Tomasz Tunguz + Jason Lemkin Talk “State of SaaS in 2018”
A little while back at the 2018 SaaStr Annual, Tomasz Tunguz and our own Jason Lemkin kicked off Day 3 with a fun look at 5 of the Top Trends in SaaS”
Click on the video below to check it out — it’s great. A transcript is also below.
— Team SaaStr
Jason Lemkin: Anyone here read Tomasz’ blog posts? Has anyone ever read his stuff? Raise your hand if you’ve ever read anything he’s ever read. All right. Everyone’s up. Okay. Good. Well thanks for coming back. This is a pretty good crowd isn’t it?
Tomasz: Oh yeah, no. Thrilled to be here. Thanks for inviting me.
Jason Lemkin: I was worried day three, after the big party, that no one would come so I needed a ringer to help me kick it off. Before I asked Tomasz if he would come back, I thought there might be six of us but we’re all here. Thanks to everyone for the incredible energy over three days. I wanted to just do a few, couple announcements and then Tomasz and I will talk about just some high level stuff, things I’m interested in in the industry and then the session after this with Teresa Tucker, I think, I don’t mean to put any pressure on her if she’s listening but this is the one I’ve been looking forward to the whole event.
Jason Lemkin: Teresa’s story is amazing. I think she founded BlackLine something like in 2002. No one would give her any money. She had to do it all the hard way, in a tough space. Finally raised some money in like 2014 and IPO’d last year and has like a third of the Fortune 500 customers or maybe Fortune 100. I don’t know. All I know is I wanted her to speak two years ago and got her this year so I just met her this morning but my hero from a distance so stay for that one.
Then last, we’ve half launched this SaaStr Pro product, which is a learning system that trains your team on SaaStr content but if you want to go check it out so that it will automatically train your team, go to SaaStr Square Park, meet with Tyler and if you sign up, you can come to the SaaStr annual for free next year. It’s basically free. Go check that out.
Jason Lemkin: First, I wanted to have a little fun and talk about ICOs and how they impact SaaS and just SaaS. This is a chart you have from the blog on ICOs. Quick story. Tell us about this. Three weeks ago I’m in our little SaaStr CoSelling Space with 30 startups. Two founders come into the office, they’re like, “Oh, we just ICO’d.” I’m like, “Yeah. We just raised 10 million.”
Tomasz Tunguz: Awesome.
Jason Lemkin: I said, “How’d it go?” “Took a couple months. It was hard but in the end, it all came together in a couple days.” They’re like, “Now we’re going to write some code.” This is a great team. This is A+. This is a great set of engineers but I’m like, as a founder, that’s a gift isn’t it? You can get 10 million before you write a line of code. What’s going on? What can we learn and should all of us ICO in this room? Should you and I do a SaaStr-Tunguz ICO?
Tomasz Tunguz: What are you doing this afternoon?
Jason Lemkin: I’ve got time. I’ve got time.
Tomasz Tunguz: ICOs are a fundamental change in the way startups have been fundraising. It started effectively in 2017 at the beginning, there was more than $4 billion raised in capital in 2017, through ICOs and in December, ICOs raised almost as much capital as Series A startups did globally, which is a huge figure.
Jason Lemkin: Do the outliers swamp that a little bit?
Tomasz Tunguz: Yeah they do. If you look at the December figure here, half of that is one company that raised about 705 million. The median ICO raises about 15.
Jason Lemkin: 15.
Tomasz Tunguz: Which is more than the median Series A of 7 in the US. For a small number of companies, the end here is about 200. For a small number of companies, the ICO is actually a viable fundraising mechanism. One asterisk to that data point is that a third to 40% of these companies actually raise some form of institutional capital before they ICO, just to finance the writing of the white paper basically. This is an important trend. We had our annual meeting where we share the story of what’s going on in our ecosystem with our investors two days ago and one of the charts we showed them was, a lot of people think about ICOs in crypto as just being a consumer phenomenon around Bitcoin but if you break up the enterprise ecosystem into application platform and infrastructure, we’re seeing block chain and ICOs happen across that stack. We’ve seen email securities using block chain in order to decentralize the storage of safe or wide list their blacklist for safe and unsafe email addresses.
