Tomasz Tunguz @ Redpoint Ventures on Benchmarking Your Startup

Thank you.

Hello. Hi, everyone. Wow, this is really big. Thank you. My name is Connie Loyzes. I am an editor at TechCrunch and I'm here with Tom Tungus of Redpoint, a general partner. And Tom is going to take us through a great presentation about sort of the state of venture financing for enterprise companies, SaaS in particular, and Series A rounds.

Terrific. Thank you so much, Connie.

Thank you.

It's a pleasure to be here. Thank you very much to Jason, who invited me. My name is Tom Tunguz. I'm a partner at Redpoint Ventures. And over the next 10 or so minutes, I'll walk you through a little bit of data about what is going on in the Series A fundraising market and then we'll have some Q and A. This will be a lot of fun. So redpoint Ventures is an early stage and growth stage venture investment fund. We manage about $3.8 billion out of the early stage fund. We do about 80% series A's. That's where I'm focused on early stage software companies and that's where this presentation is focused. We've had the opportunity to partner with about 434 different companies and we've taken public or sold about 136 of those. These are some of the companies that we've been lucky enough to work with and we've learned a lot from it over the past few. About 16 years that we've been working with them. So over the next couple of slides, I'm going to walk you through an analysis of premium software companies. These are the companies that we look at and are probably the best in class companies. And we're going to be walking through one of the questions that I hear a lot from founders, which is what does my company need to look like when I raise a Series A? And we'll be looking at it from the point of view of revenue. So a couple of key points about this analysis. There's clearly a selection bias. I'm only picking about 60 premium SaaS companies over the last three years. And there's also a sample size bias. So this is not a, this is for you statisticians out there, this is not a population analysis. This is a sample analysis. The average SAS Series A for these businesses is about $9.5 million. You can see the distribution here. So some companies raise, a small number of companies raise between zero to two and a half, which you could call a seed. But the majority of them raise between 5 to 15 million dollars in their series A. A handful raise more. The, the Average round size has increased about 11% a year. So in 2014 it was $8.5 million average. Then it grew to $9.3 million average and finally in early 2016. And yes, there are enough data points already, it's about ten and a half million. So that's been growing and it actually parallels a broader Trend in the VC industry. This is not just for SaaS companies, this is actually for the totality of US startups. You can see that on an inflation adjusted, this is inflation adjusted numbers. The average dollars raised by a Series A startup in the late 90s it was about $5 million. At the height of 2000 it was more than 12 and a half million. And then recently, as recently as Q4, 2015 it's been about above 10 and a half. And so the series, the SaaS market has also benefited from the tailwinds that have benefited the industry broadly in terms of mrr. The average MRR that these companies have when they raise the Series A has grown from about $50,000 a month to $163,000 a month over that time. And that's really driven by the fact that the round sizes have gotten larger. And as competition has amongst investors has increased, the metrics and the milestones that software companies need to show or what investors expect has become much greater. But those averages don't reveal the entire truth. So this is the distribution of those series as by MrR. And you can see nearly a third of these Series A's have zero in MRR when they raise those series as, which is unusual. Right? It's not. Most of the founders who I speak to, they come in and they say 100k. They've got this number, it seems like 7, 75 or 125k. That's the number I need. And that's true. You can see there's a little bit of a bell curve in the middle, right between 75,000 and $125,000. So there definitely is data to support that thesis. But there is an entire class of companies, non