State of the Cloud: 2018 Edition

Please welcome Byron Dieter, partner at Bessemer Venture Partners, and Christina Shen, partner at Bessemer Venture Partners. Hello, Saster Pepys. I'm Byron Dieter and it's great to be back here at Saster.

Hi, I'm Christina Shen. Great to see you all again as well.

And a special shout out to our colleague Anna Khan, who's with us today as well, who helped with this. And we're thrilled to be unveiling our annual State of the cloud report, the 2018 edition, which is for the first time going to be shared with you today and concurrently online after the session.

Later in this presentation, I'm going to be talking through some of the valuation metrics that we looked at and why we think it's changed in the last couple years. Byron will then talk about some of the 2018 market predictions we have. But first, Byron's going to kick it off and talk about what we've seen in the last 12 months of 2017.

Thank you, Christina. And to lay the groundwork, let's talk about 2017 and specifically what we saw in tech, the cloud industry and the macro economy more generally. And let's start off with the tech industry, which is one of the trends that captivated a lot of attention. This whole notion of bitcoin, Ethereum and ripple the blockchain world and what's happening there. Now, very smart people can disagree and debate actively whether the price of bitcoin should be $100 or $100,000. But what we can all agree is that the distributed ledger and this notion of blockchain is going to have lasting impact to tech, and we'll talk about that later. Our Instagram feeds have been filled with high school kids driving Lamborghinis, and you can debate the merits, but the lasting impact is quite exciting to us. Similarly, there was discussion about bots and bots taking over the world. There were slack bots and messaging bots. And although we haven't seen that and many of those companies are ACCU hires today, the impact of the early instantiation of machine learning in AI is having lasting impact in the software, and that will be impactful as we talk about the macro trends. But on the broader scale, if you think about GDP and GDP globally and how tech impacts that, let's look at the last 10 years because some very critical milestones occurred that will impact everyone in this room. And let's start with the view from 2006. This was the worldview of gas and oil companies, physical product manufacturers and finserve businesses dominated the world economy. Microsoft started to make their way in there as a tech company. And if you rolled forward five years later, you saw the emergence of Apple as one of the iconic brands and businesses. But really still, it was an oil baron's world. Intel. A seminal event. Early in 2016 and then for the first time consistently in 2017, all five of the most highly valued companies on the planet were venture backed technology businesses. If you look a little deeper in the next three, you had Berkshire Hathaway, but you also had Tencent and Alibaba venture backed tech companies in China. And so for folks in this room that want to transform industries and want to have lasting impact on a global scale, you've come to the right place and you've jumped into the industry at the right time. And you're not all doing this for money. In fact, I love the passion and enthusiasm that's sincere for founders. But there's also some good news in this, which is October of last year, our friend Jeff Bezos became the world's richest man, a tech venture backed entrepreneur. Increasingly a cloud entrepreneur became the world's richest man. And so some exciting moments that lay the groundwork for the path of a founder and as a public CEO. However, the interesting thing is not many people are going public anymore. If you look at the trends, 2017 felt like a bit of an up year, but it was only because 2016 was a historical low. You have to go back to 2008 for an equivalent period. That low in fact for tech IPOs in the industry. And so we're at historically low numbers for a couple of reasons. But the interesting thing is those that do go public are doing extremely well. The Bessemer Cloud Index, which tracks the 54 pure play public cloud companies is up over 450% in the seven years we've been tracking this $20,000 invested in 2011 would be over $100,000 just by buying a passive basket of cloud stocks. The private companies in this room have likely outperformed that meaningfully. And so the prize is big. And I'm also proud to say that shortly we'll be adding two new companies to that list. One is a fresh new IPO SendGrid, which we were pleased to be investors in. And then Adobe, notably, as one of the largest public software companies that successfully undergone the transition where a majority of their business model economics are now cloud and also the delivery model, cloud hosting, is now crossing over the 50% mark, which is a seminal moment in terms of the cloud ecosystem. Now if you think about what it Means to be public. The hurdle's now higher. The average company is taking twice as long. It's a similar trend to what we're seeing in the consumer side. And as a result, the average company is now almost twice as big. Part of this is driven by a flood of capital and private investors like ourselves are supporting these companies longer and paying healthy valuations. And so the why bother? Question comes up. A lot of why would I want to go public? And if you think a decade ago there were zero private venture backed unicorns, these billion dollar companies now, today There are over 200 ranging from consumer to enterprise, literally globally now. And the exits aren't happening as we saw the public side. But also when you add in the M and A side, the venture backed exits are actually going down, which has created this interesting backlog effect. We talked about the public cloud companies, 54 in total, 44 of which are public cloud unicorns, over a billion in valuation. The interesting thing is there are almost as many private cloud billion dollar plus businesses today annually. We do a list we call the Cloud 100 together with Forbes magazine, that'll be the September issue this year. And as we go down that list, just to get onto that list, the threshold's over 400 million, the mean is over a billion, and there are 37 companies over a billion dollars market cap on that list today. It is a staggeringly high quality and frankly awesome list of companies that are your private peers and are setting the benchmarks for the private industry. And so what we're going to do is break down that list. The benefits of being the largest cloud investor and having worked with many of these and many of the public companies is that we're able to see a lot of the raw data and understand a lot of the trends. And so Christine is going to walk you through the valuation frameworks and some of the benchmarks for these peers to understand what awesome looks like as a private entrepreneur in today's environment.