Tomasz Tunguz: We’re seeing a handful of companies trying to rip apart the core parts of the infrastructure as a service stack. We’re seeing companies that are building open source apps using the block chain and ticketing and a bunch of other categories. This is an important event we’re paying attention to and I think it’s going to impact startup land broadly, not just in consumer.
Jason Lemkin: Yeah. Yesterday we had a great founder, Brian Brackeen from Kairos in Miami. He’s doing a $50 million ICO for his facial recognition API company. Who here of the handful of folks in this room, we’re so busy as founders, who should invest time to think about an ICO?
Tomasz Tunguz: The great part about an ICO or I think, the fundamental advantage of an ICO is; if you’re looking to create a network effect or bootstrap it like a chicken and egg marketplace, the ICO is a really great way of doing it because what you’re doing is, you’re incentivizing the people who are participating in the network in some way.
Jason Lemkin: That’s some insight. Yeah.
Tomasz Tunguz: In the consumer landscape, you look at a Facebook or a Google, they win because of their centralization of talent, capital, servers, data and so, if you’re looking to compete against an incumbent who’s competing that centralized advantage, then the decentralization theme and the notion of incentivizing all the different constituencies on the network in order to make it successful, that’s the most powerful part of crypto.
Jason Lemkin: We could spend the whole time on this but just one last question on this. Let’s hit the next topic. What’s your gut? I know you love to speak with data.
Tomasz Tunguz: I do. I love it.
Jason Lemkin: I like to shoot from the hip with experience but how many, it doesn’t have to be SAAS but how many B2B startups you think can ICO in 2018?
Tomasz Tunguz: There were 220 that did in 2017.
Jason Lemkin: How many will you think will be not just some sort of maybe do something for some sort of token part of that? How many do you think that might be barely relevant to this audience? How many think can pull off an ICO in 2018?
Tomasz Tunguz: I think it would be a great year if we saw a hundred.
Jason Lemkin: A hundred’s a lot.
Tomasz Tunguz: A hundred is a lot.
Jason Lemkin: There’s a lot of great businesses here that are bootstrapped, doing millions, that can’t get traditional venture capital, should they try to ICO?
Tomasz Tunguz: I think if you need that capital to grow and you can take advantage of the decentralization as a competitive advantage, totally.
Jason Lemkin: The dilutions limited from the ICO.
Tomasz Tunguz: There’s no dilution.
Jason Lemkin: All right. One quick one. Talking to founders here, boy, private equity’s a change in SAAS right?
Tomasz Tunguz: Of course.
Jason Lemkin: This is the only one I didn’t find any of your charts and we’ve got a good one. I was meeting … when I sold Eco Sign in 2011, none of this stuff barely existed. There were only two options, one of five tech companies to buy you. There weren’t the G’s buying service mech’s that owned their own IPO, there were no options. I had like three different conversations in SaaStr Square Park of founders six, eight, 10 million where PE firms were offering to buy them for $50, $80, $100 million who were bootstrapped. I mean, that’s amazing change isn’t it?
Tomasz Tunguz: It is amazing.
Jason Lemkin: What’s going on here? Is this going to evaporate?
Tomasz Tunguz: No.
Jason Lemkin: Can folks here take advantage of it? How do you think about it?
Tomasz Tunguz: Yeah. I think SaaS companies are really great PE targets. One of the major trends in PE, private equity, is that the fundraising in PEs is at historical highs.
Jason Lemkin: Hold on, sorry. My mistake. Let’s step back for a minute. What’s the difference between PE and Venture, for this audience, for founders just to let you in?