trivial size sample set that raise with zero in mrr. And those are companies who, as we'll talk about later, those are companies who venture investors perceive as having a unique go to market advantage. So the founders know the space really well. There's unique technology and a really large market opportunity. What's really interesting is, and this was completely counterintuitive to me, so we also have a growth fund and in that growth fund we look at valuations of SaaS companies on a multiple basis. And this is how publicly traded investors value software companies. So a lot of the times they'll value a company its enterprise value as a function of next 12 months revenue, which means take the sum of the next 12 months of revenue and then divide that by the enterprise value. And that ratio has typically been 15x. In other words, in order to value a Series B or a Series B company, I'm going to take the sum of the revenue for the next 12 months, I'm going to multiply it by 15, and that's the Post Money on that round at the series A. There's been a lot of talk that this is also the case, but the data actually shows that there's actually no relationship between monthly recurring revenue and Post Money. The correlation is 0.3. It means it's effectively meaningless. What's also really curious is there's an even weaker relationship between Post Money and ntm. So the conclusion of both of those slides is when series A investors look to value a Series A SaaS company, they are not looking at the revenue metrics in order to come up with a Post Money valuation. It's still more art than science. So, as a lot of people have Talked about today, 2016 is a year of change. And so one of the hardest parts about preparing for this presentation is I'm not sure if these numbers still apply because the markets have changed so much. Right. So I can share with you these guidelines and I can tell you what the market was like in 2015, but in 2016 things are going to be different. Right. Just to kind of put it into context, the top five years for tech VC investment, over the last 22 of those top five were 2013, sorry, 2014 and 2015. Right. It's basically 2X. There was a decade there from 2003 to 2013 when we were between 17 to 20 billion dollars a year invested. And the last few years have been about twice that. And so what lots of people have said, and I think it's really true, we're going to see a reversion to the mean and we should expect that over at least maybe one year, maybe two years, that that 37 and 43 basically fall to about 20. And then in Q4 we're starting to see the first signs of this. So this is a chart that shows seed investment, early stage, AKA series A and late stage B or later investment over time. For each plot, we start the year 2010 and then we go to the year 2015. And the number, the X axis is the investment amount indexed relative to 2010. So a one means that's the average for how much money was invested in in that stage throughout all of 2010. There's a couple different conclusions we can draw from this slide. The first is seed investments have grown 5x in five years. There's a huge amount of investment there, dedicated seed funds that verticalize, and that's really benefited the startup ecosystem. But the activity rate of Those investments in Q4 fell 18%. In early stage or series A's, the amount of money over the last five years has basically doubled. But in Q4, Q3 and Q4 it fell 15% from its highs. And in B or later rounds, the amount of money that's gone into that category has tripled, but fallen off by 26% in Q4. Meanwhile, the public markets are reacting in tandem. So as I talked about before, public market investors value SaaS companies on a multiples basis, and those multiples have fallen. Actually, the newest number is 3.3 as of late last week. And so that's a 57% reduction in valuation, even if the business is generating the same amount of revenue. LinkedIn fell 50% on Friday. Tableau fell, although it's not a SaaS company. But so basically what's happening is the private markets are slowing down and the public markets are valuing SaaS businesses at less of a multiple. In fact, half of the premium multiple that they used to for those companies just two years ago. Great. Terrific. That's the presentation.

