Bessemer Venture Partners: The State of the Cloud, 2017-2018 Edition

You check the Bessemer Cloud index daily. After more than 100 cloud investments and dozens of IPOs, no one knows cloud better than Bessemer Venture Partners. Please welcome the authors of the State of the Cloud, Byron Dieter and Christina Shen. Howdy, Saster peeps.

Hi everyone.

It is great to be back here on the Saster stage and in the next 20 or so minutes we're going to endeavor to do a bunch of things. We're going to try to talk about where we've been and what happened over the last year, where we're at and then where we think we're headed. So I'm going to start off as a warm up act and then Christina is going to bring it home as we dive in. We're going to start off by setting the stage a little bit over the last year. In particular 2016. The word that came to mind was Wowza. Because it was a heck of a year in many regards. Let's start with the geeky tech side of it in all of us. And one of the things that we love at Bessemer is the harder sciences. And right now there's at least a dozen companies putting collectively billions of dollars into software and intelligence around autonomous vehicles that are starting to push the envelope in terms of what software means and harder software and softer hardware as they start to converge. The public market saw a little bit of a heartbeat, in particular with some very noticeable and strong companies were able to get out. We were proud backers of Twilio, which was the largest cloud IPO of last year. Our friend up in the Pacific Northwest, Jeff Bezos, made it rain as AWS revealed their numbers for the first time. Billions in net income, not to mention breaking through the $12 billion run rate mark in ARR in what proved to be one of the most powerful cloud businesses we've yet to see in the world. And then let's not forget our friends down on the peninsula, also another proud Bessemer portfolio company, LinkedIn, where they decided 26 billion felt about right. And Satya and team acquired LinkedIn in what was not only the biggest acquisition of the year, but actually the biggest software acquisition in software history. And so at a high level, there was a lot of excitement. Laying the groundwork for all of you and where we're at today in 2017. But actually, if you were a public company at this time last year and what I stood before you on the stage, this is actually where we were at. The market was down 35% in just a few weeks for the newly minted public unicorns. 350 million or so of your market cap had disappeared just in the start of the year. And there was a lot of anxiety and uncertainty in terms of where we're at and what's ahead. Roll forward the clock to how the year played out. We made up not only all of that ground, but actually ended 15% higher in aggregate in the cloud space. And if you pull back a little bit more, this is the BVP cloud index. You see that this is actually one of a few bumps along the way of what has been a pretty awesome but highly volatile journey to get alpha. You accept a little more. Beta is how we think of it, but how you think of it. There's three dramatic results from this in terms of how 2016 played out that were direct causal factors from this volatility that you saw. The first was in the IPO market. A crappy year, all in the worst IPO market since the recession of 2008. And if you look across the cloud landscape, only the bravest and some would say the best companies managed to get out a dozen total IPOs over the last two years and change. That's it. Record low tech IPOs. And for the explosive part of technology in which we all live and play this cloud ecosystem, only a dozen. Now, at Bessemer, we were fortunate to work with 40% of these and more than our fair share of the largest. And so that's the perspective that's going to inform the rest of the discussion today. When we talk about this ecosystem, we're going to talk about the winners, we're going to talk about those that have gotten public, we're going to talk about the private unicorns and what that means to all of you. And so the second major result from last year was M and A. We talked about LinkedIn, but even stripping out that 26 billion, it was a record year in every way. Add it back in 4x more than any other year. $60 billion of MA activity last year because there was a hiccup in the stock prices, there was a window of opportunity for the legacy vendors to finally buy in at what felt like slightly depressed prices, and they pounced. If you look at the lineup and go through the 80 or so public companies over the last eight years, the $300 billion in market cap, this is what it looks like today. Over 40% of the value of the public cloud companies has been acquired away. Strip out Salesforce at the top there and well over 50% has been acquired. That's awesome news for all of You. And it's awesome news for us as investors because this is what the ecosystem looks like. Yes, there's $180 billion in public cloud companies remaining, 129 billion of which was acquired. But it's what's below the surface. Use the analogy of the tree and seasons have come and apples have been picked or whatever. But it's the strong foundation, it's a strong trunk, it's the smaller companies that aren't yet visible to the world that are going to drive innovation and that are changing the cloud ecosystem and from our perspective, the tech world. So for the first time last year, we actually partnered with Forbes magazine and put together the Forbes Cloud 100. So Bessemer and Forbes put together a big event. They dedicated well over a dozen pages in one of their issues for this list, a cover story, et cetera. And we pulled together the top hundred private cloud companies, which in aggregate represented over $100 billion in market value. Here's a handful of them and there are dozens more. This is the quality that's laying below the surface right now. This is the quality that is in this room and represents what we believe is the next wave of great cloud success. And so the next question we get a lot is, that's great. How can I be like them? What is the path for success? What should I, as a founder, CEO, early executive team member be doing to get on this path to public company status, private company unicorn status, where I control my own destiny and ultimately success? And so Christina's gonna break it down for you in the three most common questions we get and our recommended answers.