Tomasz Tunguz: Yeah. The word PE is overloaded. There’s basically a continuum of private equity, the smallest of which is seed and angel. The largest of which is what’s called private equity. By and large, the difference between venture and private equity is that there’s no failure risk for the business. That would be my definition of it and the funds tend to be significantly larger so 500 million plus and then tend to make majority investments. They take control of the company and a lot of these private equity firms …
Tomasz Tunguz: You look at like a Vista, what they do is they actually inject operational teams into those businesses, take them, manage them, run them according for a particular playbook in order to achieve their particular profitability milestones and either sell their business to another PE firm or then take it public in order to generate somewhere between a 2x to 3x return.
Jason Lemkin: Let’s just step back because a couple founders I’ve met here said, “Should I sell 10 or 20% into a PE firm?” That’s the wrong question, right?
Tomasz Tunguz: That is the wrong question.
Jason Lemkin: We’re mixing up venture and PE.
Tomasz Tunguz: Right.
Jason Lemkin: Very few PE firms want to buy less than 51-100% of your company.
Tomasz Tunguz: Exactly.
Jason Lemkin: The flip side is a PE firm, I mean, Vista’s incredible for SAAS. How much did they raise? 8 billion, 6 billion? A lot of that is going to B2B isn’t it? Marketo, Cvent, it gets so much jive. They’re going to want to buy from 51-100% of your company.
Tomasz Tunguz: Absolutely.
Jason Lemkin: Sometimes they’ll want you to stay. Sometimes don’t even care if you stay a day. Sometimes they don’t even … you think you’re so important, sometimes they already have a team and they will write you, literally, cash on the table and leave. How many SaaS companies you think PE might buy over the next year or two, you have any sense?
Tomasz Tunguz: I think any SaaS company that’s under 10 billion in market cap is a clear PE takeout.
Jason Lemkin: How about startups between X million and ARR? 5-50, how many deals you think can be done?
Tomasz Tunguz: Loads. Maybe, I don’t know, hazard I guess, 100 to 200 next year.
Jason Lemkin: That’s a lot of options. There’s not going to be … Google and Adobe and Salesforce aren’t going to do that many acquisitions in that space are they?
Tomasz Tunguz: No but between 60-75% of tech acquisitions in the last year were non-tech buyers so that’s either the financial buyers or companies that are not technology companies so that’s where two thirds of the acquisition’s coming from. What we’re starting to see, friends of mine are starting PE funds to buy the $5-$50 million SaaS company that’s not growing really fast but spitting out a lot of cash. That’s a great PE business because you can run a discounted cashflow model on that business and figure out exactly what your return’s going to be.
Tomasz Tunguz: There’s a publicly traded Canadian company called Constellation that has been doing this for like 20-25 years and it’s an amazing business. I think you’re going to see more and more of this.
Jason Lemkin: I can tell that generally, if you get up to six or eight or 10 million in ARR, what do you think the odds are a PE firm’s going to knock on your door in 2018?
Tomasz Tunguz: That’s still on the smaller side.
Jason Lemkin: You think the odds are low that you’re going to get a call? I see folks getting, that have any brand out there, they’re swarmed with it like so Series B investors.
Tomasz Tunguz: Really? Okay.
Jason Lemkin: Yeah. I think the analysts and folks are pretty good.
Tomasz Tunguz: That’s good.
Jason Lemkin: Good to hear something different. PE I think, for founders having liquidity options is a gift isn’t it?
Tomasz Tunguz: Yeah. It’s a gift. Because the multiples that they’re paying, you look at the Cvent multiple or the Marketo multiple. Typically, you think of a PE as a buyer that buys at a much lower multiple, maybe half or two thirds of what the full multiple would be in the public markets but PE is buying them at six times forward, eight times forward and the median’s seven so they’re paying market price.
Jason Lemkin: It’s a good deal. It’s a good deal. Related to that, PE I believe, is a gift for founders. You don’t have to take it. You don’t have to sell but it’s another way to potentially de-risk your journey. Has M&A gotten any better? What does this chart mean? I think M&A is the weirdest thing. Everyone thinks that a million people are going to buy them and when I talk to CEOs, Tien from Zuora, it probably changed, but he did an interview a couple years ago when they were at 60 million and said, “I never got an offer.” This was someone that was the chief strategy officer of Sales Force.
