Sneak peek at future of SaaS investing(medium.com)
medium.com
Sneak peek at future of SaaS investing
https://medium.com/@tom.kubik/get-rich-slow-in-software-57001f41f3a9
76 comments
The re-focus on SaaS as the only class of investment that can reliably generate returns and avoid zeros or capital loss is a very real trend.
Would emphasize your point around services - SaaS investors are generally allergic to this stuff and prefer services to make up as little of revenue as possible. It's typical low margin and not seen to be very "strategic" (though this could be debated).
SaaS is also much easier to analyze and diligence than the typical non-SaaS software company or consumer internet business. I won't say it's dead simple, but it's very much not rocket science. In combination with excess capital, this leads to prices getting bid up as such ease of diligence leads many investors to throw in a term sheet. It's just so easy to get comfortable with this stuff.
One caveat to all this that ties to your last point around the market / economy is volatility. You can see in the data that companies that generate a higher amount of the their growth from SaaS-like retention/upsell see higher valuation volatility when the market turns for any reason. [1] The "best" SaaS companies in the eyes of later-stage investors are typically those with high net revenue retention - but these are also the ones that get whacked the most in corrections.
As far as a downturn taking down growth equity - time will tell.
[1] https://whoisnnamdi.com/high-retention-high-volatility/
Would emphasize your point around services - SaaS investors are generally allergic to this stuff and prefer services to make up as little of revenue as possible. It's typical low margin and not seen to be very "strategic" (though this could be debated).
SaaS is also much easier to analyze and diligence than the typical non-SaaS software company or consumer internet business. I won't say it's dead simple, but it's very much not rocket science. In combination with excess capital, this leads to prices getting bid up as such ease of diligence leads many investors to throw in a term sheet. It's just so easy to get comfortable with this stuff.
One caveat to all this that ties to your last point around the market / economy is volatility. You can see in the data that companies that generate a higher amount of the their growth from SaaS-like retention/upsell see higher valuation volatility when the market turns for any reason. [1] The "best" SaaS companies in the eyes of later-stage investors are typically those with high net revenue retention - but these are also the ones that get whacked the most in corrections.
As far as a downturn taking down growth equity - time will tell.
[1] https://whoisnnamdi.com/high-retention-high-volatility/
Exactly, SAAS is much easier to analyze, that's why everyone moved to SAAS investing because it doesn't have many "flips of coin" in order to be successful.
> As far as a downturn taking down growth equity - time will tell.
As with everything. My prediction is, as the concentration around SAAS increases, more funds will be created (especially if no other instruments can produce such a high predictable growth) leading to more concentration.
If I didn't have a business to run, I would be already trying to raise fund for Series A and B to focus on non-SAAS business. You get quite heavy discount on them as there is little competition and and you again get the 1/3 business model of early stage VC, which can produce outsized returns. over just 3x.
> As far as a downturn taking down growth equity - time will tell.
As with everything. My prediction is, as the concentration around SAAS increases, more funds will be created (especially if no other instruments can produce such a high predictable growth) leading to more concentration.
If I didn't have a business to run, I would be already trying to raise fund for Series A and B to focus on non-SAAS business. You get quite heavy discount on them as there is little competition and and you again get the 1/3 business model of early stage VC, which can produce outsized returns. over just 3x.
Risk / return trade-off still holds - great insight!
Performance through-the-cycle is a big question. One can point to Salesforce (founded 1999, IPO 2004), which has been around for 20+ years... However, big sample bias here (ditto for my article, with sample n = 1). Salesforce, a big-category-defining company - may not be representative of moderately-sized businesses.
Whoisnnamdi - per your post, revenue retention looks like a key metric driving valuations!
Performance through-the-cycle is a big question. One can point to Salesforce (founded 1999, IPO 2004), which has been around for 20+ years... However, big sample bias here (ditto for my article, with sample n = 1). Salesforce, a big-category-defining company - may not be representative of moderately-sized businesses.
Whoisnnamdi - per your post, revenue retention looks like a key metric driving valuations!
My point wasn't that all SAAS business are going to be in trouble, rather than the growth equity is going to be impacted because they are funding only SAAS businesses. There is no hedging and as such, once business stop paying for certain SAAS services, they will in turn stop paying for others and so on and so on.
