your customers guide you there and just being able to underwrite it. And companies like a gain site or a guild. It was probably as we approached the 100 million ARR mark and they both started to think about second acts. In the gainsight case, it was moving into the customer experience category. Small acquisition, a Build out. Thinking about the platform pieces there with Guild, it was it's very much about layering in the worker capabilities, broader learner capabilities there in the education vertical and skills and work training more broadly. And another example of this, I would say maybe in that range, think of it as that 10 to 100 million ARR. Those broad guardrails in the Twilio case, as I alluded to it was earlier and that was specifically because they believed the multichannel communications piece was going to be core to their vision and their customer value prop. In the case of some of our later stage companies, DocuSign, it was much later because their core act took them pretty far on the E signature central point and then they moved into more of this collaborative document mindset and system of agreement mindset. But that came later. And so I readily accept that there are different answers for different businesses. You could step all the way back and say if you could be Google and get to billions of revenue and free cash flow off of a single simple product and much of what they tried to do beyond that for years was just wasted capital and time, then of course run that playbook. But in most cases in enterprise software, what we see is there's a complimentary nature to the second act that makes your first act better, stickier, more strategic to their customers, and certainly the unit economics start to feed on each other in a positive way from that investment.

There could be a line between founder shiny object syndrome versus truly prioritizing a second act. What advice do you share with founders as they start thinking through this? What are some common landmines you've seen.

Churn stretching the product too much and not listening to customers when you get out of sync. And where I've lost the most money is with businesses that had awesome core products and ideas and just couldn't either get fully in the market. Like our shared experience. I still believe the core concept was right and just trying to get the product to a point where you hit that tipping point with customer love or where you start with something central that's valuable and you take it in a direction that breaks the rubber band of customer trust. Like they just didn't quite follow you there. And you start to get this erosion from the bottom. And that could be because competitors have moved more in lockstep or because you just, you get out of sync. And the worst, and we see this over the last couple of years, is when you throw money and accelerate away from them and launch the rocket booster, often in a direction that's even a few degrees off center and then you just find you're, you're in another area entirely from where your customers wanted you to be be. And that first and foremost and core and central to me is always if you have to slow growth, if you have to give on a lot of things, don't let the churn rate spike to a point where they're unsustainable because that's the core of any healthy business. And it's much better to go slow, to go fast ultimately than it is to outrun perceived market. And then there's a lot of things that below that in terms of mistakes and risks and those things which we were even talking before this around the cost of bad hires and those things. I do think that markets have pros and cons in any environment. The good news of the market we're going into is hiring is going to become a lot easier. And so use that as a benefit. Be thoughtful about the hires, stretch a little bit on the superstars, the 10x ers because you'll get the leverage from them and you're going to be able to hire them again. Give it a few months and those candidates are going to come to the high growth companies with a strong balance sheet and awesome team members and you're going to have your shot at some great folks again.

It seems like balance sheet is more valued than high growth and high burn. One thing you said that's pure gold. If your customers love you and keep coming back and don't churn, then you earn the right to sell them more and more things. If they're churning, then just trying to sell them more things is fixing a more fundamental problem there which won't.

And even just to build on that, a lot of people then layer in more expensive sales models to do it. So you get in the situation of okay, our customers are more resistant so we're going to throw more resources and throw more dollars at it. We're going to let our CAC payback period start to creep up because we need to push it and it really compounds a bad thing and it's dangerous. And I would say that the most exciting thing to restate the positive of your prior comment is when you see a business and a product that customers love and they're pulling it through and they're trying to buy more of it and they're taking you down the path path. Whether that business is growing at 60% or 200%, you're going to build something valuable there and the ability to walk with them and build and feed on it and that's where the second and third acts can reveal themselves. And if you're doing customer advisory boards where you're getting your thought leaders, not the easy customers that pay you a lot, but your hardest, most complex customers actually know their stuff and they're pushing you the most. Get them in a room, physically if possible, virtually if not, and just go to school on them, talk to how they're using it, what they like, what they don't like, where they want you to go. Get some prospects in the room that'll tell you exactly why they're not buying yet and walk through it and you're going to get gold out of there from a product roadmap standpoint and leaning into that as opposed to really trying to push a sales model that's not quite on target up a heavy hill will pay dividends long term.

Where should founders be investing and where should they pull back in this market? Looking across product, GTM finance, key hires, what are you seeing out there?

