Tag: saas
A few weeks ago I was in Atlanta for Techstars Atlanta Demo Day and the Venture Atlanta Conference. I had a great time and it’s fun to see the vibrancy of the Atlanta startup community. My brother Daniel came with me and we had dinner with our cousin Kenny, who lives in Atlanta, so we got some nice, quiet, emotionally intimate family time.
My favorite keynote at Venture Atlanta was from Scott Dorsey. While our paths have intersected for more than a decade and I knew him from a distance, I’ve gotten to know Scott pretty well over the past year. I put him in the awesome category.
If you don’t know Scott, he was the co-founder and CEO of ExactTarget (2000) – one of the original SaaS companies. ExactTarget went public in 2012 and was acquired by Salesforce.com in 2013 for $2.5 billion and became the core of the current Salesforce Marketing Cloud. He was on the Salesforce.com leadership team until he left to start High Alpha in 2015.
If you are doing something SaaS related and you don’t know or follow what Scott says, you should.
At Venture Atlanta, part of his keynote was a riff on the Attributes of Great SaaS Leaders. While the web is peppered with SaaS metrics and the state of SaaS, there’s a dearth of CEO-centric qualitative information. While Scott’s attributes could be for any leader, they are particularly relevant to SaaS CEOs given the dynamic of how high-growth SaaS companies – and great leadership teams – need to work to scale.
His five attributes, which he went deeper on individually in the keynote, reflect his personality and leadership style.
1. Start with the end in mind
2. Are always learning
3. Value team and culture above everything
4. Are both optimistic and never satisfied
5. Give back!
For those of you that are Simon Sinek fans, starting with the end in mind is analogous to starting with your Why. Are always learning is the essence of being a leader in a super high growth rapidly changing world which most SaaS companies operate in. Valuing team and culture above everything is easy to say, but extremely hard to do, especially when your VCs are pressuring you to perform at a certain financial level for rational, or irrational, reasons. Are both optimistic and never satisfied is interestingly similar to Andy Grove’s “only the paranoid survive” while at the same time having a completely different tone.
If you know me, it won’t surprise you that I almost jumped out of my seat at the event and did a happy dance when Scott started talking about Give back! I know I need to train him to say “Give First”, but it’s the same concept. Scott was a leader here, with the creation of the ExactTarget Foundation (now Nextech) in 2011. Nextech works to elevate technical, critical-thinking and problem-solving skills of K-12 students, inspiring and enabling young people from all backgrounds to pursue careers in technology, so he’s been ahead of the curve on the importance of computer science and technical skills in K-12, something which is a big part of addressing many of the social and educational gaps in our country.
Indianapolis’ startup community, like Atlanta’s, is thriving. There’s no question in my mind that Scott’s leadership has contributed to this in a meaningful way.
All of this comes back to the idea that as a leader you should play a very long game. Scott does this brilliantly and it’s been hugely educational and inspiring to me to get to know him.
There’s a long-standing cliche concerning SaaS companies that once you get to $10m in ARR you are unkillable. As Jason Lemkin says in his post from early 2013:
Inevitability in SaaS comes around $10m in ARR, plus or minus. Once you hit this point, you have a brand, you have a fully baked team, you have a robust product, and you have a self-generating stream of new leads and new business. Will you get from $10m ARR to $100M ARR? I don’t know. Is an IPO in your future? Not sure. But once you hit $10m in ARR or so, you cannot be killed by anything. That’s the power of compounding SaaS revenue. And actually, as we’ll get to, $10m in ARR — this is when it really gets fun.
I’ve struggled with this concept and how to translate it into action in my world. While the phrase “you cannot be killed by anything” is evocative, your actual value can be killed, as there are many problems getting from this stage (whatever we are going to call it) to the next level.
I don’t like to think in ARR when I’m working with SaaS companies. I’ve always found MRR easier to process, especially when thinking about derivative measures, like growth rate and churn, that are so important to pay attention to on a monthly basis. And, instead of ARR thresholds ($10m ARR, $25m ARR, $50m ARR, $100m ARR), I like to use MRR thresholds, which I talked about extensively in a post from 2015 titled The Illusion of Product/Market Fit for SaaS Companies. The MRR thresholds I focus on are $1, $10k, $100k, $500k, and $1m. And $1m MRR is the particular moment that is analogous to the $10m ARR inevitability.