> if you don't fit their narrative, for example you have large service revenue or you have only few enterprise clients, then you are out of luck
Can you clarify this? What do you mean by "large service revenue" and why does that mean the founders are out of luck?
Can you clarify this? What do you mean by "large service revenue" and why does that mean the founders are out of luck?
It was poorly phrased so I changed it. I meant that if a big chunk of your revenue comes from services, they are not going to be very enthusiastic about your business.
Thank you for the clarification. I hope I can ask another. What is the alternative that would make them enthusiastic? That is, if I am bootstrapping a business and want to attract these kind of investors then what sources of revenue would they like to see other than revenue from services?
Well, SAAS. That means subscription revenue, preferably in a market with large TAM that has simple CAC/LTV and churn calculations. Everything else is essentially a hassle.
I know Customer Acquisition Cost and LifeTime Value from working in free to play games. Total Available Market is a new acronymn/initialism for me. Funny how I don't know if it is pronounced "tam" or "tee, ay, em".
Don't worry, we all learn something every day. TAM/SAM/SOM are quite important metrics while judging a business. Sequoia [0] has some good information on it.
[0] https://www.sequoiacap.com/china/en/article/measuring-produc...
[0] https://www.sequoiacap.com/china/en/article/measuring-produc...
Product subscription revenue
Just as the shrewd investors who have been printing cash here for decades are moving out.
Always right on time.
Always right on time.
It seems like the investor profiles and expectations are different. Prior decades of VC / high growth and exit investors are now seeing those exits are no longer as common in SaaS. For many reasons, easier to start a company - more competition, more startups.
The area is moving to lower returns, which still can be good for smaller independent teams that can grow or bootstrap. They'll make a similar return to founders, since VC's cash was needed to fund large teams or infrastructure
The area is moving to lower returns, which still can be good for smaller independent teams that can grow or bootstrap. They'll make a similar return to founders, since VC's cash was needed to fund large teams or infrastructure
Seems like this trend is only starting to begin...
https://earnestcapital.com/investment-memo-fund-2/
https://earnestcapital.com/investment-memo-fund-2/
Yep, that is what everyone thinks at the top. The smart money is in cash and will buy out the "long-term/trend to infinity" crowd at the bottom.
Very interesting article on earnest and very well done. The author seems to argue that there is a bond like investment instrument that SaaS are starting to become. The S curve the author talks about is a continuum in my limited observation. There are companies at EVERY ONE OF THOSE points i.e. in the past as well as in the future there are commodity companies. It is not clear to me why he target SaaS to be that.
What does "up until the economy is up to the right" mean? up to the right sounds like a good growth path to me.
I believe GP means that as long as everyone has more money than they know what to do with, SaaS companies will more reliably find business (partly because other new companies, SaaS or not, are popping up and using them). However, if the economy took a downturn, these same SaaS companies would be some of the first to bite the dust. Many modern consumer companies are able to hedge against this through the fact that they are more or less "free" and people will not outright drop them, e.g. Google, Gmail, Instagram, Facebook, Fortnite BR - they are more likely to weather a downturn. Of course, these things are not true for all consumer companies nor all SaaS companies, but you can see the rationale.
This is exactly it.
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I think we'll need more examples then just Buffer. Everyone knows Buffer is a successfully bootstrapped company that grew kind of big but not massive.
If the author gave five other examples, then there's a case, but pointing out the one known example doesn't provide enough evidence in my opinion.
A separate point on style and punctuation: too many em dashes in the wrong places.
> What would make Buffer — a good investment?
No need for an em dash here.
> And, if you want to start a get-rich-slow SaaS fund — what is your target maturity?
Same.
> What if, at end of the holding period — investor sells the Buffer stake at market valuation?
Replace em dash with "the".
> But wait… that perpetuity — is a “paper valuation”.
Remove. The ellipsis could be an exclamation point, though it could be in the "personal style" bucket.
I would suggest removing every single em dash and practicing writing without them. They can be useful—for providing inline examples or explanation, for example—but should be used sparingly. Commas, colons, parentheticals, and semicolons can cover most of your use-cases.
