Grow fast or die slow: Why unicorns are staying private

In today’s world, technology companies worth more than $1 billion—and many worth $10 billion—have fewer reasons to go public than they did in the past. It’s a new paradigm shift that has really changed many of the dynamics in the startup community. A few of us in McKinsey’s High-Tech practice put together an article on the software IPO environment and the implications for founders and VCs. We hope it’s an insightful read.

The full article is available here.

Revisiting EdTech: Opportunities for 2016 and Beyond

It’s been a few years since I’ve written extensively about education technology and the opportunities that exist in the space. Since my last set of posts back in December of 2012, the space has continued to be a fast growing sector with much opportunity. Back in 2012, the sector was a $4.1T industry globally. That number just topped $5T in 2015 with a 7% CAGR. Unsurprisingly, the education sector remains the second largest industry, trailing only healthcare in terms of global market size.

Likewise, venture capital investment has picked up substantially in the last 3 years. In 2012, Series B investments totaled just $159M—that number is expected to top $500M in 2015 once the final numbers are published. Similarly, deal activity across all stages has picked up. In 2012, the total number of deals across VC/PE was ~500 deals—that number will reach nearly 800 deals by end of year 2015.

Most importantly, exits have finally begun to provide some hope for returns. A scarcity of exits has long been one of the big problems for entrepreneurs and investors considering EdTech. Indeed M&A activity has historically been slow (<1% of all M&A exits from 2002-2012) and IPO showings have often been abysmal (e.g. Chegg which fell 23% during its IPO debut and now has a market cap of just ~$620M, half of its opening day valuation.)

In the last three years, however, there have been a handful of successful EdTech IPOs including companies like 2U and Instructure. Others, such as Coursera, Udacity and Edmodo, are all not far behind in the IPO pipeline. M&A activity likewise has been quite strong. In fact, U.S. EdTech companies tend to command higher revenue multiples than the average tech exit—3.2x for EdTech companies vs. 2.5x for the broader tech industry. Furthermore, M&A exits themselves over the last 5 years have been fruitful with 25 buyers spending more than $100M on U.S. EdTech companies.

exits-1438648868.jpgSource: EdSurge

Yet despite this progress, there remain a wide array of inefficiencies and unsolved problems. Specifically, I see 6 promising near-term opportunities for entrepreneurs to take advantage of and for investors to invest in. In no particular order here are a few thoughts of what we will see beginning in 2016.

1) Cloud SaaS will finally replace on-prem at the school district and system admin level

Having spent time working at the district level in education policy, I was always amazed at how archaic many of the tools districts and school systems use at the city-wide/admin level. Software tools that track important mission-critical information such as attendance, student demographics, building information, zone data, etc. across schools within a district are still often hosted on-premise, using archaic databases and outdated software with GUIs that look like they were designed in the ‘90s. Below is an example of what the NYC DOE ATS currently looks like:

Untitled.pngSource: NYC Department of Education

I suspect that in 2016, as much of the IaaS and PaaS layers begin/complete their moves to the cloud through services provided by the likes of AWS, Azure, SoftLayer, etc, we will begin to see more B2B SaaS applications layered on top to replace the traditional on-prem software solutions. This will bring much needed functionality, analytics and a cleaner user experience to the education world. This in turn will increase productivity for educators working at the district and administrative level across school systems.

2) Learning content will be far more personalized

Recent survey data showed that less than 50% of teachers reported having digital resources that could be used to meet teaching standards. Moreover existing technology solutions often are not tailored to individual students and their specific needs. The next generation of student-centric software tools (across grade levels and subjects) will provide high levels of granularity and insight into the specific needs of individual students allowing for an end-to-end customized experience across lesson planning/ delivery, class activities and periodic assessments. This will be even more important for special needs students in ICT, 12/6:1 or similar learning environments. Personalizing learning content will ultimately allow for a more tailored learning experience and better long-term knowledge retention.

