Trident Capital Blog

1Q12 was an In-Line Quarter for Trident Capital’s SaaS Portfolio

Before I comment on the 1Q12 performance of our SaaS portfolio I wanted to mention that this week Sand Hill will publish an updated and expanded blog I wrote on Insight as a Service.  Next week (5/15), in collaboration with Zuora, I will be delivering a webinar on SaaS metrics.  This is an interim report of my ongoing work to identify the characteristics breakout SaaS companies.  Please email me your recommendations on important metrics that can predict, or simply characterize, breakout SaaS companies.  Alternatively, you can post them on Twitter to @esimoudis #breakoutSaaSmetrics.

After a good finish to 4Q11, IT companies expected a relative modest performance during 1Q12.  I think that, by and large, they got it.  As a result, during 1Q12 public and private SaaS companies had a good quarter, in-line with their expectations.  The mid-upper enterprise segment that is being targeted by many of our SaaS portfolio companies continues to embrace cloud computing.  Companies in this segment are becoming more optimistic about the US economy’s prospects and continue to update and upgrade their front-office and back-office systems.  As a result, our SaaS portfolio companies did well during 1Q12 with 90% of them achieving their revenue, booking, and MRR (compared to 85% during 4Q11).

The public SaaS companies we monitor also demonstrated solid performance.  Companies such as Comscore, Realpage, Concur, Kenexa and Salesforce reported strong results, and some even beat the market’s expectations.  Next week Jive will report for the first time since going public.  This will be a good indication not only of the market’s increasing appetite for new SaaS issues, but also of the demand for social SaaS enterprise software.  Oracle’s acquisition of Taleo during the quarter was the only noteworthy transaction.  However, just based on the inbound inquiries our own SaaS portfolio companies are receiving from large IT vendors, we expect that the pace of consolidation in the SaaS sector to increase with large companies buying large and smaller SaaS vendors.

Positive conclusions from our SaaS portfolio’s performance:

1. Sales pipelines continue to grow nicely, particularly with prospects from the mid-upper enterprise segment our SaaS portfolio companies are targeting.  More importantly, the leads are coming from a variety of industries indicating the accelerating broad acceptance of SaaS applications, and cloud-computing in general.  The QoQ bookings and revenue growth for the SaaS companies continues to surpass that of the on-premise software portfolio companies. 
2. Better monthly sales performance than I had reported in past quarters.  More of our portfolio companies were able to make their monthly sales targets during 1Q12 than during 3Q11 and 4Q11.
3. Four of our larger SaaS companies are seeing accelerating demand for their applications from European and Asian customers.
4. The channel is finally starting to perform as System Integrators (SIs are now starting to regularly bring new opportunities.  Our portfolio ended the quarter with an average of 10% of sales coming from the channel.  We are guiding them to move this to 30% over the next 18 months as we see the opportunity not only existing but growing.
5. Business unit executives continue to drive the decision process even though, as I had reported in the past, the CIOs are regularly inserting themselves in the sales cycles, particularly in the mid-upper enterprise segment.
6. Renewal rates remained steady at 85-95%.  Upsell rates were at 30-45%.  Large enterprise clients that signed during 3Q11 and 4Q11 are quickly returning with upsell opportunities both for new functionality as well as for introducing SaaS applications to additional divisions within their corporations.  This was continued indication of the value and continuous ROI that customers are finding through the use of SaaS applications.
7. Our portfolio companies have continued to increase annual license pricing with no apparent drop in sales conversion, an indication that particularly the mid-upper enterprise companies being targeted find significant value in SaaS applications.  In most cases these companies are replacing on-premise applications with their SaaS equivalent.
8. Discounting has improved and during the quarter we saw 6-7% discount per year of subscription down from 8-9% in past quarters.  We also saw more customers signing multi-year contracts than ever before and paying at least the first year upfront.  We are targeting 4-5% per year as best in class discounting.
9. Analytics-driven applications, social applications, and mobile applications with vertical focus continue to be in high demand, same in last quarter.  However, since most of our
   SaaS companies address these 3 segments we should note that we would be worried if there was no strong demand for such applications.

The characteristics my partners and I didn’t like from the quarterly performance of our SaaS companies include:

1. Higher than expected churn by SMB clients (15-20% in some instances).  For us this is an indicating of the continued softness in the economy which particularly impacts the smaller companies. 
2. Margins didn’t improve in some of our companies in the way we anticipated, reflecting higher than expected customer onboarding costs, as well as higher than expected sales costs for upselling and renewals, despite the demand.
3. Similar to what I had reported for 4Q11 performance, hiring continues to be difficult because the SaaS companies have a high demand for the same type of people as Internet companies: engineers, sales people, product managers, services people, and data analysts. 

Last time I had indicated that I was expecting a more muted 2012 with flat IT-related budgets.  Surveys conducted by investment banks during last March and April, as well as checks performed by our own portfolio companies lead us to believe that IT budgets are actually increasing during 2012 by an additional 1%, putting them now at around 4-5% above the 2011 budgets.  The increases are allocated towards SaaS/cloud, social, mobile and big data initiatives, which is great news for our SaaS portfolio companies.  It is also leading us to continue aggressively investing in these sectors.  Finally, I expect that we will start seeing increasing acquisitions in these areas, as larger IT vendors come to realize the impact that social, mobile, big data and, of course, cloud and SaaS have on the enterprise.