Thanks, Byron. So as Byron mentioned, we've been investing in cloud as a firm for over 15 years, which means we have seen not only thousands, probably tens of thousands of cloud companies. And that is a lot of data to look through. And so what we've tried to do today is take a look at how valuations have changed over time. And we're going to suggest a different valuation framework today. And so let's take a look back first at what was it like to raise private capital 10 years ago? Well, whether you were a public company growing 30% year over year or, or a private company growing 100% year over year, regardless of your growth rate, you probably got about the same valuation multiple. Back then. It was about five times revenue. But today private companies are growing faster, say let's say 100 to 300%, and they're also gaining a higher valuation multiple as well. And so clearly there's an association of growth. But what's the right way to value that company and to do that, let's first take a look back of what's happened over the last 10 years. Well, a lot of things have happened. First of all, everyone I think now in this room particularly recognizes the cloud SaaS adoption is real and all your customers and buyers now recognize it as well. The second thing is, through the proliferation of APIs and AWS services, it is now much easier, faster and cheaper to start a cloud business. In addition to that, we've been investing in cloud for 15 years, but our venture capital peers have also joined in as well. If you look at what's been invested in cloud software, it has literally quadrupled in a six year time period and represents about 50% of total venture capital funding, which is great news for everybody here in the room. And so what does all this mean? Well, given all this that's happened, private companies today, these people in the room, you're fundamentally growing faster than your counterparts and your predecessors years before. And so let's take a look at how fast do the top cloud businesses grow. Well, we're going to take a simple example of four companies. Twilio, Box, Shopify, Sendgrid, all public companies, all happen to be best of our companies, partially because we have the data. But we're looking at how long does it take these companies to grow from 1 to 10 million in ARR? Twilio got there rather quickly. They got there in a little over a year. Sendgrid took a little bit longer, took three and a half years. But these are all, first of all, public billion dollar companies and all have their own path to success. And so looking through all the data, this is what the BVP growth benchmarks say. Now to be clear, these are all phenomenal companies and timely. It's kind of like the Olympics. These are the gold, silver, bronze categories. To make it on the podium is phenomenal. But, but to give you some sense of what the different categories of growth look like, good Companies get from 1 to 10 million ARR in about four years. Better companies get there in about three years. That means you're doing about a triple, then a double double. And the best companies get there in less than two years, which means you're tripling every single year. And so hopefully this gives you some framework to think through. What is my growth rate and how does that compare to some of the benchmarks out there? But now that we have a sense of how fast private companies are growing today, let's think about how to value them. And so let's take a look at valuation multiples over time. So what this graph is basically showing is, it's showing on the yellow line, it is the average ARR, so annual recurring revenue multiple paid average for that year for private companies that are between 1 and 20 million arrangements. The blue line is the average multiple paid for public companies. So you can see that that gap between private and public has grown pretty dramatically over time. To be exact, in 2011, private multiples were about 1.5x that of public companies. But today they're about 2.5x. And so what's contributing to that increasing gap, well, we've been talking about it is, is because private companies are not only growing faster than public companies, in fact, private companies have been growing faster and faster every single year. In 2011, they were growing on average of 170%. These are companies