How to Avoid the “Valley of Death”

As a growth stage SaaS founder with $5–10M in ARR, you have much to be proud of. You have made it to a point <1% of all startups make it to. You have achieved product-market fit, real customers find value in your software, investors believe in your vision and you have grown from a few founders sitting at a kitchen table into a rapidly scaling team with org charts, all-hands meetings, and maybe even (virtual) company retreats! Looking back at the last 3–4 years, you have accomplished a lot and avoided many “near-death” moments. There’s a lot to be excited about.

But in the back of your mind, there is the next big looming hurdle to get through — the so-called “Valley of Death” that many a great SaaS startup has succumbed too. Somewhere in that $10–50M ARR range, many good startups destined for greatness peter out. Many things can happen. Maybe it’s existential: the market you were building for is not ready for your product, turns out to be smaller than expected or you are only able to appeal to a small segment. Perhaps the unit economics are not holding as burn ramps. Or maybe it’s a people issue: a key founder quit, or the leadership team just can’t scale.

Most of the time, however, the failure point post $10M ARR occurs when the GTM machine stops working. This post, which draws on my time advising growth-stage startups as a consultant and now as an investor, examines why this happens and what you, as a founder, can do to avoid the Valley of Death.

Sales Efficiency as a Key Symptom

I have previously written about the importance of capital efficiency for SaaS businesses (see here.) More specifically, sales efficiency is the single most-telling operational metric for growth-stage SaaS businesses. To get through the Valley of Death, you need to maintain a high growth rate. Maintaining a high growth rate can’t happen without dollars spent leading directly to the new ARR. Sales efficiency (as measured via magic number), directly measures the ROI of sales and marketing spend on growth. McKinsey’s SaaS Radar has some great data on sales efficiency by ARR stage:

Let’s unpack what is going on here a bit further. In that “honeymoon” $5–10M ARR range, things are working very well on a micro-level. You are post-PMF and scaling efficiently for a few reasons. Your sales team is small and nimble; you are either doing founder-led sales or have a few reps who you have personally coached and have been there since Day 1. They are intimately familiar with the company and product and have high incentives to perform. Much of the opportunities you are hunting are new logos in that initial use case you designed the product for. It’s often a perfect match so the sales are easy; you may even have a fair amount of inbound based on referrals from early customers or people in your network. You have the normal startup twists and turns, but overall, things are peachy.

But somewhere around $10–25M in ARR, the sales efficiency starts to go down-hill. Part of this is a result of being in the “early growth stage” — you have raised that first growth round (see here on how to do it) and have started to invest in more sales and marketing headcount. New AEs take a quarter or two to ramp, you have to build out a real SDR program and you’re starting to think about investing in SalesOps to marry action with data. But other root causes behind this phase of growth are more troubling: perhaps that initial use case is starting to show limitations, maybe the product is hitting certain failure points thereby creating more churn, or perhaps the return on acquisition channels is worsening.

As the saying goes, it can often get worse before it gets better. The $25–50M ARR range can often look even more problematic from a sales efficiency perspective. Maybe the GTM and sales motion is starting to mature but the rapid hiring (ahead of growth) is masking the improvements. Maybe there is something external like new competitors or the TAM ends up proving to be more challenged. Regardless of the root cause, this can be a tough stage to be in — particularly since you have likely been focused on sales efficiency for at least a year or two and are not seeing the fruits of your labor.

The good news is that, if you are able to get through the $10–50M valley of death, things typically start to look a lot better on the other side of $50M in ARR. Companies that breakthrough this threshold are usually benefiting from a hyper-optimized sales & marketing engine and are able to grow quickly and efficiently. The magic number for companies that get here, on average, is greater than 2 — meaning for every dollar you are putting into marketing and sales, you are getting more than $2 in new ARR.

So the question then becomes: how do you navigate this valley of death to the hallowed lands of $50M+ in ARR? The key is to focus on high-potential levers that can improve sales efficiency.

5 Levers to Improve Sales Efficiency

There are many ways to improve sales efficiency in that $10–50M ARR range but the below 5 are likely the highest leverage actions you can take as a founder to increase sales efficiency.

(1) Hire an A+ VP of Sales/ CRO

The single highest leverage point you have as a founder to manage sales efficiency through the valley of death is to hire a strong VP of Sales or Chief Revenue Officer. Your headcount on the sales side is going to balloon and you will need a leader who can run a tight ship and work efficiently with other departments. In an ideal world, you would find someone who has all the attributes below:

  • He or she has lived through that $10–50M ARR window several times before and has built a career in your category or in a very close adjacent category (e.g. if you are a marketing SaaS startup, look for someone who was VP or SVP level at places like Hubspot, Marketo, Mailchimp, etc.) but is hungry to take on more ownership. This person would ideally have been a key leader in SaaS businesses that made it to $50M ARR, but if they were also with a company or two that failed to break-through that barrier that can also be useful in terms of lessons learned.
  • The sales leader also needs to have been responsible for building (not just managing) sales organizations from teams of 5–10 to 50+ in the past. They should know the traits needed in each role from SDR to AE to Manager and how to hire on the right cadence. If they can bring people with them from prior roles, that “followership” can help accelerate ramp time. Importantly, they should also have a healthy perspective on other key roles that could be used to support the front lines such as SalesOps and Account Management. Sales Ops, in particular, is an important data-driven role that every strong sales leader values and puts into place early.
  • The right VP of Sales/ CRO will also come in with a playbook on the sales process and the tooling required to build a robust GTM machine. They should know how to translate the product and sales knowledge living in your head into systematic policy and procedure that can be adopted by the broader organization. Beyond this, the sales leader should also have strong views on pipeline stage gating, pricing/ packaging, and people development.
  • Lastly, and perhaps most importantly, a good sales leader is a magnet for other top sales talent — be it sales managers, AEs, SDRs, etc. Attracting a high-quality sales leader can accelerate the overall talent pool and help you get where you are going faster and with fewer “people issues” along the way.

(2) Be religious about tracking core GTM metrics

Sales efficiency and more specifically magic number, in the end, is what you are trying to optimize. However, in order to do that, you really need to be tracking at least a few more layers beneath on a quarter-by-quarter basis. My suggestion is to break the GTM machine into its 3 primary orgs: marketing, sales, and customer experience. And then track at least 2–3 of the core metrics that impact sales efficiency (in addition to everything else you are tracking.)

You should also strongly consider investing in sales analytics software. Some of our portfolio companies have had great success with tools like People AI (revenue intelligence), Clari (RevOps) and Aviso (AI-powered selling.)

(3) Drive towards product-led growth + digital enabled sales

Long sales cycles, uncertain payback periods and choppy sales motions can impact sales efficiency negatively as they drive up sales and marketing costs without the benefit of incremental ARR. This can become especially magnified, early on, if you are selling to large enterprise customers, making it difficult to do other things like attract outside investors, decrease customer concentration risk and build a scalable/ repeatable playbook.

On the flip-side, if you have a bottoms-up motion, it will be pretty hard to accelerate through $50M in ARR without moving upmarket. Moving up-market works best if you have a land and expand motion (and typically with a freemium business model.) This allows the sales team to automate SMBs and move them to a self-serve/high-velocity motion (digital enablement) while refocusing the core sales team’s efforts upmarket. Nevertheless, never completely lose sight of the SMB segment as they are your growth engine and can help spur organic, word-of-mouth growth.