Thank you, Byron, and thanks so much for having me here today. Excited to be here. So we get a wide range of questions from CEOs all the time. And so we wanted to hone in on the three main questions that top private CEOs ask. And that is how fast should I be growing and how does that evolve over time? How much should I burn and how do I trade off between growth and profitability? And how do I scale? Because it's pretty daunting to be a 10 person startup, then suddenly a hundred person startup. So let's dive right in. How fast should I be growing? Well, this is an actual email that I got a couple weeks ago and the entrepreneur is probably sitting in this room and really laughing that this on stage right now. But he asked, how long does it take to get to 10 million ARR? And what does the data say? What's good, what's better, what's best? And so I decided, all right, as a data nerd, I'm going to dive into this. And so the first thing I do is I start googling like crazy to find an answer online. And the first thing I came across is Dropbox last week announced they are the fastest SaaS company to get to a billion in run rate revenue. So that's eight years to 1 billion. And like, wow, is this the new growth standard? That is incredibly fast. The truth is that's probably really, really fast. And they are a top tier decacorn company. But you know, there's probably the next Dropbox in this room. And so I thought, okay, well for people in this room, let's say you're at a million in AR. To drag your Excel formula to 1 billion in revenue is probably pretty daunting. So let's take a step back and make this a little bit more tangible. So let's look at how do the top cloud Companies perform from 1 to 10 million in ARR. So here we show Twilio and Structure Box and Shopify, all very successful public companies, thankful all to be best of our funded portfolio companies as well and how long it took for them to get to 10 million AR. You see, Twilio got there pretty quickly. They got there in about one year. Shopify took two and a half years but is a $3 billion public company. And so there's multiple paths of success. And just for fun, we'll look at Slack who got there in just a couple months. What about from 1 to 100 million in AR? How long does that take? Well here you can see it's a broad spectrum. Again, Slack got there very, very quickly, two and a half years. Blackline took a little longer and got there in 13 years. But these are all billion dollar companies, all successful cases that show that whatever growth directory you're on, you can create value in multiple ways and create a lot of equity value for yourselves and for your investors. What do all the public companies look like? We mapped the 43 top cloud companies out there and looked at the top median and bottom quartile and we saw that the top quartile gets from 1 to 100 million in just 5 years, the median in 7 and the bottom quartile in just over 10. So the question begs, what does this mean for all of you? Well, according to the BBP growth benchmarks, we mapped good, better best to the bottom median and top quartiles of the public companies. So what does this say? If you are a good company, you got from 1 to 10 million in AR in just four years, that means you did a little better than a double double, double double. And you're on the same growth trajectories as companies like Cornerstone and Mindbody. If you're in the better category, you did in just three years, so you did a triple double double. And you're in the same growth trajectory as companies like HubSpot and Coupa. And if you are the best of the best, you got to 10 million ARR in two years and 100 million ARR in five years. And you're in the same class as companies like Twilio, Box and Workday. So the great news is whatever category you're in, there are multi billion dollar companies in all three of these categories. So there's not one single formula or growth trajectory, but there's multiple ways to be successful. And hopefully this helps you think through and map through your growth trajectory as you continue to plan your futures. So let's jump to the second question. How much should I burn? And I'm sure many of you went through 2017 planning just recently, so this is probably top of mind. Do I spend on those five extra sales reps this quarter or next quarter or should I drive that pretty top line growth? To dive into this, let us first define what we call the efficiency score. So to talk about this, many of you know the rule of 40 and it's a simple rule. It basically says your annual revenue growth plus your Profit margins should be 40 or greater to be considered a good company. We're going to change it up a little bit. We're going to define the efficiency score. And so what that is is your Carr growth plus your percent burn. Percent burn being basically your free cash flow margin. And that's because we want it to be a true representation of what your sales team is selling, the cash you collect and what you reinvest back in the business. But the major change, we're going to say that's wrong about the rule of 40. It's directionally correct. But we're going to change it up a bit is that we're not going to say 40 is the right number and we're going to make an argument it's actually a cascading scale. So we'll talk a little bit more about this throughout the presentation. But there are multiple models of success for