If the author gave five other examples, then there's a case, but pointing out the one known example doesn't provide enough evidence in my opinion.
A separate point on style and punctuation: too many em dashes in the wrong places.
> What would make Buffer — a good investment?
No need for an em dash here.
> And, if you want to start a get-rich-slow SaaS fund — what is your target maturity?
Same.
> What if, at end of the holding period — investor sells the Buffer stake at market valuation?
Replace em dash with "the".
> But wait… that perpetuity — is a “paper valuation”.
Remove. The ellipsis could be an exclamation point, though it could be in the "personal style" bucket.
I would suggest removing every single em dash and practicing writing without them. They can be useful—for providing inline examples or explanation, for example—but should be used sparingly. Commas, colons, parentheticals, and semicolons can cover most of your use-cases.
I think the author uses these to imply a dramatic pause... like I sometimes do with ellipses. :-)
Yes. It's an example of trying to write how you'd want it spoken.
The written word is a different medium.
It would be like writing:
> She enters the room. Pan left and there's a photo on the wall. Cut back to her, she's brushing a strand of hair from her face. Now cut to the bartender. Zoom in on him. He's polishing a glass, staring at nothing.
etc.
It's a pastiche of a movie scene.
It's not that you can't do it or that the reader won't know what you're trying to do. Unless there's a specific reason to do so, it's probably not the best option.
The written word is a different medium.
It would be like writing:
> She enters the room. Pan left and there's a photo on the wall. Cut back to her, she's brushing a strand of hair from her face. Now cut to the bartender. Zoom in on him. He's polishing a glass, staring at nothing.
etc.
It's a pastiche of a movie scene.
It's not that you can't do it or that the reader won't know what you're trying to do. Unless there's a specific reason to do so, it's probably not the best option.
Dramatic pauses don't work when the reader can clearly see what comes next.
Who says SaaS needs to be a startup? In the stockmarket we can find similar trends, with existing companies that switched to a SaaS model.
- Adobe (dominates DTP, can squeeze companies worldwide, small and large after switching to a subscription model)
- SAP (investors were overall pleased with their SaaS offerings)
- Microsoft (don't know the revenue stake Office 365 represents, but it's currently enough to subdue Slacks Post-IPO performance)
- Slack
But also mid- to small-cap companies like RIB Software, which offers SaaS for real-estate related industries.
Of course, thouse examples don't mean that their balance sheets provide evidence – but rather that stock market participants see SaaS-models as a path for constant high-margin low-volatilty growth.
- Adobe (dominates DTP, can squeeze companies worldwide, small and large after switching to a subscription model)
- SAP (investors were overall pleased with their SaaS offerings)
- Microsoft (don't know the revenue stake Office 365 represents, but it's currently enough to subdue Slacks Post-IPO performance)
- Slack
But also mid- to small-cap companies like RIB Software, which offers SaaS for real-estate related industries.
Of course, thouse examples don't mean that their balance sheets provide evidence – but rather that stock market participants see SaaS-models as a path for constant high-margin low-volatilty growth.
The only other big example I know of is Basecamp.
I see more and more investors looking to do this especially as a solo-founder of a bootstrapped small SaaS business. As I march towards $1M ARR, the savvy investors are looking for ways to be valuable to my business as opposed to me begging investors for the next round of funding in traditional VC-backed ventures.
I would be very happy to share 15-20% if the value-add is strong enough.
I would be very happy to share 15-20% if the value-add is strong enough.
What does that value add look like to you?
I own a few SaaS sites that I bought (because I don’t have the patience and focus to build one myself) that I then work to increase the value of (based on lessons from a previous SaaS company I worked at), and I’m always interested in private equity arrangements.
I own a few SaaS sites that I bought (because I don’t have the patience and focus to build one myself) that I then work to increase the value of (based on lessons from a previous SaaS company I worked at), and I’m always interested in private equity arrangements.
What are some of the strategies that you use to increase value post-acquisition?
