Tomasz Tunguz + Jason Lemkin on the State of SaaS

Please welcome Thomas Tungiz, venture capitalist at redpoint, and Jason Lemkin, founder of sastr. Anyone here read Tomas blog post? Has anyone ever read his stuff? Raise your hand if you've ever read anything that he's read. All right, everyone's up. Okay, good. Well, thanks for coming back. This is a pretty good crowd, isn't it?

Oh yeah, no, Thrilled to be here. Thanks for inviting me.

I was worried day three after the big party that no one would come, so I needed a ringer to help me kick it off. So before I asked Tomas if he would come back, I thought there might be 16 of us, but we're all here. So thanks to everyone for the incredible energy over three days. I wanted to just a few couple announcements and then Tomas and I will talk about just some high level stuff, things I'm interested about in the industry. And then the session after this with Therese Tucker. I think I don't mean to put any pressure on her if she's listening, but this is the one I've been looking forward to the whole event. Theresa's story is amazing. I think she founded Blackline something like in 2002. No one would give her any money. She had to do it all the hard way in a tough space. Finally raised some money in 2014 and IPO'd last year and has like a third of the Fortune 500 as customers or maybe Fortune. All I know is I wanted her to speak two years ago last year we got her this year, so I just met her this morning, but my hero from a distance. So stay for that one. And then two small announcements. One, as you probably noticed, or you might not have noticed, we tweak and rejigger things. So all the sessions today that were in the schedule yesterday before are the same, but some of the times have moved, some have shifted. One session earlier and we've tried to load balance some of the rooms. So some of the sessions have moved from one Ballroom, whatever these are Studio F G Z. I can't keep track, so I'm sure you can't either. But try to double check on the mobile app and some things have moved around, although the players are the same. And then last, We've half launched this Saster Pro product which is a learning system that trains your team on Saster content. But if you want to go check it out, so that will automatically train your team. Go to Saster Square Parkbeat with Tyler and if you sign up, you can come to the Saster annual for free next year. So it's. It's basically free. So go check that out. I don't think we talked about it much before, but let's see if the clicker works. Okay.

Whoops.

Hold on. Let's go back. Can anyone see ico? Okay, the first, I wanted to have a little bit of fun and talk about ICOs and how they impact SaaS. Just SaaS. And this is a chart you have right from the blog on ICOs. And so quick story and then tell us about this. Three weeks ago, I'm in our little Saster co selling stage with 30 startups and two founders come to the office. They're like, oh, we just ICOed. And I'm like, yeah, we just raised 10 million. And I said, how did it go? It took a couple months, it was hard, but in the end it all came together in a couple days. So I'm like. And they're like, and now we're going to write some code. And this is a great team, this is a plus. This is a great set of engineers. But I'm like, as a founder, that's a gift, isn't it? I mean, you can get 10 million before you write a line of code. What's going on? What can we learn? And can all of us ICO in this room, should you and I do a Saster? Tungus ico, what are you doing this afternoon? I've got time. I've got time.

So ICOs are a fundamental change in the way that startups have been fundraising. It started effectively in 2017. At the beginning, there's more than $4 billion raised in capital in 2017 through ICOs. And in December, ICOs raised almost as much capital as Series A startups did globally, which is a huge figure.

The other thing, how do the outliers swamp that a little bit?

Yeah, they do. I mean, so if you look at the December figure here, half of that is one company that raised about 705 million.

Yep.

But the median ICO raises 1515, which is more than the median Series A of 7 in the U.S. and so for a small number of companies, the end here is about 200. For a small number of companies, the ICO is actually a viable fundraising mechanism. One asterisk to that data point is that about a third to 40% of these companies actually raise some form of institutional capital before they ico, just to finance the writing of the white paper, basically. But this is an important trend. I mean, we had our annual meeting where we share the story of what's going on in our ecosystem with our investors two days ago and one of the charts that we showed them was a lot of people think about ICOs and crypto as just being a consumer phenomenon around Bitcoin. But if you break up the enterprise ecosystem into application platform and infrastructure, we're seeing blockchain and ICOs happen across that stack. So we've seen email security is using blockchain in order to decentralize the storage of safe or, you know, whitelist or blacklist for safe and unsafe email addresses. We're seeing a handful of companies trying to rip apart the core parts of the infrastructure as a service stack. We're seeing companies that are building next generation open source apps using the blockchain in ticketing and a bunch of other categories. So this is an important trend that we're paying attention to and I think it's going to impact startup land broadly, not just in consumer.