efficient growth. Here are just two with Shopify and Veeva right before they went public. And you can see Shopify is a great example of a growth driven, efficient model. They were going very quickly 112% before they went public. And so their efficiency score is driven heavily by their high growth. Veeva is a free cash flow driven model. And so while they were still growing quite quickly at ipo, they were actually extremely free cash flow positive. And that's really what's bumping up their efficiency score. And the markets reward this. And both are trading at close to 10 times revenue. But what's most interesting is that companies at different stages have, have different efficiency scores. And so here we're showing the public companies and their average efficiency score Pre and post IPO. So three years pre IPO, the average efficiency score is 73%. Three years post IPO, the average efficiency score is 32%. And so when you're a private early stage company, your efficiency is driven so much by your revenue growth. But as you mature and scale to become a late stage public company, eventually that converges with your free cash flow. And your long term efficiency is really what your long term free cash flow is going to be. So what does that mean? What does that mean for everybody in the room? Well, as always, we like to develop frameworks. So here's another framework. The BVP efficiency rule says if you're greater than 30 million in revenue, you just have to remember three numbers. 70, 50, 30. And that's because when you're an expansion stage company and you're call it 30 to 60 million in array, 40 is actually too low of a bar for you. You should be aiming for a 70% efficiency score. If you're an IPO company and $100,000,000 in revenue, you should be targeting 50%. And if you're a public company, over $150,000,000 in revenue, you should be targeting 30%. Then what about companies who are less than 30 million ARR? What's, what's your benchmark? We recommend you look at what is your net new ARR relative to your net cash burn and that ratio should be greater than 1. So a simple example is you grow from 10 million ARR to 25 and you burn 10 million. In the meantime, you have a 1.5x efficiency score, which we would say is very efficient. And so hopefully you can think through these trade offs as you think through growth versus profitability. The final section I'll talk through is how do I scale? And for a cloud company, this really comes down to how do I scale go to market, how do I scale my sales and marketing? You all have seen this equation. It's our CAC payback calculation. And what really matters though is less the formula. But what goes into the formula, the interchange between the different items. And so we think about the inputs as our delicious CAC cocktail formula. And people ask us all the time, what is the perfect sales model? How many A's should I have? How, what's the ratio to SDRs? What's the quota? You can see some light benchmarking on the right. And while these metrics are very important and you should track all of them, what's so much more important is the interplay between these metrics. And so we bucket all these metrics into three core inputs, which is sales rep, productivity, marketing spend and sales support. And roughly what we've seen from companies is this tends to be a third, a third, a third of your total spend. But that changes based off your customer base. So if you're selling into the enterprise and have a massive field sales team, it's pretty common for your marketing spend to be less than a third. If you've got a freemium model and you're driving huge inbound leads, it's actually pretty common for your marketing spend to be upwards of 2/3 of that spend. And so there's no perfect sales model. But what really matters is understanding your sales model and finding the right model that fits your business and customer base. We talk so much about 12 month CAC payback is the right benchmark for everybody. And that very much is true for that middle category. If you are a Mid Market Company, 12 month probably is your right number. But if you're selling to enterprise and you've got 100k ACV deals, you're driving great upsell. You should think of everything as an LTV to CAC ratio. So if you've got a higher ltv, you can spend more to acquire customers and your CAC payback might be upwards of 18 to 24. On the flip side, if you're selling into SMBs and you've got a lower ACV and you've got higher churn, you have a lower ltv and so you must spend appropriately. So your CAC payback might be closer to three to six months. So there's multiple models of being successful. And here we walk through a simple example of what are the trade offs between your CAC payback and your retention and upsell. And here with two very different companies, you can actually drive to the same cash flow business in year four. And so hopefully this helps frame up how you think about go to market. And really there's no one right sales model, but it depends on what's right for your business. So now we've walked you through our frameworks for growth burn and go to market. And so hopefully you can use these frameworks in your day to day lives and hopefully they help you think through trade offs and opportunities and as you continue to run your businesses. So next I'm going to hand it off to Byron to talk about our predictions for this year.