Do you mostly try to twist the dials a bit to boost net margins, e.g. increasing automation for a product that is "already written" and can go on maintenance mode, or is it something more nuanced? I'm super interested in this topic as I've been building out 2 pretty neat SaaS products (basically web APIs that solve concrete problems for developers, similar to a Stripe or Twilio model, but for an industry that is not quite as open as telecommunications/payments) and I'd love to hear how investors look at this segment. Thanks in advance!
Do you mostly try to twist the dials a bit to boost net margins, e.g. increasing automation for a product that is "already written" and can go on maintenance mode, or is it something more nuanced? I'm super interested in this topic as I've been building out 2 pretty neat SaaS products (basically web APIs that solve concrete problems for developers, similar to a Stripe or Twilio model, but for an industry that is not quite as open as telecommunications/payments) and I'd love to hear how investors look at this segment. Thanks in advance!
I have a strong disdain for vulture private equity models, such as going into maintenance mode and ratcheting up the pricing. I have folks I’ve run across in my career for SEO, UX, frontend, and work with them to explore methodologies to improve the product so customers extract as much value as possible, while setting pricing to be fair for value delivered. Their success is our success.
For this particular business, it's about unlocking certain levers for future growth. My SaaS has 300k+ users, mostly automated, and grows itself, but the product is positioned in a spot that draws quality issues that prohibits more premium users. The next level would be about attracting premium users.
Even that is achievable on my own if I put some effort into it, but I've been busy with another startup recently that's doing 20x my solo project. Also bootstrapped, but not entirely owned by me.
Even that is achievable on my own if I put some effort into it, but I've been busy with another startup recently that's doing 20x my solo project. Also bootstrapped, but not entirely owned by me.
How do you go about buying one. How do you get the leads?
Check out FE International: https://feinternational.com/
"Indiehackers" - community of bootstrap founders, you can find them online... Direct access to business owners. Good place to start!
Look at the return vs return std dev graph. The fact that fund of fund beats VC on both metrics suggest VCs add negative value
Investment opportunities that provide 15% return exist in the public markets with easy liquidity options, so what is the benefit of trying to squeeze that out of a private company where you can’t sell unless the company goes public or you try to find a buyer on the secondary market? Unless the company pays out a dividend I don’t see the appeal - usually VCs trade liquidity for the hope of massive returns that aren’t typically found in public markets.
What public investment continuously returns 15% yearly?
Almost any tech heavy ETF such as XLK or VGT will get you there. 10 year yearly returns are over 15%. For less risk, you could do a total stock market index like VTSAX (10 year returns around 13%.) Nothing is guaranteed or "continuous" though. This is less risky than investing in a single, private company that probably has little liquidity.
Looking at 10 year returns isn't good enough because we have been in a bull market for over ten years. You need to increase the horizon to get more accurate returns
Why would a private SaaS that sells to companies do better than the public markets in bear market? If anything if the market suddenly turns then holding a stake in a company that is illiquid is worse because you can’t sell if you need to.
Being (1) private, and (2) moderately-sized, allows you to adapt more quickly - same reason why buyouts of public companies usually end with delisting.
Useful thing in a downturn!
This is going to be one hell of a bear market. Can't wait.
> VTSAX
the past 10 years, yeah. but the prior 10 years were much worse.
the past 10 years, yeah. but the prior 10 years were much worse.
True. But do you think they were better for private tech companies? Maybe if you lucked out with the next Google. More than likely, you got a dot-bomb that lost 90% of its valuation and was sold for pennies on the dollar...
Private tech companies growing at 15% were not the "dot-bombs".
But many, many others were, or did "okay" but got nowhere near 15% growth. What makes you think you invested in one of the better ones?
Were you around during that time? Everyone thought they were going to have the next Amazon. Most folks wound up with Pets.com.
Were you around during that time? Everyone thought they were going to have the next Amazon. Most folks wound up with Pets.com.
I was around, just barely — had my first startup job in early 2000.
There certainly were a lot of bad companies without meaningful revenue seeking and getting investments, just like today.
But if you'd invested only in profitable small software companies doing 15% growth back in 2000, I think you'd have done well.
There certainly were a lot of bad companies without meaningful revenue seeking and getting investments, just like today.
But if you'd invested only in profitable small software companies doing 15% growth back in 2000, I think you'd have done well.