If you can blast through the $500k MRR mark and march to $1m MRR, you’ve found product/market fit. You are now at the magical point some people call “Initial Scale.” Cool – you’ve got a business.
If you believe the cliche, you are now unkillable. I’d suggest that instead, you are now in an entirely different zone as a company, where you will be evaluated on a different set of characteristics and will face different struggles. If you want a hint, read Fred Wilson’s recent post titled Team and Strategy.
If you are a CEO, the real work of scaling a company begins about now. The question you’ll be facing will have a lot less to do with product (and the product strategy), and a lot more to do with – well – strategy!
You can start exploring questions like: Are you the market leader? Who are your competitors? What are you doing to build a moat around your business? If this sounds like Competitive Strategy, instead of Strategy, it is, but it’s a critical starting point. If you don’t want to read Porter’s classic book (or read it again if you read it a long time ago), try a Wikipedia shortcut on Competitive Advantage.
You can shift to more specific questions around a category like sales such as: Are you making progress on lowering churn? Have you moved from monthly to annual deals? Are you trying to get three-year deals done? What is the composition and health of your channel?
These are all things that you likely ignored, or didn’t even think of when you were in the $100k to $500k MRR zone. Well – maybe you thought about churn, especially if it spiked up to a point as to undermine your growth rate and cause another cliche – the leaky bucket – to appear in all of your board discussions. But did you shift from monthly to annual deals so that you could lower your long-term capital needs significantly? If you did – great job!
We have many companies in our portfolio in the $1m MRR to $2m MRR zone. It’s fun, but challenging in a different way than the up to $1m MRR zone is. And, once you blast through $2m MRR, all the things you focus on as a CEO change again.
As we get to the end of 2016, I’m in many conversations about 2016 performance and 2017 budgets. While 2016 isn’t over yet, most SaaS companies know how things are going to end up within a few percentage points. As a result, their focus on 2017 is an extrapolation from how they have been doing in 2016, typically building on month over month activity.
Since there are plenty of variables, the conversations are generally quantitative. In the midst of one last week, I said “why aren’t we talking about increasing conversions and lowering churn?” This was in response to a CFO who had modeled conversion rate and churn at a fixed percentage each month throughout the year.
The CEO responded by defending the CFO, who he’d worked with on the model. The CEO said “we are going to model conservatively, but we think we have lots of room for upside.”
I’ve been in this particular type of conversation 5,371 times over the past 20 years. I’m still nice, but I’m no longer patient with it.
I said, “If we don’t have a plan for increasing conversions and lowering churn, by June when we are on or slightly off plan, we’ll be happy, will have forgotten this conversation, and will not be doing anything to execute on the upside. Let’s stop the budget discussion ten minutes before the end of our scheduled time and talk about ways we can increase conversions and decrease churn.”
If you are wondering why I’m repeating the phrase “increase conversions and decrease churn” I point you at the John Lilly New York Times Corner Office article On The Role of Simplicity and Messaging.
We talked for more than ten minutes on the topic of increasing conversions and decreasing churn. We spent most of it on increasing conversions and tabled a discussion on decreasing churn for the next budget call (which was to finalize the budget). In either case, the modeling for the year was to include both an increase in conversion month over month (modest) and a decrease in churn month over month (also modest). There was acknowledgement that if we didn’t have a change in the number, no one would focus on it.
We came up with a very simple operant conditioning loop framework. We used a binary measurement for each new user – they are either healthy or unhealthy.
On day one, every user is healthy since they just signed up.
On day two, there is a specific attribute measured for each member of the cohort. In this company’s case, let’s call it “create a record in the system.” Any user that creates a record is heathy and goes to day 3. Any user that doesn’t is unhealthy and gets an operant conditioning action, which in this case is an email with instructions on how to create a record. The user stays at the day two level, but they are now in category b. On day three, if they still haven’t created a record, they get a phone call from customer care asking if they’d like some help creating a record.
I’m keeping the examples “create a record” super simple so you can follow along. But until a user creates a record, they stay at day two. We have a category c option, category d option, and category e option. If by category e they still haven’t created a record, they drop out of the funnel.
On day three, another attribute is measured. If a user has achieved the attribute, they go to day four. If they don’t, they get the operant conditioning action, stay at day three, and are now in category b. The loop continues.
The free trial period for this company is 14 days long. There are several operant conditioning actions that can extend it by a week or two weeks. For example, if someone is on their 13th day of the trial but is only on the 7th day of the process, they automatically get another week on the trial.