3) K-12 teacher development will rely more heavily on software platforms and tools

As it stands today, professional development for teachers is largely untouched by software tools and applications. At the district level, spend on professional development for K-12 teachers in the U.S. is ~$3B and usually takes 1 of 4 forms: (1) periodic school-wide workshops, (2) observation of other teachers, (3) coaching (usually by a more experienced teacher) and (4) generic online research.

In 2016, we will begin to see more PD content move to the cloud as doing so makes training teachers: (a) less expensive, (b) more accessible and (c) more personalized. Horizontal HR solutions like Workday, Cornerstone OnDemand and PeopleSoft will be re-built / tailored for the education sector enabling professional development in education to be more sophisticated and effective.

4) Higher education software tools will focus more on degree completion  

As the Baby boomer generations’ offspring (Gen X) move beyond the college-age window, the college enrollment growth rate will begin to slow and the focus for many higher-education institutions, from a revenue perspective, will shift away from recruitment/ matriculation and towards retention/ graduation. As of 2012, ~50% of all college students were in at least 1 remediation course.

In the years ahead, there will be a greater focus on retention and remediation of students already admitted into colleges. Software tools will increasingly be used for (1) recruiting the right type of student to admit, (2) providing BI and predictive analytics platforms for identifying and tracking high at-risk students and (3) supporting remediation instruction for at-risk students to get them back “on track.”

5) Online courses and degrees will become more relevant

While online courses (including MOOCs) and degree programs will never replace the off-line experience, these offerings will increasingly be used to supplement off-line instruction as well as provide a new delivery format to non-traditional segments (such as continuing education students). Two important trends are happening that will accelerate the pace at which this happens in 2016: (1) online courses and degrees are becoming more socially acceptable (many programs have been accredited, employers are increasingly hiring graduates from these programs, etc.) and (2) the infrastructure (managing enrollment, handling payment, providing tech support, hosting platforms, etc.) to provide these offerings is cheaper and more readily available.

As such, we will see a greater number of higher education institutions join the ranks of UNC, USC, ASU and many others that provide courses and degrees online. This trend will create a range of software opportunities across: video collaboration, course development and delivery, student / faculty services and recruitment / retention.

6) Demand for software tools that teach skill-based training will increase  

As colleges increasingly charge exorbitant tuition fees while failing to equip graduates will real skills, demand for skill-based programs, vocational certifications and other alternative teaching tools will increase. In 2013, the number of vocational certificates granted was nearly 1M—up 35% from 2005. Similarly, from 2013 to 2015, the number of graduates who graduated from coding programs (such as Codecademy) increased 630%+.

In 2016, we will see an even greater emphasis on tools for skill-based training. Some of this will be purely software delivered via the cloud and some will be more hybrid: software mixed with in-person training. Companies like Lynda (acquired by LinkedIn), Udacity, General Assembly and Udemy have already made significant dents in this space. We will see much more of this in the upcoming year.

Bookings vs. Revenue in Early / Growth stage SaaS Companies

There is an important difference between revenue and bookings that comes into play for early stage SaaS businesses that are growing rapidly. This difference has implications on both the revenue and cost side of the equation and can also affect important decisions such as how much to raise when speaking with the investor community.

Before we get to growth SaaS businesses, however, let’s first talk about legacy software pricing. In the traditional software world, software was typically sold as a perpetual license. Customers would make a one-time payment for perpetual use of software and pay for annual support and upgrades each year. In this world, bookings = revenue and revenue was generally recognized at the time the contract was signed and the software provided to the customer. The benefit of this model was immediate revenue recognition; the downside was lumpy and unpredictable revenue.

In the SaaS world, software is provided on a recurring (often monthly) basis. The software, support and upgrades are all included in the subscription. This allows for stable and predictable revenues that are smoothed out over the life cycle of the contract. The down side, however, is that there is often a discrepancy between bookings and revenue that must be understood and accounted for appropriately.