Yeah, we had yesterday we had a great founder, Brian Brackeen from Kairos in Miami. He's doing a $50 million ICO for his. For his facial recognition API company. Who here of the. Of the handful of folks in this room who should be. Who should invest? We're so busy as founders, who should invest time to think about an ico?

Yeah, the great part about an ICO or I think the fundamental advantage of an ICO is if you're looking to create a network effect or bootstrap it like a chicken and egg marketplace, the ICO is a really great way of doing it because what you're doing is you're incentivizing the people who are participating in the network in some way. And so in the consumer landscape, you look like a Facebook or a Google. They win because of their centralization of talent, capital, servers, data. And so if you're looking to compete against an incumbent who's competing using that centralized advantage, then the decentralization theme and the notion of incentivizing all the different constituencies on the network in order to make it successful, that's the most powerful part of crypto.

So we could spend the whole time on this. But just one last question on this. Let's hit the next topic. What's your gut? I know you love to speak with data. I do, I like to shoot from the hip with experience. But how many doesn't have to be SaaS, but how many B2B startups do you think can ICO in 2018?

So there were 220 that did in 2017.

How many were you think were b. Not just some sort of. Maybe do something for some sort of token part of the. How many think it might be barely relevant to this audience? How many think can pull off an ICO in 2018?

I think it would be a great year if we saw 100.

But 100 is a lot.

100 is a lot.

But there's a lot of great businesses here that are bootstrapped, doing millions that can't get traditional venture capital. Should they try to ico?

I think if you need that capital to grow and you can take advantage of the decentralization as a competitive advantage. Totally.

And the dilution's limited from the ico.

There's no dilution.

All right, one quick one that talking to founders here. I mean, boy, private equity is a change in SaaS, right? Of course, I met. I'm going to use one of your. This is the only one. I didn't find one of your charts. I know you've got a good one. I was meeting when I sold echo sign in 2011. None of this stuff barely existed. Right. There were only two options, one of five tech companies to buy you. There weren't the GEs buying service Mex let owner IPO. There were no options. And I had like three different conversations in Sastra Square park of founders. 6, 8, 10 million. Where PE firms were offering to buy them for 50, 80, $100 million that were bootstrapped. I mean, that's amazing change, isn't it?

It is an amazing change.

So what's going. Is this gonna evaporate? Can folks here take advantage of this? How do you think about it?

Yeah, I mean, I think SaaS companies are really great PE targets. So one of the major trends in PE private equity is that the fundraising in PE is at historical highs.

Hold on. Sorry, my mistake. Let's step back for a minute. What's the difference between PE and venture for this audience, for founders just to understand.

Yeah. So. Well, the world PE is overloaded. So there's basically a continuum of private equity, the smallest of which is seed and angel, the largest of which is what's called private equity. By and large, the difference between venture and private equity is that there's no failure risk for the business. That would be my definition of it. And the funds tend to be significantly larger, so 500 million plus. And they tend to make majority investments. So they take to 10, they take control of the company. And a lot of these private equity firms, so you look at like a vista, what they do is they actually inject operational teams into those businesses, take them, manage them, run them according to a particular playbook in order to Achieve either certain growth or profitability milestones and either sell the business to another PE firm or then take it public in order to generate somewhere between a 2x to a 3x return.

Let's just step back because a couple founders I've met here said, should I sell 10 or 20% of my company to a PE firm? That's the wrong question, right?

That is wrong.

You got Venture and PE. Very few PE firms want to buy less than 51 to 100% of your company.

Exactly.

But the flip side is a P firm. I mean, Vista's incredible for SaaS. How much did they raise? Eight billion? Six billion? A lot of that's going to B2B, isn't it? I mean, Marketo is a decent check. It's so much money jive. And they're going to want to buy from 51 to 100% of your company?

Absolutely.

Sometimes we'll want you to stay. Sometimes won't even care if you stay a day. Sometimes they don't even.

They just want you to.

You think you're so important. Sometimes they already have a team and they will write you, literally cash on the table and leave. So this is totally just. And how many SaaS companies you think PE might buy over the next year or two? Do you have any sense?

I think you know, any SaaS company that's under $10 billion in market cap is a clear pen.

But how about startups between x million and ARR 5 to 50? How many think deals can be done?

Loads, maybe, I don't know, hazardous guess, 100 or 200 next year.