Tomasz Tunguz: Amazing.
Jason Lemkin: I’m sure he’s gotten 10 since then but M&A is weird isn’t it?
Tomasz Tunguz: It is weird.
Jason Lemkin: It’s weird. It’s weird.
Tomasz Tunguz: 2017 saw a greater than 50% decline in global M&A volume.
Jason Lemkin: Decline?
Tomasz Tunguz: Yeah.
Jason Lemkin: The markets are crazy. What are the odds anyone here is going to get bought?
Tomasz Tunguz: I think they’re high.
Jason Lemkin: Oh, you think it’s high.
Tomasz Tunguz: I do. Yeah.
Jason Lemkin: I’m more bullish on PE, you’re more bullish on M&A.
Tomasz Tunguz: I’m more bullish on M&A.
Jason Lemkin: Yeah.
Tomasz Tunguz: Let me say this; 2017 was about a 50% reduction of global M&A volumes but the cash on balance sheets for the 15 largest tech acquires globally-
Jason Lemkin: Were huge.
Tomasz Tunguz: A trillion dollars.
Jason Lemkin: A trillion dollars in cash earning 0.1%.
Tomasz Tunguz: Right. Exactly.
Jason Lemkin: Unless you’re Air BnB and you’ve got a hedge fund. Everyone else is earning 0.1%.
Tomasz Tunguz: On the side. Then you’ve got re-patriation, which was clarified last year. If you talk to a bunch of the investment bankers, they’ll tell you that was really a big uncertainty. I think what’s going to happen and, I’ll make some prediction that’s bound to be wrong. I think you’re going to see a landscape change in M&A in 2018, Google buying Salesforce. Microsoft buying Workday.
Jason Lemkin: You think big deals like that will happen?
Tomasz Tunguz: I think big deals happen like that because all of a sudden, cost of capital is really cheap. I think you’re starting to see some decline in the core growth rates of some of the larger companies and they’re going to want to buy that growth and really own it and compete.
Jason Lemkin: I’d be shocked if Google bought Salesforce but it makes sense. What about for folks here, what if there’s a hundred vendors in your category and you’re at 6 million in ARR? What’s the M&A landscape for things like that?
Tomasz Tunguz: There’s going to be some consolidation but it’s all going to accrue to the top four or five.
Jason Lemkin: That’s what I wonder. I think a half generation ago, four or five years ago, if you got to 10 million ARR, you were a breakout player in your category.
Tomasz Tunguz: You were a stand out.
Jason Lemkin: Maybe you were number two, maybe you were number one, but if someone was interested in your space, at least you were going to get meetings with acquirers. I’m not sure that that’s true today that if you hit 10 million ARR, that Corp Dev and SVPs are going to come to you. Do you see it in your portfolio?
Tomasz Tunguz: I think you need to be substantially bigger.
Jason Lemkin: The bar goes up. Maybe the absolute number goes up but the bar goes up to do a deal.
Tomasz Tunguz: That’s being driven by the fact that you look at Zendesk or New Relic, those are three to five billion market caps. When they make an acquisition, they’re going to spend five to 10% of their market cap on that acquisition. It has to be revenue accretive so that they’re rewarded for it by the street.
Jason Lemkin: Zendesk wants to buy something, probably, mathematically, that’s 20, 30 million ARR more right?
Tomasz Tunguz: Yeah.
Jason Lemkin: If it could, to make impact.
Tomasz Tunguz: Yeah because then the growth rate of the company’s going to go up. The market capitalization of the company’s going to go up and then the equity value of the business will offset whatever dilution they took to buy that business. If you’re buying a company at 0 in ARR, you’re not going to get rewarded for it.
Jason Lemkin: That’s why my view, you’ve got the data, at a high level, there’s probably going to be a lot more M&A but I think for the average founder here that’s past a million or something in revenue but isn’t at 50, I think they’re going to feel like there’s less M&A because there’s not going to be as many tire kickers at four, five, 10. At my day as a startup ICO and once I got to four or five million in revenue and was decent at PR, everyone came by. Doesn’t mean I got a term sheet but everyone would start to come by off the Tech Crunch article and 10,000 customers but I don’t see that happening today.