This issue is best understood with an example. Assume for a moment that a SaaS business is selling software in 3 year contracts and that churn is 0% (for simplicity.) In a flat revenue business, where growth is 0% YoY, there are no major accounting issues or business implications because revenues = bookings. For example, if bookings are flat at $100M, the business would recognize $100M of revenue each year. $33M from 2 years ago, $33M from last year and $33M from this year.

The challenge that comes into play is when a SaaS business is in growth mode. For example, a SaaS business that books $25M in Y1, $50M in Y2 and $100M in Y3, would have the following revenue numbers:

Untitled.png

As seen in the table above, for a growth stage company that is doubling in bookings YoY, revenues do not equal bookings. There is a lag effect between bookings and revenue and it becomes necessary to take a haircut on bookings to get to revenue. This haircut will of course decrease over time as growth slows, but it does create an important accounting dynamic that has real business implications

One of the largest implications for early stage companies is in the amount of money a SaaS business must raise when going out to the VC market for financing. The underlying cost structure (COGS, sales expense, marketing expense, R&D, etc.) must be looked at as derived from bookings not revenue. This is a result of the fact that the SaaS business is incurring these expenses as a proportion of bookings not the revenue actually being recognized. Because expenses are incurred in line with bookings (and bookings > revenue), the result is that EBITDA is low (and generally negative for most early / growth stage SaaS companies). EBITDA ultimately ties to cash flow, burn rate and the required investment. Thus, it is key to make sure the raise is in line with what the business needs from a cash flow, and ultimately booking / expenses, perspective.

Venture Debt: An Alternative form of Financing

In the tech ecosystem, we often associate entrepreneurial financing almost exclusively with venture capital. As a result, most of the fundraising resources for entrepreneurs are geared around venture capital. Likewise much of the media attention in the startup financing world is focused on venture capital investments.

The reality, however, is that there are many different forms of financing beyond traditional venture capital financing. And the type of fundraising instrument used is as important as the quantity being raised and who it is raised from. There is quite a bit of information out there about raising from friends and family, angel investors, crowd funding platforms and several of the other more common sources of financing outside of venture capital. But there is very little information about financing a startup through debt.

As such, Brian Feinstein of Bessemer Venture Partners, Craig Netterfield of Columbia Lake Partners and I put together a white paper on venture debt, which was released last week. It’s meant to be a fairly comprehensive guide for entrepreneurs who are interested in exploring venture debt as a viable option. Feel free to check it out here and send us any questions as they arise.

Updated Resource Section

I recently updated my resource section to include a variety of papers and presentations I authored or co-authored while at Columbia Business School. As I was sorting through my hard drive and getting rid of old files, I realized that a lot of time and effort went into some of these and that someone, somewhere might find some of this information useful.

So I’ve uploaded some of these thought pieces under 3 different sections:

  • Investment Memos: This sections contains three different investment memos on Airbnb, Prosper and Starwood. The first two are focused on later stage venture / growth equity investments whereas the Starwood memo is more of a traditional Buy/Sell/Hold analyst report.
  • Roadmaps & Theses: The next three sections contain a set of VC style investment roadmaps from the two internships I did in venture. The first deck is a roadmap focused on wearable tech, specifically Google Glass, from my time at Gotham. The second deck is a playbook on vertical saas opportunities that I put together for BVP. The final paper is an initial viewpoint on the manufacturing software sector that I put together for BVP while doing a deep dive into the space.
  • White Paper & Thought Pieces: The final section is more or less a catchall for a few other pieces that I thought were interesting but didn’t naturally fit into the other two categories. This section contains an in-depth analysis on M&A activity in the tech sector and the resulting implications for venture investors. This section also includes a deck that very accurately projected iPhone sales for Apple in Q3 of 2014 before actual figures were announced. Both of these papers rely extensively on regression analysis and other statistical methods.

So there it is, a few resources that I thought were interesting. I’ll continue to add to this collection as the opportunity arises.