Regardless of where your customer base is today, every company should be focused on driving growth via product. Even the largest of enterprises, with their long sales cycles and complicated procurement processes, will accelerate their processes if they are seeing rapid adoption of their products “bottoms-up” by their employees. I saw this happen firsthand in my time at McKinsey where Slack and Box eventually upended decades-long relationships the firm had with IBM and Microsoft in the messaging and file-management categories. PLG can be a powerful force for overcoming inertia.

Digital enabled sales, which take a few different forms, can also lead to higher efficiency. Sometimes it’s a paired-down offering distributed on a self-service basis. In other situations, it is low-cost marketing and sales funnel that results in an inside sales motion. In both cases, digital sales can generate greater pipeline momentum than direct/ field sales as well as help you appeal to a broader customer base. This has never been more true than today in a post-covid world.

(4) Get as close to consumption-based pricing as possible

A close cousin of the PLG + digital-enabled sales strategy above is to push your pricing model towards consumption-based pricing. Consumption-based pricing, when done right, is the most efficient pricing model because it allows the customer to naturally expand as they consume more with very little incremental sales and marketing spend on your end. Consumption-based pricing is also the most value-based pricing scheme you can offer, which means the pricing levels tie closely with incremental value delivered. This allows for close alignment between you and your customers.

Some of the most sales efficient (and fastest-growing) SaaS companies employ consumption-based pricing. I’m including a few of my favorite examples of effective consumption-based pricing below:

  • Twilio: varies by product line but some examples are pricing based on the number of minutes to receive/make a call, number of SMS messages sent/received, etc.
  • Digital Ocean: pricing is based on the volume of data/bandwidth and the amount of time virtual machines are active
  • AWS: one of the original pioneers of consumption-based pricing, uses storage consumed (per GB) with volume discounts that come as you enter hire bands of data usage
  • Clearbit: all plans start with a $20K platform fee but thereafter pricing is based on CRM database size, web traffic, and monthly contact creation
  • Datadog: varies by product line but examples include per million log events, per 10k sessions, or per 10K test runs

(5) Work the up-sell and cross-sell

The final strategy for improving sales efficiency is to mine existing customers. Generating incremental expansion dollars from your customer base is far less costly than acquiring a new logo. And the evidence shows that companies that expand >25% of their customers benefit from higher sales efficiency:

An important point here is that there is a “goldi-locks” level of attention that ought to be placed on the expansion of existing accounts — roughly 10–25% of your sales team should be focused on current customers. More than that and you will start to see diminishing returns and the effort is better spent on new logo acquisition.

Concluding Thoughts

Scaling through the valley of death and getting to 50M ARR is certainly no easy task. Very few SaaS businesses have made it through this phase of growth and the pitfalls that come with the territory. But hopefully, a sharp focus on sales efficiency, combined with the utilization of levers outlined above, will increase your chances of success.

As always, please reach out with any thoughts or suggestions (@MrAllenMiller). I’d also like to thank Kris Rudeegraap (@rudeegraap), Preeti Rathi (@preet1rathi), Sam East and Bill Macaitis (@bmacaitis) for their help in reviewing early drafts of this and providing invaluable feedback.

What is B2B fintech?

We originally published this piece in Forbes here.

Over the last few years, consumer fintech has been all the rage. And for good reason: consumer fintech startups have greatly improved the customer experience across many financial applications. This has led to a number of great outcomes including Intuit’s acquisition of Credit Karma for $7.1B earlier this year and Paypal’s acquisition of Honey for $4B at the end of ’19. And consumers are voting with their wallets: 14.2M Americans (6% of US adults with a checking account) now consider a challenger bank like Chime, Varo, etc to be their primary bank.

While the spotlight has long centered on consumer fintech, 2020 will mark the year that B2B fintech finally steals the show. Not only b/c of the recent exits we’ve seen (Plaid’s $5.3B sale to Visa, SoFi’s $1.2B acquisition of Galileo and nCino’s recent IPO) but also because of the ever expanding purview of B2B fintech. This begs the natural question: what is B2B fintech?

A 20-year Evolution

Defining B2B fintech requires going back in time a few decades. If we look at the evolution of B2B fintech, we are effectively on the cusp of a 3rd wave: fintech 3.0. The last 20 years have witnessed a widening of B2B fintech’s mandate and, as a result, a broader base of enduring public winners.

Modern B2B fintech first began in the early 2000s with companies focused on just two “core fintech” areas: payments and banking-as-a-service. The most notable company to come out of fintech 1.0 was of course Paypal. Founded at the dawn of the internet, Paypal actually operated via a B2B2C model, embedding at the point-of-sale with merchants and enabling consumers to transact with merchants effortlessly. Paypal now has a market cap of over $230B.

In the 2010s, fintech 2.0 emerged and the definition of B2B fintech began to expand. Within “core fintech,” we saw payments and banking-as-a-service continue to deliver big outcomes (e.g. SquareAfterpay and Q2.) But core fintech expanded with the rise of lending-focused companies (e.g. LendingClubGreensky) as well as commerce infrastructure (e.g. Shopify.) We also saw the emergence of enterprise software/SaaS companies in fintech-adjacent verticals like real estate (e.g. RealPage) and horizontals like finance operations and HR benefits (e.g. BlacklineBill.comPaylocity.)

In the 2020s, we are sure to see fresh winners emerge in the fintech 1.0/2.0 categories. Many of these categories (like payments) are evergreen and continuously evolving. Others are still quite nascent in their overall development arc. But fintech 3.0 will continue to further fintech’s broadening mandate. Core fintech will expand to include winners in identity, fraud and risk (several of which are already in the making.) We are also likely to see additional winners in fintech-adjacent verticals like insurance and fintech-adjacent horizontals like compliance, privacy and security.

Historically Strong Performance

Fintech 3.0’s prospects are particularly exciting given just how well earlier generations of B2B fintech (1.0/2.0) have performed on the public markets. With the notable exception of the lending category, every other category has posted at minimum triple digit growth post-IPO. In fact, the aggregate market cap of this basket of B2B fintechs has increased 1,661% post-IPO and is now worth half a trillion dollars.

Themes & Building Blocks for Fintech 3.0

As we look towards the 2020s, fintech will continue to broaden in scope and mandate. We will see core fintech areas like payments, banking and lending continue to re-invent themselves again and again. We will also see a greater number of enterprise software/ SaaS entrants rising up across verticals and horizontals in adjacent areas to traditional fintech.

Perhaps even more intriguing will be the meshing of these fintech themes with the broader trends in technology, product functionality and commercialization. Many of the building blocks seen in other parts of the technology landscape will be expressed through these fintech 3.0 entrants. This will include, for example, the latest tools in machine learning, automation and open source. This will also include a myriad of gtm approaches (e.g. top-down, bottoms up, product-led-growth, etc.)

Suffice to say, the 2020s are going to be an incredibly exciting time to be building and investing in B2B fintech. The number of B2B fintechs that will be public in 10 years’ time will triple, generating well over $1T in total aggregate value. B2B Fintech has arrived and is not going anywhere anytime soon.