that are between 1 and 20 million ARR. Today they're growing about 250%. And so we've established two things. One is that private companies are growing faster and faster each year. And two, the valuations have been rising for private companies each year. So what's the right way to compare these two numbers and come up with a valuation framework? So we're going to introduce what we call the BVP ARRG metric. So this is going to be our pirate metric, ARR growth to mult or ARR to growth multiple. And so what that basically means is you can take your ARR multiple, your annual recurring revenue multiple divided by your year over year growth. So a simple example of this would be. Oh, sorry, I'm going a little backwards here. Well, ok, so a simple example would be if you had a 10 times ARR divided by 150, that would be a 6.7x. So let's look at how this would actually compare. So, so you saw that while ARR multiples look very high, if you plot your ARG multiples over time, it's actually relatively flat. You can see that green line plotting in the center. So the yellow, which is your ARR multiples, is roughly a 2.5x multiple to your public, but your ARG multiple is only a 1.3x multiple on top of your public. So that implies two things. One is that on a growth adjusted basis, private valuations today are actually fairly close to public companies. And two, it's been pretty consistent over time. Now, there's been a couple bumps along the way. In 2013, the public markets were a little overvalued. You can see that blue line bumps above the green. And the flip was true in 2015, where the private multiples were a little bit overvalued. So what does that mean? That means in the last two years, despite seemingly high private company valuations, it actually shows on a growth adjusted basis, private valuations have actually been fairly reasonable. When you do the comparison, we're actually paying relatively close valuations for public companies as we are for private companies. And so what does that mean for all of you in the room? Well, by far the most important thing to valuation is always going to be what is the market opportunity, the team competitive dynamics. And these are always going to be the most important components. But growth will always be the most important metric. In terms of numbers, that does help indicate your valuation. And so we believe that looking at an ARG multiple will be one of the great valuation frameworks that you can leverage as you go forward. And so what are some of the other valuation frameworks we can look at? Well, growth is always going to be the one we look at the most, but some of the others we look at as well. Your CAC payback, so looking at your sales efficiency, your churn, so looking at what percentage your customers are retaining on an annual basis, and your cash flow efficiency, which we define as your net new AR divided by your net churn. So hopefully this gives you some benchmarks and valuation frameworks for you to help think through. How do you compare to some of the benchmarks out there? And so next, what we want to talk about is, is some of our market predictions for 2018. Now, as a firm, what we've tried to do over the last couple years is really put our predictions or our roadmaps out there for all of you to see. But actually, internally, we've been doing this process for quite a while and we call them roadmaps. And so I'm going to share with you, this is actually an internal slide. These were our cloud roadmaps that we did internally in 2013. And you can see we're excited about things like it, data management, CFO software, the B2D developer API roadmap. And so let's see how we actually did against this roadmap. So we've actually made a lot of investment, dozens of investments in the last five years across these roadmaps. And so it just, you know, we put our dollars where our mouth is when we put out predictions to showcase that we're excited about something. We do love to invest behind them. And you can see here that Twilio and Sendgrid are the first two companies on here to go public. We've got another several unicorns on here as well. And we've invested in about 13 of the hundred Cloud 100 companies to date. And so next I'm going to hand it over to Byron who's going to actually talk through some of our 2018 predictions.