Related articles

• Notes from SaaS Growth and the Cost of Capital (davidcummings.org)

When 100% Growth Is Not Enough for Startups

A couple of weeks ago I passed on the opportunity to invest in a SaaS application company that has been growing around 100% YoY for the past couple of years and can now be considered a solid expansion story. While the company’s overall story was good, it was not great.  As I have been talking about some of my colleagues in other firms I heard similar stories from them about passing on companies that were good but by today’s standards were not considered great.  So I started thinking why our standards are changing and where are these changes leading us.  Top technology venture firms like Trident Capital which are investing on B2B business models in areas such as cloud computing, mobility, social/local/mobile (also known as SoLoMo), ecommerce and big data are looking for breakout companies.  In fact, this is a term you hear more and more often in the Valley these days.  A company may be growing by 100% YoY and may still not be considered breakout.

In my opinion “breakout companies” have the following characteristics:

1. Leadership position in their market (this means that they are number 1, 2 or 3 but not lower).  For example, there are approximately 45 companies providing solutions for Facebook page management.  Buddy Media and Vitrue are the top two competitors in this category.  Top venture investors competed hard for the opportunity to invest in either of these companies.  Today we routinely receive business from lower-ranked competitors that are raising a round of capital and we always pass on the opportunity to invest.
2. Work in markets that are either already large and are growing consistently at 8%+ annually, or are projected to become large and is growing at over 25% annually.  For example, Corporate Performance Management is a $7B/year market that has been growing at 8%/year for the past several years and its growth is projected to remain at least at this level.  The Facebook page management market is growing at 40-50% YoY.
3. Grow much faster than the market and typically over 100% YoY even when its revenue becomes large, i.e., while growing a business is always hard, it is nonetheless typically easier to grow the revenue from $2M to $4M to $8M but much harder to sustain such growth when the revenues reach $30M to $60M or $120M.  Host Analytics, one of my portfolio companies, that provides the leading SaaS analytic application for Corporate Performance Management has been growing at 100% YoY and its revenue is now such that for it to be considered a breakout company.
4. Points of leverage which can be utilized to sustain, and even accelerate, the growth rate in a capital-efficient manner.  Even though venture capital is flowing rather freely again in specific sectors, investors still want to work with companies that demonstrate decreasing churn, decreasing cost of new sales, increase the lifetime value of their existing customers, and maintain their growth rate by combining direct sales with channel partners.
5. Strong management teams with members who have worked with successful startups before.

Investors are competing fiercely for the opportunity to invest in breakout companies.  They often approach such companies before they need to raise money and pre-emptively offer term sheets with high valuations and other entrepreneur-friendly terms. We typically see 4-5 investors, competing for the same opportunity.  And most of the times, this group of 4-5 are drawn from the same collection of 30-40 venture firms.  Because of the valuations offered, the size of each investment is also very large as the investors want a meaningful piece of each such company.  For example, breakout companies like Yammer, Klout, Lithium, Marketo, and Brightroll have recently raised large pre-emptive rounds.

Investors prefer to invest in breakout companies for the following reasons:

1. There exist too many early-stage companies in each subsector because of a) an abundance of risk capital from angels, superangels, etc., and b) low technological barriers to enter many of these sectors.  Under these conditions, VCs prefer to let the market identify each sector’s leaders, i.e., the breakout companies.
2. Exits, either through IPO or M&A, appear to reward the breakout companies.   In a recent study he conducted, Morgan Stanley’s Adam Holt observed that IBM, one of the most active IT acquirers over the past 10 years, buys only category leaders.  This is an acquisition approach that several other large IT corporations also use.  Moreover, as the number of potential acquires has shrunk, venture investors realize only so many acquisitions can take place in each subsector.  Therefore, unless an investor believes that a private company has IPO potential, the investor would want to invest in a company that will likely be an acquisition target, leading us again back to the breakout companies.
3. Early stage risk is not being adequately rewarded.  Over the past 10 years VCs have come to realize that by and large they are not being rewarded for taking early stage risk, as startups take longer to mature and require more capital than many early investors had anticipated.  The proceeds from the exits of early stage companies don’t provide sufficient returns for the funds these VCs have raised.  For example, having a 2x return on a company where a venture investor invested $5M out of the $300M fund is not “moving the fund’s needle.”

Related articles

• Things To Consider Before Saying "I Do" To Investors (techcrunch.com)
• How To Find The Right Investors and When (grasshopper.com)

CMOs are Starting to Drive the Next-Gen Application Agenda

A couple of weeks ago my partners and I hosted a meeting of our SaaS advisory board.  This is one of our firm’s four advisory boards.  I had written about the role of these boards and the value our firm and portfolio companies derive from our advisors’ insights, feedback and help.  Our SaaS advisory board includes executives from SaaS application vendors, CIOs and CTOs of companies that are heavy users of SaaS applications, and leading SaaS consultants.  One of the most interesting insights that came out of our meeting was that the Chief Marketing Officers (CMOs) are starting to drive the corporate application agenda.  This is consistent with Laura McLellan’s position who in a recent Gartner webinar stated that by 2017 the CMO will spend more on IT than the CIO, as well as the conclusions presented here. 