Great. Well, I don't cover SAS terribly closely, so I might be asking questions that are a little bit obvious. Forgive me, but a lot of that I found pretty shocking that you just said, I mean, especially, you know, valuations really having no correlation to revenue. But let's back up and because I think most of the people in this audience are maybe early stage entrepreneurs. So, you know, bottom line, what does it take right now to raise a Series A round?

I think it's still pretty similar. I think you'll see lots of Series A's kind of raise at between 50 to 100k in MRR. I think the big. And you'll still see companies once they get to 15 to 50 to 100k in MRR. Yeah. And I think you'll also see companies continue to raise at zero in mrr. Right. Just the way that they always or they have been, at least in the data set that we shared today.

Let me inter quickly, how long does it take on average for a company to get to 50 to 100,000 mrr?

It really depends on the business. But, you know, roughly two, two and a half years. Some companies are much faster, some companies take a little longer.

Okay. So they've got to bootstrap until then essentially.

Or.

Okay.

Or they raise the seed round. We often see companies raise seed rounds.

Okay, okay, I'm sorry. So.

No, no, no, yeah, actually I remember there's three slides missing from this presentation, so I'm just going to touch on them really quick.

Okay, yeah, go ahead.

So I'm going to get up. So the consequence of all these different factors is as the fundraising market slows, I think we're going to see a couple of different things. The first is we're going to see a rationalization of public and private market valuation. So it used to be that you would pay 50, we would pay 15 times forward revenue for a later stage SaaS company. And now that the publicly traded median is about 3.3x, that means that we're paying four times or five times nearly the median. And so those valuations have to compress. And so valuations in the private markets are going to decline. And then the second thing that's really going to happen is it used to be that a SaaS company could crown themselves or anoint themselves the winner of a particular category by raising the biggest war chest. And I think that's going to go away or it's going to happen not nearly as frequently. Like we saw more than over the last two or three years, we saw more than 200 IPO sized venture financings and that trend is going to slow. And the last is as the valuations of SaaS companies fall on a relative basis, you're going to see a lot more ma. So there are quite a few businesses with billions of dollars in capital that need to invest in next generation software platforms and you're going to see them acquire startups. Thank you.

In terms of the funding changing. I know he's great. In terms of the funding picture changing so dramatically, what's going on? Exactly. I mean, I had written today on a study that the law firm Fenwick and West had published and it noted that in the last nine months of last year there was sort of a spike in the number of newly minted unicorns. But the very last quarter there was a sort of precipitous drop and I think, I think that was kind of the first sort of, you know, where we actually saw a peak and a downturn in the number of newly minted companies. But those companies that were still getting funded were still getting funded by non traditional venture Sources like the hedge funds and the mutual funds. So it seems like those guys are still involved, but they're just applying many more sort of onerous terms to deals. So do you think, I mean, are they just. It seems it's sort of like a mutual by mutual agreement that entrepreneurs are just going to say, look, I can't sign up to this deal despite the valuation you're willing to give me. And they're going to say, you know, your trajectory is less sort of certain than I thought. So let's, you know, what do you see?

Yeah, I mean, I think you're right. So in the late stage market, non traditional venture investors have grown from about 30% of the dollars to more than 80% is the last data that I've seen. And those are hedge funds, mutual funds, family offices. And that's fast, you know, what you could call fast money? Fast money in, fast money out. And you know, in talking to many of them, their interest in investing in early or software companies and also consumer companies is they really want to get exposure to these businesses before they go public for a wide variety of different reasons. One of them could be they could actually get better insight into a company when it's private than when it's public because of how much, how little a public company wants a disclosure close and those kinds of reasons. And the other thing is private companies have been growing historically or at least over the last couple of years, significantly faster than their public counterparts. So the projected returns can be really high. And then the last thing to consider is that a lot of non traditional venture investors don't have the return targets that we do. So like a hedge fund might be looking to beat the S and P, which has been at 5% IRR or less over the last couple years. So that's not a very high hurdle rate. But I do think that now that you've seen the like, we're in this kind of crazy time where there's an illiquidity premium. Historically you afforded a liquid security premium, which is that you were willing to pay more if you could get out of your stock really fast. But now it's more expensive to buy in a liquid security. It's more expensive to buy privately held shares than it is to hold publicly held shares. And that is going to go away. And I think what we really saw on Friday was just kind of a general rotation out of high, multiple high growth stocks into more conservative stocks with LinkedIn and Tableau. You mean with LinkedIn and Tableau. And so that I think is a You know, and what do I know? But like, I think that's basically foreshadowing a lot of these hedge funds and mutual funds start starting to look at the public markets as they have for a long time before they enter the private markets. And that will definitely change. They represent about a quarter of the 40 billion or so invested last year. And so it's not inconceivable that that $10 billion just kind of goes away this year.

What about corporate investors? They historically get sort of freaked out easily too and they represent something like 20% of all the deals getting done right now, or they did last year. Are you seeing in your sort of day to day work anyone kind of retrenching?

I haven't seen it yet, but we're only a month in and a lot of the financings that were, you know, when startups go out to raise in January, probably takes six to eight weeks, maybe a little longer for those financings to be announced. But yeah, so there's no real trend I can point to yet.