Thank you, Christina. Now, as she said, a lot of what we try to do is comment not only on where we see the industry going, but also to invest behind it. And so part of our predictions that used to be internal roadmaps, we now expose to the world. One, to plant a flag saying we're open for business and we'd love to talk to you if you're in these areas. But two, to share it with the industry. And there's a chart that we've used for over 10 years now, certainly going back to May of 2008 when we first unveiled Bessemer's 10 Laws of Cloud computing. But even before that, which was a three layer stack chart for Cloud, SAS, PaaS and Infrastructure as a Service IaaS. We're adding a fourth bucket today which is for the first time and I suspect many of you in the room can't even guess what the acronym stands for. The hardcore technical folks I bet do immediately. It's function as a service. There's the emergence of a world around serverless computing, the AWS Lambda environment. And if you think of it in terms of the impact for tech, we believe it's on parity with these other layers in the stack, which is why we're calling it out as such. So prediction number one is the rise of serverless computing. And I'm gonna explain it in a little bit more detail because for the non technical folks, this is something that I absolutely think will be impactful for your business. Either because you should be building your applications using microservices, or potentially your businesses themselves should be going into these areas. But to set the stage, if you think back about what virtualization was all about, it was taking the bare metal tech phenomenon of the prior decades and abstracting that away. It was really creating multi tenancy in a dedicated hardware environment and companies like VMware were born. The emergence of Docker and others have really blown open this containerization and taken that to another extreme. And really what serverless is, is the next extension. It enables this world of computing resources and function calls in a dynamic, stateless way that allow applications to be built in much more agile and nimble ways. It also has impact because there will be function sprawl and manageability implications, which we'll talk about briefly. But the net impact is transformative. This idea of being able to focus on capabilities as opposed to infrastructure is finally real. And as one small example, look at Google trends. Docker here is a proxy really for container calls and queries. But what used to be a virtualization world or an OpenStack world is now very much a container in Docker world. Now, as an engineer and as a developer, there are several trends that are underlying this that all feed into the serverless wave. Certainly the containerization phase, the proliferation of APIs and the ability to pull these services rapidly. And then open source as it's going mainstream, not just in the developer world, but in the enterprises and how open source enterprise companies have emerged to help make this durable, secure, reliable and predictable so that companies in mass are able to embrace it. And so as you think about where we go from here, specifically around the serverless world, the future is about managing these containers at scale. And at first what was about the fundamentals of what is a container and how can these work together has very much become the next phase of issues and opportunities, which is how do I scale and monitor and manage and increasingly the sub management layers where new businesses will be built and within your dev teams, new opportunities will be created as they push in this world. And so as we think about the new stack chart, we think this is actually the visual that people will start referring to, which will bring us to predictions in the second layer, the paas space or the platform as a service arena. Now the explosion of APIs has been a gift for developers worldwide. And if you think about that Uber app that you open and what's going on with the payments calls behind the scenes, or the email confirmation, the anonymous voice message that's happening and powered by Twilio, or the text confirmation, those composite services are now pulled together through a list of APIs that extends into the hundreds. Now we know of the first few IPOs in this space with Twilio and Sendgrid, companies like Stripe and Adyen will certainly be multi billion dollar successors. And we've seen the power of AWS and Amazon Web Services financials as they broke it out to the world and showed what high margin, high cash flow businesses can look like in this space. And we're seeing now dozens of critical mass businesses behind them, and as I said, hundreds in total. For companies today building an application, it's crazy to build this capability yourself and to replicate what's available in an API way. They're fast, they're variable cost, they're secure, and you can stand them up and break them down as you need. And so your engineering teams should be thinking about how to pull these resources together and how to push the envelope beyond that. And for net new entrepreneurs in the room, and I know there's a lot of you, this is an entirely new frontier for net new businesses and venture money. And teams will follow quickly into this space to try to create this next wave that will follow the pass wave and the SaaS wave around the API economy. Now part of this and a foundational platform building block refers back to the bitcoin comments of before and it's the blockchain. Now, we can debate the merits of the currencies themselves, but this notion of a distributed ledger and the notion of a blockchain fundamentally itself is powerful, real and lasting. If you think about industries where so much money is tied up in trying to verify custody, and the digital pedigree of high value parts going into aerospace aircraft, and the risk associated with fraudulent parts being introduced, or with food recalls, and trying to understand where and when and who touched food at various points and to understand what that looks like through the custody chain. Nonetheless, financial services, which is being disrupted from within in very fundamental ways by blockchain implications and savvy entrepreneurs, many of you in this room will take the insights that have come from this blockchain wave and apply them in very real enterprise oriented applications. Whether that's at the app layer or below. And as extension of that on the financial services and payments world, we used to think of payments and software in very different ecosystems, that you would have the hardware device, you would have the embedded software to run it, and then you'd have a transactional system and a payments clearinghouse and vendors to power that. That is