All right, a round of applause for Christina. Thank you. Now we've laid the groundwork in terms of where we're at. The 2016 review of the state of the financial markets today in 17. We've talked about the operational imperatives, the three primary questions that you're probably asking your exec team having in your board discussions, et cetera. And so now we're going to attempt to go a little bit ahead, literally and figuratively, the road ahead, with some of our predictions of the things strategically that our executives and founders are thinking a lot about. And we're going to build on this idea of the AI notion as we go into number one here, which is that one foundational part of the AI approach we think is wrong, which is that literally in this case, a lot of the effort has been around avoiding humans, in this case the point cloud and the virtual display of avoiding pedestrians. But also figuratively the idea of how do you take humans out of the process, how do you reduce work but in many cases alleviate the need for human entirely. However, we actually think this is the state of AI today, which is the Uber car on the side of the road, the Volvo on the side of the street running out of gas because they forgot to instrument the gas gauge for the self driving part of automation. And so the human here is doing the walk of shame with the gas tank, filling up the car because they forgot this important step. That's actually the state of AI today, which is this interplay, this mutual dependency where the power of compute, the power of smart software is starting to reveal itself in awesome ways. But there's this interdependency and in fact this complementarity by making humans better. And that's where we're seeing it. First prediction one is that this year and in the coming few years will be the era of the human assisted AI. Take the most valuable knowledge workers, the high wage employees, across your customer base and figure out how to help them figure out how to take in the security industry, the thousands of signals that they're getting in, wade through that and expose the issues for human resolution. And that's where in the early days AI will make a difference related to that in terms of building product is the other edge of smart construction of smart software. And that's number two. That's where APIs come into play. We have this fantastic gift of, of wonderful software and services available in the market today. Virtually any foundational infrastructure need can be delivered via someone else that's doing that as a dedicated business. And if you're not leveraging those like crazy, you need to go to your engineering team. You need to ask your cto, your head of engineering, your co founder, in many cases, why not? Because nine times out of 10, these will be better, faster and cheaper than your internal team can build. And they're getting in the way of you building the high value layer on top of it. And so that's the foundational layer. But because there's infinite resources available, almost literally in the case of infrastructure as a service, you can't put infinite costs against it. And that feeds into law number three and our prediction for this year, which is that architecture and success is architecting for success. It's planning ahead with a resource dependent world where a zero sum game is still at play. In terms of your dollars you can spend. And it's fabulous to be able to leverage these compute clouds and resources out there. But more and more of our companies that are getting ready to go public will come to us and say, wow, we just refactored our code and saved a million dollars on that AWS bill. We've had multiples of that actually in many of these discussions, because lazy is the wrong word. No engineers in your companies are lazy, but just they're focused on more interesting, in many cases, higher value things. And yet if you can pull a dollar out of your infrastructure costs out of those service relationships and put it into the incremental sales head count, the incremental engineering body, or the incremental marketing program, that will be a net benefit to the business. And so you can't afford to be inefficient and put the introspection against the tech model the same way you do against the sales model to look for opportunities to leverage it there. Now the next layer of the stack is the user interface. And we've talked about mobile first businesses. A lot of the discussions today and yesterday were about this. And there are some fantastic companies starting to emerge, both vertical and horizontal, that are mobile first or mobile only in many cases. For those of you in the room that are building SaaS businesses today, or already have an existing business that isn't mobile only, we like to use the term mobile awesome. Which is how can you make mobile and the mobile phone, the tablets, et cetera be a strategic advantage for you. And the simple reason if you don't believe all the market trends with ubiquity and penetration is the defensive one. If you're not going to be the best in your chosen category, someone else is and they will leapfrog you and be the disruptor of your business in the future and so leverage mobile as a strategic