So Series A, you have to in order to get it. You mentioned there are certain types of founders that are more likely to get it, including what founders who are coming out of these big companies or else have had success in a previous startup who's sort of like more best positioned to lend money right now.

So one of the things I think that's going to happen in this environment is because you can't anoint yourself the winner with a huge war chest. You're going to have to compete upon a bunch of other competitive axes and they're kind of the classic ones. It's a better technology, it's a better go to market, it's better relationships or its unique and novel approach to the market. And all those things or some combination of them actually afford a startup a long term sustainable competitive advantage. And I think increasingly investors, and certainly for us, we're going to be looking for those characteristics in founders much more than we have in the past. Right. And those, if you can demonstrate any one of those four things at the earliest stages, then it, it's very possible that you're able to raise a Series A at zero in mrr. Right. And on the other hand, you know, there might be an unknown entrepreneur who comes out of the university and who suddenly built an amazing SaaS company. That happens very frequently. And what that person is going to have to show is a remarkable sales and marketing execution. Right. And those are going to be the rounds that get done at around 100k. And so I don't think necessarily the dynamics around the Series A market are going to change in terms of when companies raise or the characteristics that we're going to be looking for so much. But we will be weighing the sustainable competitive advantages more than we have in the past. Right.

Okay. So for those companies that are going to have a little bit harder time or they're going to need more time to get to your offices, what can they do? I mean, trying to get to lower their burn is easier said than done, I guess I should say. What are some ways to reduce burn? I mean, is layoffs sort of just like the most obvious thing or.

Well, layoffs is kind of an extreme measure. Right. And the way that I think about it is I wrote this post once called the fundamental unit of SaaS growth. Right. And in order, when you hire a salesperson, you don't just hire the salesperson, you hire a salesperson, you hire some fraction of a sales development representative to provide them sales qualified leads in order to hit their quota. And then before that person, you hire some fraction of a marketing person to provide the marketing qualified leads. And then you also invest some marketing budget in order to help the marketing person. And then you also need post sales people. So you need customer success, customer support, professional services. And so when you hire one salesperson, you aren't hiring one. Your cost isn't 120k or 150k for an inside sales rep or 300k for an outside sales rep. Your cost is really probably closer to $750,000 or a million dollars all in just to be able to feed that sales rep the right leads and make that person successful. And so one of the best ways to reduce burn is to slow your sales hiring just because the amounts of money that we're talking about with those fundamental units is so substantial.

Right. But of course then you have to worry about distribution, which is never easy. So what are some ways to get your product out in the world without your sales team?

Yeah, I mean, I think, you know, one of the. I get lots of questions by email about really effective customer acquisition strategies for SaaS companies, right. And most of the SaaS companies that we look at are probably 60, 40, inbound, outbound. They're probably ACVs are kind of like 20k to 40k and they. And some of them are kind of bottoms up, built through content. And so we've been really, you know, the four main channels of distribution that we really see pretty frequently. One is content distribution. Obviously HubSpot is the leader, kind of created that category and that works really well for SMB. Right? And in concert with that, content marketing plus mobile app store distribution are really cost effective mechanisms, particularly with Facebook now and the retargeting with the email matching, those are really cost effective mechanisms of acquiring users. Where your ACVs aren't large enough to support a traditional inside sales team, then there's inside and outside sales. Those probably won't change. Hopefully the cost of those things kind of go down and the efficiencies improve, particularly with lots of the tools that many of the vendors here displaying are selling to the market. And then the last and the most novel is our channel partnerships. So channel partnerships really existed, you know, worked really well in the kind of the classic client server, big software era. And it worked really well because you would buy this monolithic system and you were an enterprise company and you were paying a lot of money, millions of dollars in some cases, and you really wanted a system that was bespoke or fit to your needs. And so you were willing to pay either the software provider or value added reseller or some kind of a consultancy, like an IBM to configure and shape that piece of software exactly the way that you wanted it. And when SaaS came on the scene, 2001, 2002, kind of depending on which company you want to point to, most of the products that they were selling was really kind of off the shelf software and meant to be bought by it with a credit card without a whole lot of customization. But what we're starting to see now is there are new kinds of SaaS software like an ERP or really big categories where they do lend themselves to channel. And the other part of it is what I alluded to a bit before in the presentation. These large incumbent software companies are looking for new products to sell because their existing products aren't flying off the shelves anymore. And so it's quite possible that you can, a startup can find a way to effectively rent a large enterprise company's sales team and push their product through the channel. And that's something that we're seeing increasingly, which was a little bit of a surprise to me.