Let’s Talk Series Bs

When I first landed in venture, it was with an early stage focus: predominantly Series A. The body of knowledge available to founders raising a Series A was pretty robust at the time thanks to investors demystifying a once opaque process via public blogs and forums. YC has since added even more transparency, creating a great Series A guide for founders looking to raise a Series A.

As I’ve move into a multi-stage environment (early + growth), I’ve been surprised by the dearth of information on fundraising for growth rounds, particularly that first growth round: the Series B. There are of course lots of good posts focused on metrics of all sorts, scaling in the growth stages, etc, but the existing literature doesn’t really cover how to raise a Series B — and certainly not in a tactical way.

This is particularly relevant in a post-covid world. If you look at the Pitchbook data from the last few quarters across stages, the story is quite interesting. Early stage deals (Series A) and late stage deals (Series D), saw a massive drop-off in dollars invested between Q4 ’19 and Q1 ’20 but then a decent sized recovery in Q2 ’20 (not all the way back but venture dollars returned 30%+ and the upward trend will likely continue into Q3 ’20.) Series Cs actually saw an acceleration through Covid.

The Series B round, however, while declining in a more measured way, continued a several quarter decline with almost no recovery from Q1 ’20 to Q2 ’20.

Source: Pitchbook

My hypothesis here is that the market is bifurcating around this new “ugly duckling” round — creating something like the Series A crunch of 2015. Why is that? At the Series A, investors can put in a relatively small check and get higher ownership to compensate for the risk taken. Not every Series A needs to work; high ownership in a few measured bets can return a fund making up for losses elsewhere.

In the later stage rounds (e.g. C and D), the winners start to become much clear and there is plenty of later stage capital ready to go to work into obvious winners. The returns in the later stages may not be as out-sized as at the A, from a multiple perspective, but a big check can return a sizable dollar amount at a decent IRR while ensuring investors are unlikely to take a 0 on any given investment.

But that first growth round (Series B) is becoming an increasingly difficult round for investors (and, consequently, for founders.) The company is perhaps somewhat de-risked from a PMF perspective but there are still substantial GTM and scaling questions that need to be answered. As such, Series B investors are forced to put fairly sizable checks to work ($20–$40M) without the ownership level of a Series A or the “certainty” of a later stage round. This becomes a bit more amplified in a post-covid world where there are even more unknowns.

This post is my attempt to shed some light on how to approach the Series B so that you can raise a successful first growth round.

A Quick Preface

Before we get started, because the letter of the alphabet can mean many different things to different people, I’ll begin by caveating what I mean when I say “Series B.” The profile for most companies going out to raise their first growth round (i.e. Series B) looks something like:

  • ~$5–$10M ARR (though the range has become much wider on both ends)
  • To-date has raised anywhere from $5M to $25M (across angel, pre-seed/seed and A rounds)
  • Raising ~$20–$40M with a single lead or co-lead(s) doing the majority of the round
  • Has anywhere from ~2–4 years of financial history; company likely ~4–6 years old
  • Original founder(s) most likely still at the helm and running the day-to-day

This is, of course, overly simplistic as Series B companies have a broader range of profiles (so bear with me!) I will also assume a SaaS business model (though the learnings could be extrapolated to other B2B models, including hybrid models, which I have previously written about here.) I’ll also briefly mention that many of the lessons discussed below for the Series B also extend into later-stage rounds (e.g. Series C, D, etc.)

Building on the A

The best way to frame the Series B and how investors will evaluate your company is through the lens of “building on the A.” Most investors, generally speaking, focus on five key areas: (1) team, (2) market, (3) product, (4) GTM and (5) metrics. The first 3 have some additional features that build on what was established at the Series A while the latter two have a materially increased focus vs the Series A.

This is probably obvious: more time in the market means more data investors can analyze to assess whether a company has the potential to scale into an enduring brand. Let’s take a closer look at each of the 5 focus areas and how the Series B builds on the A.

Team

At the Series A, investors are looking for exceptional founders (passion, vision, grit, deep knowledge, charisma, etc.) There is a lot to unpack there but that is a separate post on its own! We are also often looking for early signs that the founders can attract high quality talent in the form of early team hires.

At the Series B, much more attention is paid to the broader executive team and how it is starting to shape up. In addition to assessing your ability to recruit great functional leaders, who have their own strong follower-ship, investors tend to start thinking in terms of “gaps that need to be filled” as part of the post-B phase of growth. Maybe you are at the point where you need a VP of Sales to lead GTM. Maybe the founder needs to transition product to a VP of Product to focus on other areas. Or maybe it is everyone’s favorite: time to hire that seasoned COO to support the young first-time founder!

The other area Series B investors will start to focus on is culture. Often by the B a distinct “cultural ethos” has started to form. Investors will try to glean what sort of vibe your startup has and how it is perceived in the market. This can be accomplished by spending time on-site at the office, looking closely at employee NPS and digging around to see what can be found “outside-in” via channels like Glassdoor. In a post-covid world, where in-person visits are now much harder, a company’s digital footprint will likely matter even more. Investors will also spend more time 1:1 with key executive leaders over video.

Market

When raising the Series A, the market story needs to be one of a large ($10B+) and growing (5%+ CAGR) TAM. There also needs to be some story around a gap in the market or a greenfield opportunity enabled by sleepy incumbents underserving some portion of the market (e.g. SMBs, developers, a new function like SalesOps, etc.) Articulating a clear “why now?” is also a very important part of the fundraise story.

At the Series B, investors will look for validation of the story you told at the Series A and whether the early momentum backs up that story. It is most compelling if your company is very clearly emerging as the market-leading new entrant. Investors will validate that by speaking with customers, reading product reviews from G2 and digging around on sources like Pitchbook and Google trends, to understand brand awareness and signal.

Product

Demonstrating early signs of product market fit at the Series A is paramount. In the end, this may be the single most important factor (outside of the founders) in determining a successful A raise. Investors will look for customers who “pound the table” and sticky enterprise user behavior. Beyond that, they will look at the road map to see if it is compelling and headed in a direction that matches the broader vision.

At the Series B, there are a few more product-components that matter. At this point, the product should show a clear and quantifiable ROI for the customer. There should be case studies and “customer-wide data” that demonstrate the ROI (whether it is cost savings, revenue lift or some other metric.) It also often helps if the product is developing in a way where there is a tech asset that creates a broader moat.

GTM

Relatively less attention is paid to GTM at the A. At that stage, founder-led-sales is common — though there may be some early signs of a transition to non-founder AEs. Typically the pricing and delivery model has been validated at the Series A. End-state unit economics (e.g. LTV:CAC, payback, etc.) are largely theoretical but improving quarter over quarter.

When you set out to raise the B, investors will be looking for a tighter story around GTM. They will look to see a scalable, repeatable and profitable motion in place. At this point you should have a pretty well understood sales cycle (e.g. how the funnel gets filled, how much time is spent at each point, what % convert, etc.) The unit economics that were theoretical at the A should be more proven-out at the B.

It is also really powerful if you have diversified the customer base. If moving “bottoms up,” for example, you may have a core startup-base of early adopters but now also have a strong set of mid-market logos, maybe even some 6-figure enterprise ACVs. You may have also started diversifying from one industry to several — this has become particularly important post-Covid when it has become clear that reliance on 1 vertical, even if performing well, can lead to a very false sense of security.