advantage for your business. Now, the customer experience part of this is demanding mobile and is pulling it through. But the way to quantify this and understand what do your customers want, what are they insisting on and how do they react is to measure it. Number five, nps everything. It doesn't need to be Net promoter score. Specifically, it can be any one of the multitude of survey tools and products. But the concept is the same ask and increasingly customers are gonna tell you the leading indicator of churn is customer success is the net promoter score or is related customer satisfaction metrics. Your customer success team needs to be instrumented with these insights and these tools to to be effective. Now the other side of this coin, the right side of this chart is the employee side. And this is the one that's just starting to come up and people are just starting to realize that the other critical element of long term value creation is employee churn. These knowledge workers that are building the foundation of your business and where's their head at with regard to your company, their manager, their career progression, et cetera. The majority of people in this room, and in fact the majority of people in the workforce at large are millennials, born 1980 and beyond. Very demanding, very high performing and also on balance, short tenured. Over 90% of them don't expect to stay around to see their first chunk of equity vest over the typical four year period. So what does that mean? You've got to show upward progression, you've got to show responsiveness to issues and you've got to have a management structure in place that rewards and scents and develops them. Survey your employees, ask these issues, use any one of the products out there that are strong here and they will tell you their issues and you can get ahead of it because it is so much more expensive to hire a net new employee than to retain a great one you already have. And that's a business imperative. Now related to this is the technology UI on top of the product. So we talked a little bit about the mobile imperative and we've seen this progression from the green screen to the thin client in SaaS to the browser client or the thin screen. With mobility, it's the small screen. And we're introducing today the concept of screenless screenless software. You see it a little bit with the Apple watches. Those of you that talk to your cars now, we're seeing that more and more. But it's where the graphical user interface actually disappears. And whereas an engagement metric is an important sense of value for productivity tools in many cases, and time in product, in this case it's actually time out of product or where it's taking out friction. In terms of their engagement, our holiday gift to our CEOs this year was hundreds of these Google Home devices. One because they're cool, but two because it's great mind candy. It's a great way for them in their holiday breaks. I did it too, to play around and see what's coming. You look at Amazon, Alexa, 8 million of these puppies have sold already. You look at the engagement and in terms of search stats, the numbers are staggering. 20% of searches in the Google engine are through voice today, 25% for Microsoft, Bing, and most impressively, look at the right, 41% of these were just within the last six months, meaning it's only growing and exploding. So we are entering an era where different interfaces, and in some case no graphical interface is the winning paradigm. You combine that with AI and APIs and some of the other trends and smart software starts to become a pervasive part of the world in which we live. And then to execute on this, I'm going to leave you with one thought which is the one prediction that we're repeating from last year, which we think is particularly relevant in this environment in this day and age, which is around team strength and team diversity. Now, independent of your social or political views and as Bessemer Venture Partners as a firm we put out a very clear statement on this with regard to that and we support our companies that do, but simply for business reasons. Look at the data. A majority of the billion dollar companies that you want to be part of, that we want to invest in, are founded by diverse teams. Gender diversity makes a company better. On the right hand side, look at the stats. Cultural, ethnic, religious, gender, et cetera. Those are the businesses that we as a global firm want to back. And looking at the Sasser lineup, over 2,000 attendees were international, which for us is absolutely awesome because you're living it and you're benefiting from it. And so you combine the team dynamic with the technical advantages with some of these forward looking opportunities around AI, around leveraging other people's services and software in the API world and architecting for scale with infinite objectives but not infinite costs. And you start to unlock a lot of the valuable elements here that we list in the other predictions. And so, in the words of Jeff Lawson, who spoke on stage yesterday, Twilio founder, who we've been fortunate to back at Bessemer, we can't wait to see what you're going to build. Keep kicking ass. Thank you.