Recognize that these are not drip campaigns or email triggers. Instead, it’s a very deliberate operant conditioning process. And, as part of any system that involves operant conditioning, there are a significant set of measures by cohort and across the system so the operant condition elements can be A/B tested and modified as we get more data.
Now, this might seem complicated on the surface, but it turns out to be more complicated to explain than it is to work out on a whiteboard. Putting the system in place varies based on the underlying tech you are using, but it’s not that difficult if you approach it with a clear framework.
The goal is deep and immediate engagement by new users. So many companies talk about increasing the number of prospects at the top of the funnel, but they spend remarkably little time making sure actions are taking – on a daily basis – to make sure these prospects convert into paid users.
We have many rapidly growing SaaS companies in our portfolio. Over the past decade, I’ve observed too many companies see their growth rates decelerate, or even stall, because they didn’t focus enough on increasing conversion and decreasing churn, which henceforth I will refer to as ICDC.
2017 is the year for ICDC in my world.
Congrats to my friends at Rally Software on the announcement that they’ve signed a definitive agreement to be acquired by CA Technologies for $480 million.
Part of the fun of having a blog for a long time is that it captures some of the history – in the moment – of what’s going on. For example, from a post in 2008 about Rally’s $16.85m financing, I riffed on the origins of the company.
Rally started out life as F4 Technologies. I remember my friend Ryan Martens sitting down with me and Chris Wand around 2001 and walking us through his idea for changing the how he approached managing the software development process. I can’t remember if Ryan used the word Agile at that time, but I remember scribbles on a white board that listed out all the different software that Ryan had used at BEA to manage his dev team and how maddening it was to try to integrate information in Word, Excel, Project, a dev workbench, a set of testing tools, and the support / QA system. Ryan had a vision for an integration web-based system to layer on top of all of this to help support and manage the software development process.
We weren’t the first investor in Rally. Ryan quickly raised about $400k of friends and family money. We offered Ryan space to work out of our office which he did for a year or so as he got things up and running. About a year after he got started, he was ready to raise a venture financing. At the same time, his partner at his previous company – Tim Miller – was doing an entrepreneur-in-residence at a local Boulder VC firm (Boulder Ventures). Ryan was encouraged to team up with Tim and shortly after that happened we co-led the first round VC financing with Boulder Ventures.
It has been a rocket ship from there. Tim, Ryan, and team have created a phenomenal company that is built on two trends that have picked up massive speed in the past few years: (1) Agile and (2) SaaS. In 2003 – while Agile was known – it was largely limited to ISVs and a few leading IT organizations. SaaS was beginning to be talked about as Salesforce.com’s success (and leverage from the SaaS model) became apparent.
Or if you want to go back to 2004 and 2005 when I was really learning about Agile, well before it had become a household name, you could read my posts Agile Software Development with SCRUM or Do You Develop Software For A Living? – Get Agile with Rally Release 5.
Or maybe dip into the 2006 and 2007 time frame when Rally was in an award cycle with my posts Rally’s New Financing and the E&Y Entrepreneur of the Year Award and Boulder 2007 Esprit Entrepreneur Awards.
Over the fast dozen years, Rally has gone from a raw startup to a 500 person public company. Tim Miller (CEO) and Ryan Martens (CTO, founder) have been working together from the start of the journey. Jim Lejeal, the CFO, was an original angel investor, then board member, and then CFO joining full time when the company was around 200 people.
It makes me so happy to reflect on my relationship with each of Tim, Ryan, and Jim. I first met Tim when he had just started Avitek (his previous company) working in the same office space as Andrew Currie, who had just started Email Publishing (my first angel investment in Boulder.) I met Ryan via Young Entrepreneurs Organization – we were both in the same YEO forum. And I was the seed investor, via Mobius, in Jim’s second company (Raindance, which he co-founded with Paul Berberian – CEO of Orbotix and Todd Vernon – CEO of VictorOps.) But more importantly, I’m close friends with each of them, even though my direct involvement in Rally ended about two years ago when the company went public.
There are hundreds of paragraphs I could write about all of the amazing things Rally Software has done for the Boulder Startup Community and for the extended city of Boulder. But I’ll end with one of them – the creation of the Entrepreneurs Foundation of Colorado (now Pledge 1%). The story starts in 2007 with the founding of EFCO, which Ryan and I spearheaded and had a huge punch line in 2013 when Rally Made a Gift of $1.3 Million To The Boulder Community after their IPO. Ryan continues to head up EFCO and is co-founder of Pledge 1%, which is the effort to take EFCO international.