Metrics

Perhaps the biggest difference between the A and the B is that the availability of data makes the numbers matter a lot more. Much has been written about metrics but the most important areas to focus on at the B are:

  • Growth rate: demonstrating the company is on a “triple-triple-double-double-double” trajectory is commonly acknowledged as the ideal path. While that is the gold standard, the reality is most companies are not going to be on that trajectory by the time they raise a B. And different companies hit their stride at different times. A more simple goal around the B, is that you should try to be growing at least 100% yoy to attract high quality investors.
  • Retention: High net dollar retention is what you will ultimately be judged on because that is, in the end, what matters most. But pay attention to gross dollar and logo retention as well. Some great barometers to benchmark against, depending on the underlying GTM motion and customer base are here and here.
  • Efficiency: Both capital efficiency and sales efficiency (sub-category) are key operating levers to scale your business successfully beyond the Series B. Aim to have an efficiency score as close to 1 as possible and your magic number should likewise be around 1 as well. As I’ve written before, efficiency is even more important in today’s post-covid world.
  • Gross Margins: Most SaaS businesses are naturally blessed with high gross margins (80%+) — though those margins may take time to materialize. You may also have a hybrid model with multiple revenue streams. Showing high or improving gross margins at the Series B is important as it helps investors buy into the dream that your company can command high multiples at exit.

Running the Series B Process

Now that we have covered the fundamentals of what you will be evaluated against at the B, let’s turn our attention to how to run an effective process. Don’t under-estimate the importance of running a tight and well-managed process. A successful raise is more likely to happen with careful planning.

Note: If you are 1–6 months out from raising a Series B, skip this first section and move to the next section: “Build the Right List of Investors.”

Backwards Plan

The first thing to realize is that as soon as the Series A closes, the “clock starts ticking” for the B round, which typically happens 18–24 months after the Series A — though timelines may stretch a bit longer in this current environment. When the Series A closes, start thinking about where you want to be when you raise the B. Some questions to ask:

  • What is the top-line ARR goal for a compelling B?
  • How much capital will be consumed between now and then?
  • What does net retention need to look like (and broader cohort trends?)
  • What is the target gross margin?
  • What are the key exec-level hires that need to be made?
  • What product milestones need to be hit?

Once you have the Series B goals written down and aligned with your team and Board, figure out the quarter-by-quarter plan to get there. Be thoughtful about what you aim to accomplish each quarter and hold yourself accountable to the quarterly milestones. The plan will change, but you are much more likely to have a successful Series B raise if you are deliberate about planning the journey to get there.

Build the “Right” List of Investors

Another important thing to do shortly after the Series A is to build a list of the right set of investors. Many founders end up wasting time talking to investors that are just not going to be the right fit for reasons that are “strategy-related” (e.g. stage or category.) For example, many Series A focused firms do not invest in Series Bs — check size is too high, ownership too low or valuation not in range for their strategy. Other, later stage firms, don’t do Series Bs — it’s just “too early.” If a firm is not investing out of a fund of at least $250M, they are unlikely to lead a Series B round of $20M+.

Some firms have areas they won’t touch (i.e. “we don’t do consumer.”) Others will only follow once a lead is identified. Corporate VCs/ strategics can add a lot of value, but may also take much more time. As a founder, you may also be inundated with inbound from various firms who are simply prospecting or doing research on a space. Bear in mind most firms invest in <1% of the companies they talk to. So taking meetings with lots of firms can be time consuming and distracting from the core business.

My suggestion is to “go deep, rather than broad.” Work with your existing Seed and Series A investors to craft a highly targeted list of ~10–15 firms worth getting to know more intimately. If you don’t have an existing relationship with those firms, have one of your investors provide you with a warm intro.

Allocate some amount of your time (but definitely <5%) to building deeper relationships with these firms over the course of 1–2 years — and specifically with the person at that firm who would be sponsoring the investment. This will allow you the opportunity to really assess whether they would be a good long-term partner. It also allows the investor to get to know you and to socialize the opportunity internally so that you are a “known entity” when it comes time to formally raise.

Create the Data Room

In the weeks before you decide to kick-off the formal raise process, you will want to have your data room fully structured and ready to go. Do not start the process before you have this in place! Frequently founders underestimate the pain caused when they prematurely kick-off a process and have 10–15 firms asking for different data items.

Create a single, well-structured data room with everything a firm could possibly want to know and have that ready to go. You will come off as more structured/together and will also limit the back and forth requests and internal scramble that comes with being less prepared. See below for an example of how to structure your data room and the items to put in each folder.

Another best practice is to have a “go-to” list of 5–10 customers who can serve as reference checks for investors. Have these customers prepped in advance of your fundraise. Try your best to spread the customer references around as no customer wants to spend their whole day talking to VCs — no matter how much they love your product!

Rehearse the Pitch

In the few weeks before you go out to formally raise, focus on practicing the pitch. This includes understanding timing (you will typically have 30–60 minutes) depending on where you are in the process with any given firm. You’ll have to understand pacing and how to deliver concise responses. We are also in a hybrid environment right now, so be prepared for a mixture of phone, video and (perhaps) some in-person.

Another important dimension is who to bring to the meeting. In the early parts of the process the founder/CEO should be doing the meetings 1:1 but as you progress, you’ll likely need to bring in co-founders and other key exec team members. Have a plan of who you are going to bring in and at what point in the process. The firms you are speaking with may make suggestions as you progress through their process. To minimize disruption to the team, ask for the level of “seriousness” before taking team member’s time away from the business.

I also highly recommend that before you go out to formally raise, practice the pitch with your earlier investors. When you do this, ask for a sub-group of the broader firm to round-out the perspective of your lead sponsor with fresh eyes. A good way to think of this is a 60-minute pitch session where you pitch the team on doing their pro-rata. Have your lead sponsor collect the feedback from the team and share it with you. Incorporate the feedback before you go out.

Manage the Process

Once you formally go out to raise, realize that this is your full-time job and will require 100% of your time/ energy to succeed. You will also likely need to designate someone on your team as a “diligence-point-person” (e.g. VP of Finance, COO, etc) to field requests from potential investors. So make sure to have a process in place internally.

In addition, be sure to create a timeline of when first meets happen, when you want to receive term sheets by and the steps in between. Try to keep all the firms you are working with on a similar schedule. If a few jump the gun, that could create a forcing function for others to catchup and accelerate their process, but it could also result in some firms getting turned-off by a fast process. Never create a false sense of urgency or exaggerate where you are in the process.

While there is a loosely similar process across firms, each firm runs their “deal pipeline” slightly differently. When it comes to getting a decision, there is an even broader spectrum (in some firms it’s totally up to the sponsor, in other firms there is a vote and at some places there is just 1 decision maker.) As you move further into the process with any given firm, ask the lead sponsor (your original point of contact) for clarity on process and how decisions get made. This will help you a) understand the steps to a TS and b) allow you to best position yourself to navigate internal dynamics.