Tomasz Tunguz: I agree with you.
Jason Lemkin: Right.
Tomasz Tunguz: Yeah. That makes sense.
Jason Lemkin: Okay. IPO. We did this four years ago. This is the fourth year. Aaron Levie came two weeks after the box IPO. Everyone thought SaaS was stupid.
Tomasz Tunguz: Boy were they wrong.
Jason Lemkin: We talked about in the kick off. Now all these companies that were borderline unicorns, are worth three billion right, the Hub Spot, the Zendesk, the Box, the billion club became three billion. For folks here, how should we think about IPO? Do we have a shot? Is it going to be easier? The press is so confusing. Bash on Snapchat. What’s Snapchat worth, still 28 billion?
Tomasz Tunguz: It just spiked like 300%.
Jason Lemkin: Yeah was that failed IPO? Not in my book.
Tomasz Tunguz: Yeah. They’re huge. I think that IPO is still … it’s a fundraising mechanism. You go public in order to raise capital and you do it because you can. You’ve got a hundred million in trailing and you’re growing at roughly 70%. That’s what every banker will tell you about what you need to achieve. It’s also a great milestone for the business just to kind of build a brand.
Tomasz Tunguz: I think it’s still a very viable thing for SaaS companies to do. The great part is, we have SaaS companies now that are 80 billion, that are 20 billion, that are 30 billion. We didn’t have that two or three years ago.
Jason Lemkin: We do have it.
Tomasz Tunguz: You have a really nice distribution in the value of these companies and so, I think it’s still a really important milestone in the life of these companies. It institutes a rigor that you don’t see in a private company.
Jason Lemkin: There’s so much press saying it’s so hard to IPO, people wait. Is it really harder in this market? I think it’s gotten easier. I think there’s more appetite, IPO is easier for B2B than it was a couple years ago.
Tomasz Tunguz: Yeah. The IPO market, the window is open.
Jason Lemkin: You get to 100 million in revenue, grow at a decent clip, market cap aside, you can IPO.
Tomasz Tunguz: You can IPO.
Jason Lemkin: When we were in 2016 after the flash crash, everyone was making fun of unicorns. There won’t be any SaaS unicorns. Everything felt inflated in 2015 didn’t it?
Tomasz Tunguz: It did.
Jason Lemkin: Now, like you said, we’re thinking about decacorns. We can see Zendesk at 10 billion market cap, HubSpot at a 10 billion. We could have seen Marketo if they hadn’t sold. Decacorns aren’t crazy in SaaS are they?
Tomasz Tunguz: No they’re not. We’re going to see more. We’re seeing companies that are worth $25-30 billion and I think the reality of software penetration is still very low.
Jason Lemkin: Still low. That’s what’s driving it isn’t it?
Tomasz Tunguz: It is.
Jason Lemkin: It’s still early for the cloud isn’t it?
Tomasz Tunguz: It’s very early for the cloud and you’re starting to see … the point that I made before that 60%-75% of acquisitions are being made by non-tech buyers, you have a whole swath of the US and international economy that haven’t deployed software at all.
Jason Lemkin: Whole swaths?
Tomasz Tunguz: Yeah.
Jason Lemkin: SMBs are just getting there too right?
Tomasz Tunguz: Yeah. If you think about the early majority and the late majority, we’re still … the way I think about it is, we might be a third of the way through the early majority, maybe halfway through the early majority. We’re not even into the late majority yet.
Jason Lemkin: We’re not. We’re not.
Tomasz Tunguz: No. There’s at least half the market or more, that’s still yet to adopt software as a service which means that, one of the questions that you asked on the other side was; what inning are we in in SaaS and I think we’re probably in three or four.
Jason Lemkin: Three or four. All right. I want to do more but as usual, old friends run over. Let’s give it up for Tomasz.
Tomasz Tunguz: Thank you so much. I really enjoyed it!