Thank You

Yesterday I graduated from Columbia Business School ending a two decade educational journey that started on the west coast and end here on the east coast. These past two years have been two of the best years I’ve had both personally and professionally. And so I just want to take a moment to say thank you.

My experience at CBS has been inextricably tied to New York City. Some of the best professional opportunities I’ve had were a result of being here in the city. During my first year, the guys at Gotham Ventures were nice enough to give me the opportunity to learn the ropes and get an insider’s perspective on the venture business. That experience was only enhanced during my second year when I worked on a variety of projects with Bessemer Venture Partners. Lucas and Brian – thank you both for taking a chance on me.

Back on campus, there were two organizations that really shaped my MBA experience. The first, InSITE Fellows, is one of the most innovative student groups I’ve come across. Before I even stepped foot on campus, I knew I had to join. Huge thanks to the year above me for letting me in and the current fellows for being the smartest yet also most humble group of soon-to-be founders, investors and technologists I know. And a big thank you to the folks at 2U, Betterment and the many other startups I was fortunate enough to work with.

The second group was my cluster—Cluster E. I really couldn’t have asked for a better group of people to spend time outside of class and work with. Within my cluster we had a diverse mix of veterans, attorneys, teachers, entrepreneurs and of course…bankers and consultants. I’m amazed by how talented, but at the same time, down to earth everyone was. It was an honor to get to know all of you and I know this is just the beginning of many long friendships.

Finally, I have to thank my family, with-out them I wouldn’t be here today with this degree in hand. Mom, Dad and Andrew thank you for your support throughout these two years and throughout my entire life. Mom you have been my rock since birth—I’d be nowhere without you. Liza you have been my biggest cheerleader since our Cornell days; I can’t thank you enough. And to my extended family—I couldn’t have asked for a better group to celebrate the weekend with. I only hope that I can shower you all with as much love and support as you have showered me with.

And lastly, thank you Columbia Business School. What an amazing place #attheverycenter. Next stop, McKinsey & Company but not before one last stretch of traveling and relaxing with friends and family.

Airbnb and the Problem with Later Stage Investing in Today’s Environment

A couple of months ago several news sources reported that Airbnb was raising $1B at a $20B (pre-money) valuation. This article on TechCrunch sums up the story pretty well.

I have a lot of respect for Airbnb as a business and the tremendous growth of the company in just 7 years. Airbnb currently boasts 1M+ listings across 34,000 cities and 190 countries. Though still a private company, revenue estimates for 2014 were said to be over $400M w/ yoy growth of 65%. Not bad for a company many famously passed on (including Fred Wilson) or wrote off as completely absurd. I’m confident the founders and early investors will be handsomely rewarded when the company eventually goes public.

I do, however, have concerns with the current massive round that Airbnb is raising. And it’s a concern I believe should be shared by many of today’s unicorns and, in particular, their later stage investors. If I were a prospective later stage investor in Airbnb’s $1B round, I would not invest at this stage and at that valuation. My thoughts can be summed up in three points:

  • A $20B valuation overinflates the true value of the business, which by my analysis is closer to ~$10.2B. This high private valuation will hinder returns for later stage investors—it’s a problem I think many of today’s later stage investors in unicorns are going to face. The infographic in this Forbes article shows a similar story with one of the more recent unicorns to go public: Box.
  • Airbnb has important competitive advantages in terms of network effects and customer captivity—they may even have a bit of a regulatory advantage thanks to their scale. The problem is that Airbnb has nothing that will allow it to be a complete “winner-takes-all” business. At the very least, it will have to share TAM with its most direct competitor, HomeAway, not to mention all the major hotel chains that have been around for decades.
  • There are a number of unknowns that make Airbnb a risky business to invest in including: macro-economic tourism and vacation trends, the decentralized nature of regulation and an uncertain cost structure that is likely to erode margins. Some of these unknowns could be very detrimental to Airbnb’s growth and continued success as a business.

For a more in-depth analysis of the investment opportunity, I’ve put together an investment recommendation deck below:

Follow

Get every new post delivered to your Inbox.