And I guess, I mean, not that pivoting is also easy, but where, like what industry should these guys be targeting or what subsectors? I mean, you told me something backstage which was shocking to me, which is that something like 2% of software now is in the cloud, just so obviously there's tons of opportunity, but at the same time there's something like 2000 sales and marketing SaaS apps which seems like a lot. So what's kind of like a little bit overdone or you know, and what's. What where are some of the great opportunities?

Yeah, I mean I think, I don't think I could point to a particular vertical or sector that hasn't been touched by SaaS. And I think all of them eventually will become sassified or whatever you want to call it. You know, going back to that statistic, there's about $2 trillion in enterprise software market cap and only 2% of that is now cloud market cap. Right. So even if you assume that 2/3 of the dollars are untouchable, we still have something like a 15x growth from here. So we're really still in the early days. So I think you know, the main things that we're going to be looking for. You can kind of think of software going in three ways. You have the kind of client server era basically you know, Oracle founded in 1984 to. Or 81, sorry to kind of the early 2000s. Then you had Salesforce in 2004 that really kind of spawned the SaaS era. And now I think you're going to see just being SaaS is no longer enough to be differentiated. Right. And I think with the explosion in the number of SaaS companies, sales and marketing is probably the greatest example. Right. There's that lumascape that the number of sales and marketing companies has grown from like 5002000 to 2000 in three years. Just being a SaaS product and using the go to market advantages innate in SaaS there just aren't enough. And so we, I think one of the biggest. There are two forces that we're paying attention to right now. One is really machine learning. So relate IQ is a great example of this that we were lucky enough to be investors in Roulette IQ use machine learning in order to simplify one of the most painful parts of using Salesforce which is data input. And there are lots of other ways to use machine learning, anomaly detection or suggestions or recommendations. And so we're going to see machine learning infiltrate every part of sas and that's going to create a new wave of SAS coming companies that are first going to try to aggregate enough of a proprietary data set to be able to produce a unique machine learning model that they can bring to market and then just kind of change the nature of the game, what the buyer wants and all that stuff. And then the second is changes in user interface. So I think there's definitely a trend around chat and that user interface and the Way we've been thinking about it internally is it's really much more. I don't really want to talk to a database. Right. Like, I don't. I don't really want to fill in a bunch of fields in a form that looks like a visualization of a database, but I don't really mind having a conversation. So could there be a world in which every SaaS app is replaced by every SaaS app where you're doing some kind of data entry is actually replaced by chat? And machine learning also powers that, because the Chatbot is a human at the beginning, is a human, and when you have enough of a data set, ultimately becomes some kind of automated bot. And I think that's a much more agreeable user interface than the lists or the collections of text boxes that we have in our.

That's really interesting. Is Redpoint an investor in Slack?

You are not selecting.

You're not. I'm surprised. So you don't think that that technology is going to be sort of like, rooted necessarily in Slack? I mean, they do seem to have such a strong footprint foothold.