To the extended Rally Software family past and present – congratulations. You’ve built something very special that is part of the long arc story of Boulder. And – to Tim and Ryan – thank you for letting me participate in your journey.
There are lots of blogs and anecdotes on (a) how to build a successful SaaS company and (b) what a successful SaaS company looks like. Yesterday’s post by Neeraj Agrawal from Battery Ventures titled The SaaS Adventure is another great one as he describes his (and presumably Battery’s) T2D3 approach.
If you want to follow these posts more closely on a daily basis, I encourage you to subscribe to the Mattermark Daily newsletter. Or take a look at the VCs I follow in my Feedly VC channel.
I was at a board meeting recently and heard something I’ve not heard before from a late stage investor. He described what his firm called the 40% rule for a healthy software company, including business SaaS companies. These are for SaaS companies at scale – assume at least $50 million in revenue – but my Illusion of Product/Market Fit for SaaS Companies correlates nicely with it once you hit about $1m of MRR.
The 40% rule is that your growth rate + your profit should add up to 40%. So, if you are growing at 20%, you should be generating a profit of 20%. If you are growing at 40%, you should be generating a 0% profit. If you are growing at 50%, you can lose 10%. If you are doing better than the 40% rule, that’s awesome.
Now, growth rate is easy in a SaaS-based business. Just do year-over-year growth rate of monthly MRR. You can do total revenue, but make sure you do MRR also to make sure you don’t have weird things going on in your GAAP accounting, especially if you have one time services revenue in the mix. It’s always worth backtesting this with YoY growth of gross margin just to make sure your COGS are scaling appropriately with your revenue growth, regardless of whether you are on AWS, another cloud provider, or running bare metal in data centers.
Profit is harder to define. Are we talking about EBITDA, Operating Income, Net Income, Free Cash Flow, Cash Flow or something else. I prefer to use EBITDA here as the baseline and then back test with the other percentages. If you are running on AWS or the cloud, this should be pretty simple and consistent. However, if you are running your own infrastructure, your EBITDA, Operating Income and Free Cash Flow will diverge from your Net Income and Cash Flow because of equipment purchases, debt to finance them, or lease expense. So you have to be precise here with which number you are using and “it’ll depend” based on how your SaaS infrastructure works.
While the punch line is that you can lose money if you are growing faster, the minimum point of happiness is 40% annual growth rate. Now, some people will focus on MRR growth rate, others ARR growth rate, and yet others on weird permutations of year of year growth rate by month. Others will focus on the same strange permutations for GAAP revenue to justify growth rate. Regardless, you need a baseline, and I’ve always found simply doing year-over-year MRR growth rate to be the easiest / cleanest, but I always make sure I know what is going on underneath this number by using the other calculations.
I often hear – from sub-scale SaaS companies, “we can get profitable right away if we slow down our growth rate.” And – that’s often a true statement, but you will end up being sub-scale for a much longer time when you end up with a 20% growth rate and a 20% profit. So – if you are going to raise VC money, get focused on the T2D3 approach to get to scale, then start focusing on the 40% rule.
“We have product/market fit.”
“We are searching for product/market fit.”
“We are raising this financing to find product/market fit.”
“Our customer traction demonstrates product/market fit.”
Product/market fit. It’s a wonderful phrase, thanks to Marc Andreessen, Sean Ellis, Steve Blank, and Eric Ries. But it also one of the most overused, and inappropriately used, phrases that I hear with SaaS companies on a daily basis.
I was in a meeting a month ago with a company I’m on the board of where product/market fit was asserted. I sat quietly for a moment and then stated as clearly as I could that the company didn’t have product/market fit, they had the illusion of product/market fit. A long conversation ensued which resulted in me pondering this illusion and trying to put some parameters around it.
But first, some history.
There’s a fun post from Ben Horowitz in 2010 titled The Revenge of the Fat Guy that weaves in comments from Fred Wilson about product/market fit where Fred argues in his post Being Fat Is Not Healthy. While ostensibly it’s a post about lean vs. fat startups, it really is about discovering product/market fit and it gives a good history lesson on the thinking circa 2010 on this issue. Ben eventually states, and then explains, four product/market fit myths.