In general, black swan events notwithstanding, good Series Bs happen in ~4–8 weeks from intro session to TS in-hand. Sometimes things can move much quicker — especially if you have an existing relationship with a firm. If the round is taking longer than that, there is likely low interest and you may need to re-think the strategy. Explained “Nos” (if you actually get an honest explanation) can be helpful in terms of adjusting the strategy. At the same time, don’t read too far into a pass because there are a thousand reasons for passing that are well beyond your control. For example, a firm has decided they have already made 1 bet in your space and don’t want to do another.

There are differing opinions on valuation, but in my experience, it is never a good idea to throw out a number when pitching VCs. If the number you suggest is too high, you can quickly turn-off an investor who might otherwise be interested. If an investor asks you what valuation you are looking for say something to the effect of: “We care more about finding the right long-term partner than optimizing around a specific number. We have made considerable progress since the Series A and hope for the Series B valuation to reflect the value accrued, but we will let the market set the price.”

Close the Deal

Once you have succeeded in getting a few term sheets, it’s time to evaluate and make the right decision. Remember you are going to be working with the firm you choose for the next 5–10 years, so choose wisely. The first thing to do is a hygiene check on all the terms. Have your legal counsel and Series A investor take a look and make sure there aren’t any problematic terms.

Many founders get caught up in maximizing valuation but be careful here — the highest price isn’t necessarily going to be the right fit long term. It’s totally fine to use the leverage of optionality but pick your battles wisely and make sure to prioritize accordingly.

You should also run your own diligence on the firm you are working with. Ask for the firms you are evaluating to provide founder references but also do your own back-channel diligence. Get on the phone and spend time understanding how the firm has historically behaved. How involved are they? Do they contribute meaningfully? Do they operate with a steady hand through the highs and lows of company building? Do other founders like working with them? Ask for examples — the more specific the better.

Concluding Thoughts

Raising money is almost never a fun thing for founders. But the right founder/VC pairing can be a powerful acceleration to help you achieve your vision. Understanding what Series B investors look for and how to manage your fundraise is the key to success. Hopefully with a lot of careful planning and a little bit of luck, you will end up with a successful Series B outcome.

As a final parting thought, I’ve aggregated the thoughts above into a packaged view (“Series B checklist”) of the things to do before you raise your first growth round. Remember, you don’t necessarily need to have all of these checked off. But the more you do, the more compelling the round will be.

As always, please reach out with any thoughts or suggestions (@MrAllenMiller). I’d also like to thank Kris Rudeegraap (@rudeegraap), Michelle Palleschi, Rishi Taparia (@taps), Ricky Pelletier (@RickyPelletier), Parsa Saljoughian (@parsa_s), Preeti Rathi (@preet1rathi) and Lenny Rachitsky (@lennysan) for their help in reviewing early drafts of this and providing invaluable feedback.

The Return of Capital Efficiency

Capital efficiency has long been a desirable trait in early/growth stage businesses. But over the last few years, an abundance of capital combined with a “growth at all cost” mindset, allowed founders to deprioritize efficiency. Ignoring efficiency, however, can lead to making cardinal mistakes like misreading true product-market-fit, over-hiring for the stage you are in and burning through too much money too quickly. Furthermore, growth rate and top-line progress are a function of how much capital a business has consumed to get to that point (i.e. getting to $10M in revenue is less impressive if you spent $50M to get there vs spending $5M to get there.)

In a post-covid world, capital efficiency has returned as king. This is especially true in SaaS (which, as a category, has outperformed almost every other category.) Many of the companies that have outperformed during this time frame have been very efficient businesses (e.g. Twilio, Zoom, Shopify, Datadog, etc.) As the fundraising markets dry up a bit and sales cycles lengthen, founders will increasingly be forced to think more about efficiency and investors will pay a premium for efficient businesses.

But how should SaaS founders think about efficiency? Several years ago, Bessemer put out a simple, but helpful rule-of-thumb called the BVP efficiency score. The efficiency score shows a “good-better-best” framework for thinking about capital efficiency (defined as Net New ARR / Net Burn.) They advised founders (under $30M ARR) to think about good-better-best using the table below:

1

While this is a great high-level framework, efficiency among SaaS businesses is a bit more nuanced depending on stage. In the formative days, finding product-market-fit can take time and money. In the early days of growth, building a scalable and repeatable playbook can require significant up-front investment. As the company moves into expansion-mode, the business benefits from clear economies of scale and an improved gtm playbook. In the later stages, the business should be humming and efficiency ought to be at an all-time high.

The point is: benchmarking efficiency in a meaningful way requires looking more closely at stage/ revenue profile. What we really need is an efficiency score for each stage. Or, put differently, a rubric showing how much capital ought to be consumed (and, yes, there is a difference between “raised” and “consumed”) to achieve various ARR milestones along the journey from $0M to $100M in ARR.

Below are two frameworks for founders to use to help answer this question. These tables were developed based on what I’ve seen in the field over the years and have been triangulated with what several other SaaS investors have also seen. The first table is simply a good-better-best framework for total capital consumed to get to different ARR thresholds. The second is a “stage-adjusted” efficiency score. These two tables are, of course, two sides of the same coin.

2

3

Bear in mind these are simple guidelines / “rules of thumb” and anecdotal in nature. Every business has its own set of nuances and unique circumstances. And there is definitely more variability earlier on depending on the nature of the product (i.e. some companies have to invest a lot more in R&D to get the product to market.) Where you land on the grid is less important than what the trend-line looks like and whether you have managed cash wisely (i.e. been a “good steward of capital.”)

To bring this to life a bit, here are a few “hall-of-fame” worthy examples of companies that scaled past 100M in ARR with record breaking efficiency. Note that we are listing capital raised here as a close proxy in the absence of public data on capital consumed:

  • Veeva raised a total of $7M pre-IPO. Current market cap: $33B
  • Appfolio raised a total of $30M pre-IPO. Current market cap: $5B
  • Ringcentral raised a total of $44M pre-IPO. Current market cap: $24B
  • Wix raised a total of $59M pre-IPO. Current market cap: $11B
  • Salesforce raised a total of $65M pre-IPO. Current market cap: $162B
  • Zendesk raised a total of $86M pre-IPO. Current market cap: $9B
  • Realpage raised a total of $86M pre-IPO. Current market cap: $7B

It is no surprise that almost all of the above examples got going in the “good old days” of the 2000s, when capital was less plentiful, and efficiency much more in vogue. Much of this changed in the 2010s, but I suspect we will see the pendulum swing back to some degree in the decade ahead. Hopefully, this helps provide some useful data points in this return-to-efficiency world we now find ourselves in!

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I’d like to thank Alex Kurland (@atkurland), Brian Murray (@murr), Chetan Puttagunta (@chetanp), Logan Barlett (@loganbartlett), Murat Bicer (@itsbeecher) and Parsa Saljoughian (@parsa_s) for their feedback and help in triangulating the numbers here.

Hybrid B2B Revenue Models…and How to Value Them

Summary:

  • While the 2000s and 2010s gave birth to many B2B SaaS greats, the 2020s will usher in a new wave of winners that have far more heterogenous business models.