They do, yeah. I mean, I think Slack has an opportunity that very few software companies have, which is to become a platform. Right. And they've demonstrated this already, at least in the engineering world, where you have lots of integrations for, like, code commits or pushes and that kind of stuff. And all the alerts come up through these groups. And so I think there's going to be a category of applications where they use chatbots that are probably core to their platform, and we don't know what those are yet. And so if you're going to build a chatbot or a Slack bot, there's clearly platform risk, and that's kind of innate and intrinsic to the category. But there's going to be a much larger set of products. Just like the, you know, great analogy is the Salesforce app ecosystem. Right. Like, Salesforce can't do all those things, so they can still build big businesses like Viva or others. And there's a lot of opportunity, I think, there. So, you know, the sky's kind of the limit in terms of chat.

Also mobile. Mobile first companies. I've talked to a lot of VCs this year who are like, oh, enterprise mobile apps. That's where it's at, putting technology in the hands of these people who've never sat behind a computer. Something like 80% of the world's workforce works not behind a desk or behind a laptop. Is that a huge opportunity that you're tracking?

Yeah. So Mobile is. The way we think about mobile is like you said, there are 90 million blue collar workers in the US and many of them don't sit in front of a computer all day. So there's clearly an opportunity to build software for them. And the thing that gets us most excited about mobile is we really want to invest in companies that use a technology advantage to enable a go to market advantage. So all of a sudden there's some kind of a discontinuity, whether it's machine learning or mobile app store distribution, that suddenly whoever figures out the dynamics within that new technology paradigm or distribution paradigm, whoever figures that out first, is going to win disproportionate market share. And we're investors in Expensify. And Expensify has grown to quite a significant run rate exclusively through mobile app store distribution. So we don't have any traditional sales models. And that bottoms up model can be really quite powerful. So what ends up happening is a bunch of people, sales people download the app, they say we don't really like our existing expense management software and so they get the finance team to switch. And that works really well. So that's one up sales model through mobile, the other. So that's kind of the bottoms up. And then the other is kind of a meet in the middle where you have mobile app store distribution to get software in the hands of people, typically using a free model. And then you have an inside or outside sales team that sells top down. And then by the time the sales team actually reaches the executives, the company is basically primed to buy because they've got enough social proof within the organization that everyone agrees whatever software it is that we're talking about is the right one to actually buy. And so that's really effective. And then the last part about mobile is unlike SEO or different than SEO, you can still SEO is really expensive because it's super competitive and a highly efficient auction. And because of places like Facebook and LinkedIn, you can actually still acquire a download for like two or three bucks. And so if your conversion funnel, conversion sales funnel is efficient enough, then you can actually make pretty attractive unit economics using paid mobile acquisition.

Great. Well, we're almost out of time. I did want to ask you about Zenefits. You are not an investor.

We're not.

I don't know what's going to happen with a company now that Parker Conrad's been seemingly elbowed out the door, but how does that impact? I mean, is that going to have a sort of a broader impact on what you're doing and company valuations. And I guess just how. I mean, it was like the highest flyer, one of them, of the, you know, the past year.

Yeah.

I'm wondering if it's like a big black mark or if it's just, you know, seen as more sort of anomalous in terms of VCs understanding what they're getting into in some of these.

Yeah, I mean, Zenefits is an amazing business. Right. It's definitely. I think it's top two or three fastest growing SaaS companies ever. I have tremendous respect for Parker and David Sacks. Both of them are amazing entrepreneurs and they've built an amazing business. Right. In a very traditional category. And I think lots of businesses hit potholes. Right. Like there's no perfect execution and there never will be. And when you're such a high flyer, I think the every once in a while when you hit a pothole and you're so much under the microscope, it can be amplified. So I don't think Zenefits, in and of itself is really going to change the way that we think about investing. I mean, I think some investors are more inclined to invest in regulated industries, and Zenefits is operating in a regulated industry. And so you definitely have to be clear on how you satisfy the government regulations when you go to market. But I don't think them in and of themselves is really going to change anything. I think the macroeconomic picture that's changing, and particularly this division or this public private market disparity in multiples is a much bigger force than one company.

Right, Great. Well, Tom, we're out of time. Thank you so much.

Thank you very much.

Great talking with you.