- Myth #1: Product market fit is always a discrete, big bang event
- Myth #2: It’s patently obvious when you have product market fit
- Myth #3: Once you achieve product market fit, you can’t lose it.
- Myth #4: Once you have product-market fit, you don’t have to sweat the competition.
As I rolled this around in my head, I started to realize that part of the illusion of product/market fit is that there’s a belief that once you have it, you never lose it (myth #3). There’s also the belief that there’s a magic moment where you have it and declare it (myth #1). Worse, there’s the belief that it’s obvious when you have it (myth #2). And tragically, a lot of companies believe when they have it, they don’t have to worry about anyone else because they’ve won (myth #4).
I’ve experienced the downside of each of these myths many times. I’ve seen companies have to rediscover product/market fit after getting to a $500k MRR (monthly recurring revenue). I’ve been involved in companies that thought they owned the market at a $2m MRR only to have a new competitor come out of no where and beat the crap out of them. I watched companies at a $4m MRR enter new markets and struggle mightily to discover product/market fit for these new markets. Or worse, I’ve seen a new product release that was late completely toast product/market fit and force a company to hang on to customers any way possible while rushing to fix what was broken.
The illusion of product/market fit pops up at multiple points in time. So I started thinking about heuristics for these points in time and came up with MRR as a parameter to explore. Suddenly, the illusion problem came into focus for me based on MRR, with clear transitions happening up to a $1m MRR. While I’m going to keep exploring this, I have a hypothesis now about the dynamics around product/market fit in SaaS companies that I’m playing around with. Feel free to tear it apart.
When you have $0 of MRR, you have no product/market fit. Ok – that was easy. You are working on a product and searching for your first customer.
From $1 to $10k MRR, you have the illusion of product/market fit. You finally found someone to pay you for your shitty MVP, but you’ve got a long way to go before you truly have product/market fit. Do not pour on the gas at this point. Stay calm and keep doing what you are doing.
$10k to $100k MRR is a super exciting time. You’ve got a semblance of product/market fit. You are starting to learn what your customers will pay you for. You feel like things are actually cranking. You probably have one or two salespeople and one of your founders – maybe your CEO – is still the head of sales. If you try to raise a Series A, the process is straightforward. It’s easy to believe you’ve got it figured it out here. This is the point at which myth’s #1 and #2 usually kick you in the ass. If you aren’t growing a compounded 10% each month, you don’t have product market/fit yet. If you are growing faster than that, you have found something.
Going from $100k to $500k MRR is a product/market fit sweet spot. You are starting to build a sales organization, have visibility in the market in your segment, and might even have customers coming to you on a regular basis. This is where myth #3 bops you on the head. You think you’ve got it and it’ll keep scaling, but you hire the wrong VP Sales, you focus on the wrong metrics, or you end up struggling to renew your customers when the first annual renewal cycle hits. You get confused about negative churn and conflate upsells with growth with churn. Lots of companies stall here – some due to self-inflicted pain; others due to the illusion of product/market fit.
If you can blast through the $500k MRR mark and march to $1m MRR, you’ve found product/market fit. You are now at the magical point some people call “Initial Scale.” Cool – you’ve got a business.
Now, your value is going to be determined by your growth rate. At any point in time, if you are growing > 100% year-over-year you will be highly valued – think at least 10x revenue, but I won’t tell you whether it’s trailing or forward, as that’ll shift around based on the public markets. And, the faster you are growing, the more discontinuous (e.g. higher multiple, but not linear) your valuation will be.
If your growth rate is between 50% and 100% and holding steady, that’s good and you’ll see a nice, big, healthy valuation. But if it’s declining, watch out for that magic 50% year-over-year mark. It’s like a trip wire that will send off all kinds of weird alarm bells. Once you decline below 20%, you better make sure your existing investors are going to be ready to step up to finance you, or else start the rapid march to profitability, which likely generates even slower growth.
Myth #3 and myth #4 show up all the time at MRR’s > $1m. You disrupted someone a few years ago which is what caused you to discover product/market fit. Don’t be confused about the world – someone else is gunning for you now that you are the big player in whatever segment you are in.
Every time you work on something new, whether it’s a new feature, a new product, or a new product line, recognize that you are searching for incremental product/market fit. The search is a continuous and never ending quest. Don’t confuse illusion with reality.