0. Josh Kopelman

As we begin to reach a certain level of maturity among cloud applications, it has become increasingly clear that we are now moving beyond the first wave of pure SaaS players that came to define the 2000s and 2010s and produced big B2B wins like Salesforce, Atlassian, Zoom, Hubspot and many others. In more recent times, we’ve migrated from this homogenous SaaS world to a more complex world of hybrid businesses, which generate different types of revenue in their quest to build enduring value. This, of course, has played out in many industries beyond software. Costco, for example, was one of the OGs here with its membership subscription fee + item price revenue model.

In some cases, hybrid models are an evolution over time: an early stage company starts with a wedge software product that customers love and then evolves in the growth stages to include additional features that drive new sources of revenue like lead gen fees, payment transaction revenue, lending revenue, etc. This is the story of Shopify, which originally generated subscription revenue for access to its ecommerce software tools before evolving to include additional revenue sources like payments, transaction fees from apps in its app marketplace and other “store-front fees” like domain registration.

In other cases, mixed revenue streams can happen right from the get-go. Our portfolio company, Sendoso, has operated as a SaaS + Transaction revenue-model from Day 1. Customers pay a subscription fee for access to the platform and a set of integrations into the sales, marketing and customer success stack. Additionally, they then pay a separate transaction fee for physical or virtual items sent through the platform to current customers or prospects.

Shopify and Sendoso are certainly not the first businesses with a hybrid model, nor will they be the last. As we enter a world where mixed-models become more common, the two questions then become:

(1) What will these mixed-models look like?

(2) How do founders think about valuation in the absence of less established rules of thumb?

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SaaS: Established Rules of Thumb

But before we get to answering these two questions, it’s helpful to review the basics behind the most successful B2B business model of the last 2 decades: pure SaaS. It is well understood that the two most important financial drivers impacting the valuations of public SaaS companies are, first and foremost, growth rate and second, to a lesser extent, gross margin (though the latter may increase in importance given the recent times.) Below is a view from a basket of SaaS businesses. For illustrative purposes, this is a snapshot taken from February, before the market volatility caused by coronavirus.

1. Growth Rate

2. Gross Margin

To sum: most public SaaS businesses north of 100M ARR that are growing 30–40% with 70–80% gross margins can command a multiple of ~10–12x on the public markets (or at least they could pre-coronavirus; we will know over the coming months whether the current deflation is temporary or here to stay.)

In the “earlier” venture to growth-stage world, this translates into a number of operating levers that are well understood. This post is not meant to be a review of the literature on SaaS metrics but there are some great resources for further reading on these topics, which I’ve included in an appendix at the end.

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Mixed Revenue Models: Forging into Newer Territory

In today’s world, we are seeing a notable uptick in mixed revenue models. B2B companies chasing additional growth opportunities are realizing that once they have achieved clear customer lock-in with one product, maintaining a high growth rate and expanding their TAM, can often be accomplished by cross selling other ancillary products — many times with different types of revenue. This has taken the shape and form of at least four playbooks:

(1) Software + Services

Selling services in addition to software is of course nothing new. In the on-prem/ perpetual license world, professional services were essential to the delivery and implementation of enterprise software. In the cloud application world, professional services typically play a similar role when selling to large enterprises (e.g. the customer base has a lot of F500 customers.) These customers typically require broad integrations, time-consuming security audits and a white-glove experience. While necessary and incremental to top line, services revenue is broadly viewed as less valuable than SaaS revenue.

Workday and Veeva are two great examples of companies that have continued to excel at growing both SaaS and Services revenue. To this day both companies still have a very significant (and growing) services revenue stream (i.e. hundreds of millions of revenues annually) in addition to the SaaS revenue.

3. WDAY and VEEV

(2) Bundled Financial Services

A common theme we are seeing, especially within FinTech is the bundling of financial services. Typically, a business will find initial PMF around a single product with a single source of revenue — for example payments. Overtime, the business will offer its customers additional financial products generating additional revenue from things like lending, referrals to 3rd parties, % of AUM, interchange and a range of other revenue models.

Stripe is a great example of a company that has executed very well on this playbook. In “Act One,” Stripe created tremendous lock-in around it’s payments platform by enabling companies to process card charges on a 2.9% + $0.30 per transaction basis. But as the company evolved over time they built new products with different revenue models (see here for more info):

(3) Software + Bundled Financial Services

But FinTechs are not the only players to bundle financial services. We have begun to see a number of SaaS businesses use application software as an entry point, create lock-in with recurring revenue and then embed a host of other financial services directly into the platform. In doing so, these businesses can generate incredible momentum, widen their TAMs while also maintaining a broad base of stable recurring revenue.

No one has executed better on this playbook than Shopify, which has grown to over $70B in market cap (accelerating through covid-19 no less) and has commanded a revenue multiple of over 30x at certain times. Shopify’s SaaS business gives merchants access to its ecommerce platform + tools to build storefronts; while it’s Merchant Solutions business (i.e. bundled financial services) generates revenue from customers via lending, payments, shipping and referral fees. In the early days, software was the main driver of revenue growth, but over time the financial services have accelerated in a very impressive way.

4. Shopify

(4) Software + Bundled Financial Services + Hardware

The final hybrid model we have seen is effectively #3 above with the addition of hardware. Hardware stand-alone businesses, of course, are notoriously difficult and very hard to operate successfully at scale. But hardware combined with the margins of SaaS and the extended reach of bundled financial services can be a very powerful business. Toast is a great example of a company that has successfully leveraged all three revenue sources to build a very effective business in the restaurant vertical (see here for more info):

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Hybrids: A Weighted Average Approach to Valuation

Mix-model business are thriving and clearly here to say. But valuing high-growth hybrids is more challenging in the absence of the simple heuristics developed for the SaaS world. My suggestion on how to value these companies in the early/growth stages (~$2-$20M in revenue) is to use a weighted average revenue multiple approach. In other words:

1. Break down the business into its various components based on where it is today from a net revenue perspective

2. Apply specific multiples to each of the distinct parts of the business based on general heuristics associated with underlying characteristics like growth rate, margin profile, usage frequency, etc

3. Add in a “boost” or “mute” for external factors like TAM, LTV, retention, depth of competition, customer profile, how the revenue mix may shift over time, etc. This is a big part of the “magic”

4. Use a Sum-Product function across revenue and revenue multiple

Below is a table that illustrates the valuation equation and some general “rules of thumb” as guidance:

5. Valuation

Example One

SMB SaaS business that helps its customers make payments to vendors and also generates a lead gen fee for referring its customers to new vendors. On the SaaS side (SMB so self-serve and no services), the business seems to be in the early innings of a strong growth trajectory (3x.3x.2x.2x.2x) having grown from 2M ARR to 6M ARR in the last year ($4M in revenue associated with the SaaS ARR.) The business did an additional $4M in payments revenue and $2M in lead gen revenue; for a total of $10M in revenue. The company operates in a large, mostly greenfield TAM and, over time, the payments revenue will grow to be the clear leading driver of revenue while the lead gen revenue becomes less relevant.

1_MoweVX8lmWhnLZriKsYzOw

As illustrated above, this is a SaaS + Bundled Financial Services model consisting of subscription revenue, payments revenue and lead-gen revenue. In addition, we applied a relatively high Boost of 0.75 to account for the strong growth profile and large/greenfield TAM; somewhat muted by the lower-multiple payments revenue being the predominant driver of long-term growth. The weighted multiple is ~9x.