But that's a lot of options. There's not going to be, you know, Google and Adobe and Salesforce aren't going to do that many acquisitions in the space, are they?

Well, no, but 60% to between 60 to 75% of tech acquisitions in the last year were non tech buyers. So that's either the financial buyers or companies that are not technology companies. So that's where two thirds of the acquisition's coming from. And we're starting to see, I mean, friends of mine are starting PE funds to buy the 5 to $50 million SaaS company that's not growing that fast, but is spinning off a lot of cash. That's a great PE business because you can run a discounted cash flow model on that business and figure out exactly what your return is going to be. There's a publicly traded Canadian company called Constant that has been doing this for like 20 to 25 years and it's an amazing business. So I think you're going to see more and more of this.

So I think what I could tell actually, if you get up to 6 or 8 or 10 million in ARR, what do you think the odds are PE firm's gonna knock on your door in 2018?

That's still on the smaller side.

You think the odds are low that you're gonna get a call? I see folks getting that have any brand out there, they're swarmed with it. Like CSV investors. Yeah, I think the analysts and folks are pretty good. Okay, that's good data anyhow. Good to hear something different. So pe, I think for founders, having liquidity options is a gift, isn't it?

It's a gift because the multiples that they're paying, you look at the cvent multiple or the marketo multiple. Typically you think of a PE as a buyer that buys at a much lower multiple, maybe half or two thirds of what the forward multiple would be in the public markets. But PE is buying them at six times forward, eight times forward, and the median is seven. So they're paying the price.

It's a good deal related to that. So P, I believe, is a gift for founders. You don't have to take it, you don't have to sell. But it's another way to potentially de risk your journey. Is MA gotten any better? What does this chart mean? I think MA is the weirdest thing. Everyone thinks that a million people are going to buy them. And when I talk to CEOs Tien from Zuor, it probably changed. But he did some interview a couple years ago when they were like a 60 million AR. He said, I never got an offer. And this is someone that was the chief strategy officer of Salesforce.

Amazing.

I'm sure he's gotten 10 since then. But M and A is weird, isn't it?

M and A was weird.

It's weird.

17 saw a greater than 50% decline in global MA volume decline.

And the markets are crazy. So what are the odds anyone here is gonna get bought?

I think they're high.

Oh, you think it's high?

I do, yeah.

So I'm more bullish on P. You're more bullish on M and A. I'm.

More bullish on M and A, Yeah. So let me say this. So 2017 was about a 50% reduction in global MA volumes. But the cash on balance sheets for the largest acquirers, the 15 largest tech acquirers globally. A trillion dollars.

Trillion dollars in cash earning 0.1%, right? Yeah, exactly. Unless you're Airbnb and you've got a hedge fund, everyone else is earning 0.1%.

And then you've got repatriation. That was clarified last year. So if you talk to a bunch of the investment bankers, they'll tell you that was really a big uncertainty. And so I think what's going to happen, you know, I'll make some prediction that's bound to be wrong. I think you're going to see landscape changing M and a in 2018. Google buying Salesforce, Microsoft buying Workday.

You think big deals like that will happen?

I think big deals happen like that because all of a sudden the cost of capital is really cheap. I think you're starting to see some decline in the core growth rates of some of the larger companies and they're going to want to buy that growth and really own and compete.

So I get. I'd be shocked if Google bought Salesforce, but it makes sense, right? What about for folks here? What if there's 100 vendors in your category and you're at 6 million ARR, what's the M? And a landscape for companies like that.

There'S going to be some consolidation, but it's all going to accrue to the top four or five.

That's what I wonder. I think a half generation ago, four or five years ago, if you got to 10 million ARR, you were a breakout player in your space.

You were a standout.

Right. Maybe you were number two, maybe you're number one. But if someone was interested in your space, at least you were going to get meetings with acquirers. I'm not sure that's true today, that if you had 10 million ARR, the corp dev and the SVPs are going to come to you. Do you see it in your portfolio?

I think you need to be substantially bigger, substantial.

The bar goes up, maybe that, maybe the absolute number goes up, but the bar goes up to do a deal.

Well, and that's being driven by the fact that like you look at like Zendesk or New RELIC, those are 3 to 5, maybe, you know, 3 to 5 billion market caps. When they make an acquisition, they're going to spend 5 to 10, 5 to 10% of their market cap on that acquisition. It has to be revenue accretive so that they're rewarded for it. Yeah, by the Street. Right. And so they can't.