I'm seeing a retrenchment to the core in the sense of really product and go to market. And those are the two pillars of most businesses. And a lot of the discretionary stuff where you can save a dollar on the shiny office, the G and A expense, even the discretionary marketing program that you're not sure yet is feeding into funnel conversion or things and you can reallocate that into awesome product or very pointed go to market, that'll pay off for you. And I think this goes to the mindset of shepherd the dollars and think about it truly. And people use the term like it's your own but think about it, it's your last in that what can you do with the capital you have to round trip it enough that you're building on top of the business. And I see some good comments in the chat thread around the horizontals and how this ties together. We've talked a lot about vertical businesses. I would say that a lot of the same applies to horizontals and that when you're building a horizontal platform a lot of the same optionality exists. In some cases though, it's, it's harder because you have more optionality, different more points, more go to market motions. And so the same issue exists. So you need to find where you providing that 10x better solution that when you get it in front of important customers, they're going to love it, use it, buy it, et cetera. And so it's all about the tip of the spear where you're going to enter that market and where you're going to start, you know, building that flywheel and every dollar that you can spend around awesome engineers to build that and then sales reps or go to market motion, dev, evangelism, whatever. Your go to market motion is to get that into customers hands to get the FE feedback. Those are the dollars that are going to compound most directly. And it's not to undersell all the other important parts of an organization. But running as lean as you possibly can in every other way will get you the compounding effect on the engine. Especially in those early days when capital may be tight and buying a few extra months could materially change the slope of the line for you.

The one positive thing Covid has done is the best engineers are not relegated to Silicon Valley. Developers have been democratized to Eastern Europe, India, wherever, working with some great developers across the spectrum, which has brought down the cost. We talked a lot about what existing founders should do in this market. What about new founders in this market just starting out? How would you advise them? Would you want them to focus on one app, one vertical? Or you say no, you know what, keep your job, don't start anything.

Great businesses are started in all market cycles and so I absolutely believe it will be a compelling time to found businesses. Still largely because of these other positive attributes of the cycle, including ability to bring in team members and those things. I would stretch some things on the margin more than you ordinarily would, which is flesh out the idea as much as you can while still on the paycheck of someone else. And not in an insincere or IP infringing way certainly, but use your evenings and weekends to sketch things out, have discussions, talk to people, really bake the idea as much as you can to preserve every dollar and every minute of time to dive into the idea when you're ready, ready, have those discussions with team members, really work through it, Talk to prospective customers to understand their needs, flesh it out as much as possible before making the jump. When you do make the jump, understand that financing's probably going to be meaningfully harder and your friends that did it or maybe you've done it before where just jumping out on the strength of your resume and or the idea was enough, it's going to be harder and so have versions of the plan. Have a commitment to yourself of how far you're willing to go with your own own balance sheet and savings and what it takes externally and then definitely know where your first customers are going to come from and how you're going to enter that market. I think you need to be more fleshed out than ever before on really how you're going to start that snowball rolling downhill. And those are the types of things that you can really nail in a way that previously weren't possible. It's the best time technically in the history of tech to be able to start one of these businesses where you've got all these tools, the IAAS platforms at your disposal. You've got all these paths products with open APIs to build from and assemble different amazing products on top of, and so use those to your advantage so that you can get that quick start when you're ready to go. But the macro trends in these segments are awesome. The competitive environment's going to get a lot easier and talent's going to get easier. So if you've got a concept and if you can get enough funding to get into market and get the puck on the ice, so to speak, you're going to love the game and have a real shot at building something great.

You guys put out a fantastic report today. State of the Cloud out 2022. What are your favorite top predictions from that?

We are seeing so much growth. A lot of this conversation appropriately has been just trying to be good counselors to all you amazing founders and entrepreneurs out there for what is ahead and just being in the state of mind and prepared. But I thank you for pulling back to just to remind us, and tied to the last question, how awesome this trend we're living is is and just what a unique point in time it is to be entrepreneurs and investors and participants in this replatforming and this explosion of software where the challengers are advantaged relative to the incumbents and the net new companies have this have a tailwind for the first time in taking on incumbent categories because of this technological shift. And the others have baggage that need to deal with inertia. And so the report talked a lot about the globalization of cloud, a lot of the accelerants within the markets. One of the counterintuitive things we even talked about was finally the emergence of channels. We do think that these marketplaces among the major IaaS platforms will finally start to be distribution channels for companies. This will hopefully simplify the go to market motion and great products will be seen, discovered and pulled through Amazon, Google and Microsoft and their various marketplaces. And one of our hopeful predictions is that we're seeing much more of that start to take place and product discovery becomes easier for great products.