Example Two

The second example, a POS terminal business that operates in corporate cafeterias, is also doing $10M in revenue. In addition to charging for the terminals, the company charges an installation fee for set up, generates payments revenue from processed transactions and takes a cut of revenue from any 3rd party apps installed on its devices. However, this business is slower growth due to longer sales cycles (grew < 40% last year.) The company also faces fierce competitors like Square, Toast and Revel.

2

As noted above, this is a Software + Bundled Financial Services + Hardware company. In addition to being comprised of different components than the company in example 1, this is also a lower growth business with 2–3 dominant competitors in market. As such, we added a lower boost scale and the weighted multiple ends up being ~4x.

Template: If you’d like to access these examples, and maybe run a few scenarios yourself, I’ve included a google sheet (here) where you can give it a try. Always open to suggestions on how to improve this so feel free to send my way.

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Final Thoughts

We’re moving into a more heterogenous world, where mixed-model revenue businesses will continue to emerge and thrive. As this new class of companies grow and thrive, founders and investors will need to better understand how to operate, grow and (ultimately) value these businesses. In some cases, it may make a lot of sense to start by valuing a company with one approach (e.g. SaaS) and then layer in other approaches over time as the company evolves. But taking a weighted average approach to valuation in conjunction with a bit of good judgement is a great way to understand valuation for these hybrids.

Appendix: Further Resources on SaaS

Overall SaaS Frameworks:

Growth Rate:

Retention

Sales Productivity / Efficiency

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If you have a different approach, I’d love to hear about it (@MrAllenMiller!) I’d also like to thank Kris (@rudeegraap), Dimitri (@dadiomov), Ian (@iankar_) and Sheel (@pitdesi) for their contributions to this piece.

Navigating the tough times ahead

It’s pretty clear at this point that things are going to get a lot worse in the weeks and months to come before they get any better. The number of COVID-19 cases is accelerating worldwide. Travel restrictions have gone into effect as countries around the world close their borders to curb the spread of the virus. The S&P 500 is down 30% from its peak a month ago and the Dow plunged 3,000 points on Monday alone. Morgan Stanley is now viewing a global recession as their “base case” with an implied $360B loss to US GDP.

As if all that wasn’t enough, some of the yoy OpenTable data coming in is absolutely terrifying with respect to the broader implications we will soon see in the macro economic data. The downturn ahead of us will impact many sectors and millions of households in the US.

OpenTable

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Restructuring & Transformation in a Recession

As I’ve spent much of the past week discussing what this all means with founders in and outside of our portfolio, I find myself thinking a lot about my time in the consulting world. During that time, I had the fortune (or misfortune!) of working on a handful of projects involving companies that had fallen into hard times and required what we called “Restructuring and Transformation Services (RTS).” Regardless of the specific situation, in all of these cases, we would follow a very basic framework designed to diagnose and then triage the (mostly) cost-cutting work from “least painful” to “most painful.”

If you are a founder/CEO finding yourself in a situation in the months ahead where you need to go through a restructuring/ transformation exercise, hopefully this basic framework can help you think through what to do and how to do it.

1. Establish dedicated owners: The first thing to understand about any transformation effort is that you have to have clear ownership. In my consulting years, we would always start by working with the client to set up a “Transformation Office” led by a Chief Transformation Officer. The “TO” would lead the effort, create urgency and drive action. As a startup CEO, the buck stops with you. But it’s a good idea to create a small, cross-functional task-force to serve as an advisory council and to drive change within the organization. These people will be working on the transformation while also doing their full-time job so important to pick people who have the capacity and commitment to the company to wear multiple hats through a difficult patch.

2. Diagnose the problem: The next step is to figure out where you stand, particularly from a cash perspective. Some basic questions to ask and get clear on before you jump into problem solving:

3. Establish the target: After you have diagnosed the problem, determined your cash position/ runway and understand at a high level what levers you have to pull, you now have a “Baseline” to work from. It’s now time to establish the “Target” for cost-take-out. This is the total cost you need to remove from the business to get to a certain “cash-inflection” point (i.e. a new injection of cash via fund raise or getting to break-even.) This target now forms the basis for all actions you put into motion. The target should be a specific number with very clear milestones (ie. mini-targets) that you can work towards achieving.

4. Create a cadence and review process: It is important that the transformation task force you meet with gets into a regular cadence (this means meeting weekly and if the situation is dire enough, daily.) Get in the habit of tracking all transformation initiatives using a project management tool. During my consulting days, we used Wave. But you can use AsanaTrelloMonday or another project-management tool of your choice. The important thing is to ensure that the tool can track initiatives, owners, progress and tie to real outcomes in the P&L. The transformation task force should regularly review progress using the tool’s dashboards and elevate the most important decisions to you, as the founder/CEO, to ultimately make.

5. Focus first on non-personnel costs: When hunting for cost-take-out, the easiest place to start with is non-personnel costs. Here are a few areas to look into — remember any savings here could well mean one less RIF:

6. Be thoughtful about personnel costs: For obvious reasons, things get tricky once you start tapping the personnel-cost bucket; exploring RIFs should be a “last resort.” Once it becomes clear lay-offs are coming, morale tends to slip as does productivity. This is particularly difficult at a startup where things tend to be smaller and feel more personal. Some general tips:

7. Remember the good times will come back: Keep in mind that recessions are temporary and your short-term goal as founder/CEO right now is to “just survive.” But eventually things will pick back up. Customers will return and the momentum will swing back in your favor. When this happens, you will want to be in a position to seize the moment and bounce back in full strength. Having a bit of foresight to “see around the corner” and prepare for that moment will help you return in full force.

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Additional Resources by Topic

In the last few weeks, there have been some really great resources that have come out on topics related to the coronavirus, navigating the pending recession and how to move forward during these difficult times as a founder. Below is an aggregated list of resources worth reading by topic.

General Coronavirus (COVID-19)Information

HR & People Management Resources

General Advice on Downturns

Tools for Planning in a Downturn

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Here’s to hoping that this downturn is as short-lived as possible and the roaring ‘20s come back in full force quickly! If you have additional resources I should add to the list above, send them my way and I will make every attempt to keep this list current.

Announcing our new Podcast Series ‘Focus on the Founder’ with our first guest – Ryan Williams of Cadre

Over the years, we’ve heard from our founders here at Matrix that some of the best learning opportunities they’ve had has come from 1:1 conversations with other entrepreneurs. And while there is no shortage of resources for entrepreneurs (including content we have built at Viewpoints and forEntrepreneurs), there are very few public forums where successful founders and operators speak candidly about their career journeys and discuss what has/ has not worked for them as they’ve scaled their businesses.

That is why we are excited to announce ‘Focus on the Founder’ – a podcast series that will do exactly what it sounds like—bring the focus back on the founder. In the coming months, we will be releasing a series of episodes where we ask successful founders and operators questions about their journey into entrepreneurship, how they’ve gone about making critical decisions (e.g. hiring, fundraising, etc.) and what they would do differently looking back.

The initial focus will be on founders and senior execs in FinTech—though this may evolve over time. We will keep the episodes short, informal and frank. The very first episode is with Ryan Williams the CEO and co-founder of Cadre. You can find the podcast episode on SoundCloud, iTunes & Google Play.