no more. Trend number four and prediction number four that goes mainstream is payments as a service. Now, for those of you that look at the public filings of Shopify, another proud Bessemer alumni portfolio company, they're trading at $10 billion plus and over half their revenue today is from this emerging category of payments. A massive growth driver and also a massive revenue and profit contributor for them comes from payment processing and Increasingly, we're seeing companies like mindbody, also a Bessemer public company or service Titan, a hypergrowth Cloud 100 private company that launched a payment solution a year ago and is already generating millions of dollars of ARR for payments processing for their customers. Because if you've delivered awesome software, if you have that user interface or that mobile application and your customer has trusted you to be the provider, you've earned the right to provide other services. And the pleasant surprise starting in vertical software, and we believe moving to horizontal, is that payments is one of those where everyone wins. Your customers would love it if you could bundle that complexity, take away another step and another layer in many cases, and you've earned the right. If you can charge equivalent rates and take out some friction, you, you are the more logical provider of that service. And so we absolutely believe that applications more and more are going to layer in payment capabilities and find that as an upsell driver, that's a hidden gem and massively expand your market size as a result. Now, as we go into the app space directly and as we think about the SaaS layer, a couple of specific predictions here. The first one is around this notion of battleground areas. Now, back in enterprise software, people used to fight about the database and the system of record. There used to be this notion of create customer lock in. If you could have their data set, then they were yours for life. Quickly people realized that you moved much more to a system of engagement, where owning the UI and owning the user and adding to their workflow capabilities or decision processing was the way to drive value and therefore capture ROI and high ARR. We believe now we're transitioning to results and what that means is that engagement is important, but you should actually be thinking about how you can take time in your app away from the user rather than increase it. In the sense that getting to the end result oftentimes means AI and machine learning behind the scenes and moving to the answer. Increasingly, it means take away that application or take away those application clicks or application minutes to get to awesome. And we'll take that so far as to reintroduce one of our trends from last year in a much more material way, which is the explosion of screenless software. Now, the big wave in cloud at first was moving from green screens and heavy client server architectures to a lightweight browser interface, and that was transformative. Mobile is starting to be more responsive and nimble in terms of applications, and now we're seeing smart watches and increasingly voice. If you think about the tens of millions of voice enabled devices that are making their way into homes and soon to follow businesses, you're seeing that great software actually means the interface may disappear. Now that can be in the form of voice, it can be in the form of texting, it can be in the form of of lightweight mobile apps or wearables. But in enterprise applications, we absolutely believe that screenless will increasingly lead to success and that businesses, as you think about disrupting the incumbents, or for those of you who are leaders in your industry, think about how you can disrupt by way of screenless as your leading interface or increasingly a way to drive value. Now, if we think of holistic company building initiatives, there's two observations we want to make which are tied to predictions, the first of which was a statement that Samir Delakia made in a board meeting two weeks ago. The SendGrid CEO, in a very matter of fact way is a passing comment where we were commending him on a great IPO and some different things and he said values create value. And it wasn't showy at all. It was just very matter of fact. And rather than concentrating on all the negativity that's been in our industry around corrosive cultures and some of the negatives, I want to emphasize the positive here, which is to say that culture and values set by you as the founders and CEOs of your businesses are an opportunity to differentiate. In Sendgrid's case, Samir and Patty have what they call the four Hs, which it's not rendering here on the chart, but it's happy, harm, humble, honest and hungry. Those are the four values that they live by in terms of openness, transparency, enthusiasm, aggression. And for them, it's the pillars of their company. Every company will have some different combination of what are your four or eight. But setting that culture leads to almost perfect glass door ratings for the CEO, for the company, cultures that people want to join teams that they want to be a part of. And economically, values create value. You will be paid back for that in spades. And the last prediction I want to share is an exciting one. As a global venture capital firm and knowing that the Saster audience is over half international, is that truly the cloud is going global. Now we have waited a decade for this as we've been looking for investments far and wide. And as a board member who sat on the board of Cornerstone on Demand in Santa Monica and Curtailo in Paris and Eloqua in Toronto and Instructure in Salt Lake City and Sendgrid in Boulder, the fact that innovation is happening all over the country and all over the world to me is awesome. And the amount of exciting opportunities we're seeing globally means that for Bay Area based entrepreneurs, these are your customers and your employees increasingly spread out around the world. And for these remote businesses, you now have a peer group and a support group not just through online communities like Saster, but through a peer CEO set that is absolutely world class and that is driving the wave of innovation that we're all enjoying and benefiting from. And that tipping point has happened meaningfully in the last years and we think 2018 will blow wide open. And so as you step back and look at the trends and look at the stack holistically, we're proud to share with you the eight and the predictions ahead. This will go online at the BVP website, bvp.comtoday in parallel. And we look forward to watching the journeys and hopefully watching you over time transform the market caps and the leaderboards across our entire industry. So keep on with cloud. Thank you. Thank you.