What was one prediction from last year that didn't work out Channels was one.

That has underperformed for years and it's finally taking hold. But we didn't include that in the prediction list last year. We talked about AI last year and I would say that it's taking hold but slower than we hoped and expected.

Expected.

And it's fascinating what's happening. I mean just look at OpenAI and what the capabilities of GPT3 and soon GPT4. It's just amazing mind candy what's possible now with these frameworks. And so we're just starting to see those present themselves and we're seeing some companies built on those that are doing some mind bending things that are seeing some awesome market growth. And so I think we're still early in AI actually impacting decision making or decision substitution in mainstream software. But that's coming and it will make us all superhuman users and it will make your products super capable. And again this is an area where startups are advantage relative to the incumbents because you'll be able to test it, use it, understand it, insert it and rapidly move with the industry whereas the incumbents won't. And so I think that's an area where of just immense opportunity and we want to see your businesses if you're in these worlds. We've talked about the vertical SaaS markets, the PLG horizontals, the AI based segments. I just think there's so much innovation and so much opportunity ahead in these worlds.

And I think going into the future, just like we don't say web company or we don't say cloud company anymore, we won't be saying AI companies, it will be embedded and we won't be saying fintech companies. So Bessemer puts out a lot of great resources. BVP.com, the state of the cloud. You absolutely must read it, read everything that Byron and his team put sell. It's pure gold. Byron, what are your top resources? Otherwise what are the top things? People should go to your website bbp.com and read.

Yeah, so we thank you for saying that. We spend a ton of time and money with an amazing team trying to go really deep on content because we are still early days of this transition and it's to help our companies but also the industry because we all think we benefit. And so if you do go to bvp.com cloud we have a long list of resources. At the highest level, the BVP NASDAQ Emerging Cloud Index is a trackable index for the public comps and things. So we have data there. You can sort on the 78 pure play public cloud companies today the Cloud 100, which we release in the late summer in conjunction with Forbes in, is a definitive ranking of the top 100 private cloud companies. The State of the Cloud report is then the annual summation of data of trends and awesome that it's now released so you can see that and dive into a lot of that data. And then we have a ton of white papers and blog posts around the 10 laws of cloud computing, the five and six Cs of cloud finance. There's a lot of documents on these phases. There's one that my partner Mary D' Onofrio just put out recently on getting from 1 to 10 million of ARR. There's sales learning curve documents and we were attempting to pull together the best practices from our best entrepreneurs over the years and share that back out. We're not brilliant ourselves, but our entrepreneurs are. And so we do our best to at least learn from them and synthesize their takeaways to share that back out for the community.

What a great source of value. Go to bvp.com cloud and also check out the State of the Cloud 2022. Byron what's one piece of unconventional advice that founders ignore but shouldn't? You've seen all kinds of companies is over the years you've been part of the best.

There's all sorts of things on team building we touched on a little bit. Maybe tactically I would say think about the channels with the iOS platforms where we for years would have told you, don't even think about it. It's not worth the time or energy. I think looking into what AWS and Azure, depending on if you're more SMB oriented or more enterprise oriented, is probably your starting anchor. What they can do for you from a distribution standpoint could be helpful. We're investors in Tackle, which is one of the companies that helps with that onboard. But you can go direct and there's other ways also. But I think that is starting to become real and my hope is that's a game changer for great entrepreneurs to enter markets and to get leverage on very small sales teams by going through these. And so it's early and it's risky and it's certainly contrarian still. But my hope is that becomes a real opportunity for this next great wave of entrepreneurs.

One of the hardest things is building these marketplace relationships and then also figuring out repeatability of revenue and predictability of revenue. And Tackle seems to be solving that problem helps you accelerate revenue through cloud marketplaces. I'm going to drop the link to that as well. Byron, Wishing you the next hundred centaurs in your portfolio. Thank you so much for being gracious with your time and sharing all these nuggets of knowledge. Gold in every sentence. Wishing you great success.

Byron. I love I love being part of this community. By extension with the great questions from the chat and when in person at your events. Very sincerely a pleasure. Great to see you keep kicking butt up there, Lloyd, and looking forward to getting back together in person with this crew.

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