In this episode you will learn about…

  • How Ryan went from selling headbands at age 13 to flipping houses in college to launching Cadre. Or as he puts it “Headbands to Houses to High Rises”
  • When the real “Aha” moment came for Ryan that led him to believe that there was a big opportunity in real estate technology
  • What Ryan believes is the single most important characteristic behind the success of companies like Amazon, Airbnb and Fidelity and how Cadre has embraced that characteristic
  • How Ryan works with his investors and the value they have provided to him beyond the obvious capital injection
  • The crucial metrics and KPIs that Cadre tracks and measures
  • What other areas Ryan is excited about and would explore if he were not building Cadre…hint some of them are pretty controversial in the venture world today

Core & Emerging Platforms as we Move into 2017

Innovation at the platform level (whether it be improved hardware, changes in infrastructure or new ecosystems) has always led to new opportunity at the application level for both entrepreneurs and the investors that back them. As 2016 winds down and we look ahead to 2017, it’s as good a time as any to take stock of the innovation we’ve seen at the platform level in the last few years and the trends in tech that will drive new opportunity in application software.

More specifically, I see four core and emerging trends that will continue to dictate opportunity in B2B software: (1) continued dominance of cloud, (2) acceleration of mobile enterprise, (3) increased attention to AI (more specifically machine learning) and (4) the rise of AR & VR – particularly AR in the B2B setting. The figure below provides an overview that will be explained in further detail below:

tech-platforms

(1) Continued dominance of cloud

This is an “old” one but a good one. Of the four platform trends this is the most established one and has produced the most opportunity to-date.

From a horizontal perspective, the cloud has penetrated (though not yet dominated) every function within the enterprise. Salesforce is the prevalent choice for most in the sales / CRM functions. Companies like Workday, Cornerstone and SuccessFactors have gained real traction within HR. Eloqua, ExactTarget and Marketo are widely used marketing tools. NetSuite has a strong presence in ERP while Zendesk is a strong force in customer success. And there are many other more recent horizontal SaaS companies that have made big waves: Slack, Stripe, DocuSign and DropBox are just a few of many that had big years in 2016. And there are many more opportunities remaining in relatively untouched areas like: sales ops, SMB-focused HR tools, inventory management, market intelligence and customer care analytics.

Vertical software, is still very much in its infancy. There have certainly been some early winners like Veeva (life sciences), RealPage (real estate) and Fleetmatics (fleet management), but there are many more industry cloud winners to come. Industries like manufacturing, construction, logistics, agriculture, oil and gas and others have slowly begun moving to the cloud after remaining cloud-allergic for many years. 2017 will be a big year for many of these industries and the vertical-focused, category-winners that reshape them.

(2) Acceleration of mobile enterprise

Aggregate mobile enterprise revenue in 2016 was just under $100B –pretty solid for a platform that didn’t exist 10 years ago. However, this one is also just getting started. Forecasts show this number doubling by 2020 (and I wouldn’t be surprised if the growth rate is higher than that). Part of this growth is fueled by increased vertical software opportunities. Procore is a great example of a company delivering a vertical specific solution (in construction) via mobile enterprise. Industries like education, insurance and real-estate will soon follow.

(3) Increased attention to AI  

2016 really marked THE year when AI (or more accurately, machine learning) really came into focus in the startup and venture community. As seen in the figure above, deals done and investment dollars poured into the sector have grown exponentially in the last 2-3 years. In that time, AI has done a few interesting things:

  • It has re-opened the door in a real way to more horizontal software opportunities giving rise to the “disruption of the disruptors.” Suddenly, machine intelligence has allowed for greater insights and better products and services that opened the door to new entrants looking to enter horizontal spaces.
  • It has allowed for more focused solutions that really benefit from machine learning applied to large data sets to flourish. Little Bird (a market intelligence and data analytics company based out of Oregon) that was recently acquired by Sprinklr is a good example. AI powered point solutions like Little Bird, once bolted onto larger platforms (like Sprinklr’s social media management platform) can exponentially increase the utility to their enterprise customers.
  • It has brought back IBM’s relevance among innovators and early stage companies. Ironically, rightly or wrongly, IBM’s Watson is the most common machine associated with machine learning. Whether IBM is able to harness the potential of AI remains to be seen, but the company attempts to be mounting a bigger challenge to be a dominant presence in the space rather than giving way to the big four (Apple, Facebook, Amazon and Google) as it did with consumer devices, social, ecommerce and search.

Expect AI to be a powerful trend in 2017 and beyond, with both startups and established players getting involved, especially as the technological innovation becomes more advanced.

(4) The rise of AR & VR

AR and VR are the furthest off in terms of real platform potential and 2016 was largely a pretty big disappointment for these platforms. The biggest thing in AR/VR in 2016 was Pokémon Go, which was an entirely consumer play (and appears to largely have been a fad). I expect VR to still be a few years away from going mainstream –and even when it does, it will continue to be a consumer play.

That being said, I do think in 2017 we will see the start of some AR-based software applications that will gain traction among enterprises. And by 2020 forecasted revenues in AR will near $120B. Some of the important early verticals AR will start with will be healthcare, manufacturing, defense and architecture among others. Some of the early startups playing in these spaces, that I’ll be following in 2017 include: CrowdOptics, APX Labs and Pristine.

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.

Cap Table Modeling: Understanding the Mechanics of Equity vs. Convertible Debt

Cap tables are an important concept for entrepreneurs to grasp when taking outside financing. A cap table is a schedule that lays out the ownership stakes in an early stage company. They typically take the form of a spreadsheet that changes over time as more capital is raised and more investors become involved in the growth of a company. Cap tables can also vary based on whether the capital is raised through equity or through convertible debt (debt that converts to equity at a future point in time).

Much has been written on the merits and challenges of both equity and convertible debt. There are a number of great posts that explain each at a high level and then go on to take a stance on which method is preferred and when. A number of notable investors have weighed in on the topic through a variety of posts including: Fred Wilson, Mark Suster and Josh Kopelman. All of these posts do a great job of explaining the mechanics of each financing option and provide sound reasoning around when (and when not) to use convertible debt vs. equity.

The problem with these sources, is that rarely do they actually dive into the mechanics of building a cap table from scratch and modeling out the differences over time of equity vs. convertible debt. Of course, there are courses taught by organizations such as Wall Street Prep that do extensive training around cap table modeling. While these courses are great, they tend to be a) very expensive b) time-consuming and c) highly detailed-oriented (too detailed for what most entrepreneurs are looking for). So what do you do if you’re an entrepreneur who wants more than just a high level understanding of the pros and cons of various financing options but doesn’t want to pay a premium for a time-consuming, detail-heavy course?

I recently came across a great resource put together by my Professor at CBS and 37 Angels founder, Angela Lee. Professor Lee has built a step-by-step guide to modeling out cap tables for equity and convertible debt deals (both when the discount or cap come into play). The guide, which is posted below, provides detailed instructions on how to calculate the various components of a cap table (shares owned, share price, % owned, etc.,) across various rounds of fundraising. Although the tool is simplified, it provides an intuitive way to model various financing scenarios and their implications for your ownership over time. Hopefully this sheds a bit more light on the mechanics of how cap tables are put together. Big thanks again to Professor Lee!

37 Angels Cap Table Template