Usually, if we're referring to SV VC, but there are others. Bain is notorious for squeezing dividends out of investments and they're categorized as Venture Capital.
Traditional private equity, ala Berkshire Hathaway, is still pretty prevalent. There are plenty of self-described VCs who aren't necessarily looking for a 10-100x return amongst 100 small investments, but 2-5x returns across dozens of investments.
The vast majority of companies will never have a significant exit event triggering liquidity (IPO, M&A). Does that mean they're not worth investing in?
At least with private equity, you hopefully have some ability to influence those steering the ship, and get to avoid all of the regulatory hurdles. Opaque quarterly reports and short-sellers aren't exactly encouraging.
Traditional private equity, ala Berkshire Hathaway, is still pretty prevalent. There are plenty of self-described VCs who aren't necessarily looking for a 10-100x return amongst 100 small investments, but 2-5x returns across dozens of investments.
The vast majority of companies will never have a significant exit event triggering liquidity (IPO, M&A). Does that mean they're not worth investing in?
At least with private equity, you hopefully have some ability to influence those steering the ship, and get to avoid all of the regulatory hurdles. Opaque quarterly reports and short-sellers aren't exactly encouraging.
Being a tiny seed fund means you are likely a minority stakeholder in most of the businesses you invest in. To compare what these people are doing with a small amount of capital e.g. $50k to $100k check to Blackstone is a wild stretch.
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30% profit margin? I though most tech companies had a lot of trouble breaking even.
Remember: Hacker News is not a financial service, and people upvoting articles about financial behaviour is not the same as financial advice. If it sounds too good to be true, it probably is, and was probably written by someone who mistook the luck of doing the right thing at the right time for a transferable skill.
boasting about a 15% annual return with an illiquid stake in a early to mid stage private tech company is the opposite of “too good to be true”
I'm a little slow this morning but am having trouble parsing what the opposite of "too good to be true" is. Too bad to be false?
meaning it's plainly bad
the risk you take to earn 15% is way too high to justify such a small return. if you want to earn 15% just invest in some REITs and call it a day
the risk you take to earn 15% is way too high to justify such a small return. if you want to earn 15% just invest in some REITs and call it a day
Could you please expand "REITs"? (no clue what a REIT is)
REITs are "real estate investment trusts." Basically they are stocks in companies that own tons of property, bring in large amounts of rental income, and have to pay out a percentage as dividends. Many people like them for that guaranteed dividend.
Creating a 20-years projection based only on data after the crisis of 2008/2009 might not be wise.
And pitching small stocks (which appear to be unlisted) that return 15% yoy - sounds rather shady.
Predicting that a company will grow at 10% a year forever (never flat, never down) when their growth has been steadily falling their entire history is particularly presumptuous.
Yes, big question if Buffer represents average return profile for "late-stage SaaS"... time will tell!
Tiny capital is relative.
EDIT: It's also the name of the VC firm. D'oh! Keeping the rest for posterity.
Notice how there’s no actual values for what “tiny” means?
If you have cash to invest on a VC company, you’re most likely already quite well off, with an equal amount invested in less risky ventures.
EDIT: It's also the name of the VC firm. D'oh! Keeping the rest for posterity.
Notice how there’s no actual values for what “tiny” means?
If you have cash to invest on a VC company, you’re most likely already quite well off, with an equal amount invested in less risky ventures.
That means they abandoned 1/3 portfolio strategy they used to have (1/3 loses money, 1/3 returns exactly 1, 1/3 returns fund) but instead are focusing on steady returns by SAAS companies at 2-3x of the investment.
There are a few major implications:
- for the founders; if you don't fit their narrative, for example you have big chunk of revenue coming from services or you have only few enterprise clients, then you are out of luck
- for the funds; the deals are overly competitive driving up the price and diminishing the returns
- for the market; up until the economy is up to the right, things will be fine. Once things start changing, the first things to go will be a lot of these "nice to have" SAAS companies. In turn they will take down growth equity and freeze funding at the later stage (Series B, C, D, ...).
The last point applies to also to the the article. You can build bootstrapped $1M ARR business, but can you defend it? I think that's the biggest question.