Zendesk wants to buy Something probably mathematically that's 20, 30 million ARR or more, right?

Yeah.

Because if it could to make an.

Impact, because then the growth rate of the company is going to go up, the market capitalization of the company is going to go up and then the equity value of the business will offset whatever dilution they took to buy that business. Right. If you're buying a company at zero in ARR, you're not going to get rewarded for it.

That's why my view, you've got the data at a high level. There's probably going to be a lot more M and A, but I think for the average founder here that's past a million or something in revenue, but isn't at 50, I think they're going to feel like there's less M and A because there's not gonna be as many tire kickers at 4, 5, 10. In my day as a startup CEO, once I got to 4 or 5 million in revenue and was decent at PR, everyone came by. Doesn't mean I got a term sheet, but everyone would start to come by off the TechCrunch article and 10,000 customers. But I don't see that happening today.

I agree with you. Yeah, that makes sense.

Okay. IPO it was when we did this four years ago. This is the fourth year. Aaron Levy came two weeks after the box ipo. Everyone thought SAS was stupid in the kickoff. Right now, all these companies that were borderline unicorns are worth 3 billion. Right. The HubSpot, the Zendesk, the Bok, the Billion Club became 3 billion. And so for folks here, should we even be think. How should we think about ipo? Do we have a shot? Is it going to be easier? The press is so confusing. Bash on Snapchat. What's Snapchat worth still? 28 billion.

Well, it just spiked.

Yeah. Was that at some failed ipo? Not my book.

Huge. I think the IPO is still of fundamental. It's a fundraising mechanism. Right. Like you go public in order to raise capital and you do it because you can. You've got 100 million in trailing and you're growing at roughly 70%. Right. That's kind of the. That's what every banker will tell you about what you need to achieve. It's also a great milestone for the business just to kind of build a brand. So I think it's still a very viable thing for SaaS companies to do. I mean, and the great part is like we have SaaS companies now that are 80 billion, that are 20 billion, that are 30 billion. We didn't have that two or three years ago. You look at ServiceNow Workday. I mean, you have a really nice distribution in the value of these companies. And so you know, I think it's still a really important milestone in the life of these companies. It institutes a rigor that you don't see in a private company.

Let me ask the founder one quick question. Let's hit the next topic.

Yeah.

There's so much press saying it's so hard to IPO people. Wait, is it really harder in these markets? I think it's gotten easier. Last, I think there's more appetite, like IPO is easier for B2B than it was a couple years ago.

Yeah, the IPO market, the window is open. And so it's open. Yeah.

You get to 100 million in revenue, grow at a decent clip. Market cap aside. You can ipo.

You can ipo.

You can ipo.

Yeah.

All right, I think. Let me just. Hold on. This is me. Let me see if I got one more. Okay. I think we'll have to end it at Decacorns as a good. But this is. You know, when we did, when we were here in 2016, after the flash crash, everyone was making fun of unicorns. There won't be any SaaS. Unicorns. Everything got. Everything felt inflated like in 2015, didn't it?

It did.

And now, like you said, we're thinking about Decacorns. We can see Zendesk at a 10 billion market cap. HubSpot at a 10 billion. We could have seen marketo if they hadn't sold. And so Decacorns aren't crazy in SaaS, are they?

No, they're not. We're going to see more. I mean, we're seeing companies that are worth 25 to 30 billion. And I think the reality is software penetration is still very low.

That's what's driving it, isn't it? It's still early for the cloud, isn't it?

It's very early for the cloud. And you're starting to see, I mean, you know, the point that I made before that 60% to 75% of acquisitions are being made by non tech buyers. You have whole swaths of the U.S. and international economy that haven't deployed software at all.

Whole swaths? Yeah. S and P's are just getting there too.

Right, right. And so like, if you think about the technology diffusion curve, right, you've got the, the early majority and the late majority. We're still. The way I think about it is we might be a third of the way through the early majority, maybe halfway through the early majority. We're not even into the late majority yet.

We're not. Yeah, we're not.

No. And so there's at least half the market or more that's still yet to adopt software as a service, which means that, you know, one of the questions that you asked in another slide is, what inning are we in in SaaS? And I think we're probably in three or four.

Three or four. All right. I want to do more, but as usual, old friends run over. Let's give it up for Tomas and then intro and we'll have Therese.

Thank you so much. Enjoyed it.