There are several reasons for the CMO’s emerging power:

1. The accelerating move from offline to online for commerce, entertainment, and socialization.  The web with its various personas (desktop, social, mobile, local) is enabling corporations to finally become truly customer-centric, i.e., to understand the problems customers face and provide mutually advantageous solutions.
2. The big data that is collected from the various online and offline interactions between a consumer and a brand can now be utilized effectively through a new generation of analytic solutions that enable corporations to better target existing customers and prospects with the right message, at the right time through the right channel, as well as to assess the effectiveness of each message based on the resulting actions.
3. Through the consumerization of the enterprise we are seeing a new generation of easier to “consume” applications that don’t resemble the monoliths of the past but instead take their cues from mobile applications, i.e., task-specific pieces of functionality that are easy to install, learn and use effectively.
4. The cloud that is making acquisition and deployment of these next-generation applications easier and faster.
5. The new generation of marketing personnel, including CMOs, that is more analytical, data-driven and technology-savvy.

Today we are seeing marketing departments acquiring applications to address online advertising for brand development and direct response commerce, social and mobile marketing and commerce, and analytics.  Having anticipated this trend, over the past several years Trident Capital has been investing in such applications and today our relevant portfolio includes the online advertising technology companies Turn, Exelate, Jiwire, Brightroll, Sojern, the social marketing and commerce applications Extole and 8thbridge, and the retail analytic applications company Pivotlink.

Though the opportunities may appear brilliant, based on our experiences with these portfolio companies we have learned that working with the marketing organization also presents several challenges:

1. There is little tolerance for long application-implementation periods, inappropriately functioning software and need for specialized personnel to operate these applications.  Marketing departments want to see results quickly and, under today’s typical corporate budget environments, they don’t want to have to hire new people just so that they can use a new application.
2. Short period during which to demonstrate meaningful ROI.  Marketing departments may be willing to evaluate several different applications but they will ultimately commit to the ones that give them quick time to value with sustainable and growing ROI.
3. Data is not always well organized and structured.  This is area where most frequently application vendors see a big difference between working with the marketing and the IT departments.  For marketing departments managing data and maintaining its quality are new tasks.  This task becomes harder as the volume, velocity, complexity, and structure of customer data are increasing.  Marketing application vendors must be prepared to help by providing appropriate services in this area and thus ensuring that the application’s time to value will be short.
4. Skills for data analysis for insight-generation are lacking.  While marketing departments are becoming awash in data, they often don’t have the people who can effectively analyze this data.  Again, the marketing application vendors need to step and fill the void by offering their own data analytics and insight generation services.
5. Shorter initial licensing contracts and smaller marketing campaigns.  As they try to understand the value of the myriad of applications offered to them in order to implement their customer-centric strategies, marketing departments feel that they must first “get their feet wet.“  In most cases this approach results in application licensing contracts that initially are short-term (1-3 months), or in smaller-dollar (typically $10-50K) marketing campaigns.
6. Need sales people who can first speak the marketer’s language rather than IT’s language.  Over the past 30 years we have trained a cadre of application sales people who are expert at interacting with IT organizations, speaking IT’s language.  This was necessary because front- and back-office enterprise applications, regardless of who was using them, were mostly purchased by the IT organization.  If the next generation of marketing application companies is to be successful, they will need to hire sales people who can interact with marketing executives.
7. The sales cycles for these applications are becoming longer and more complex (see also here).  Before the final decision for the licensing of these applications is made, IT is now becoming involved, and will continue to do so.  Though the CMO’s prominence is rising, don’t expect the CIO’s role in marketing technology decisions to disappear.  Over the past year our relevant portfolio companies started to see CIOs participating in important procurement decisions involving solutions for the marketing department.
8. The application’s user experience must be tailored to the marketing department’s users.  We are starting to see application developers creating user experiences that are more akin to the practices being established around consumer software, particularly PostPC consumer applications.  To easily adopt the multitude of new applications offered to them, marketing departments must want to interact with them and must be able to do so easily and with little or, preferably, no training.

As corporations become more customer-centric and the move to online continues, data-driven marketing departments stand to reap big rewards.  For this reason they are acquiring a new generation of applications to help them improve their interactions with customers and prospects regardless of channel. Marketing application vendors must understand this trend along with its positive and negative implications, as well as the evolving roles of CMOs and CIOs, in order to best capitalize on it.

Related articles

• IT Risks Irrelevance In Digital Marketing Revolution (informationweek.com)
• Ten traits of a successful serial CMO (customerthink.com)

Insight as a Service (Part 3)

A few days ago I presented a webinar on Insight as a Service. In the presentation I tried to provide further details on the concept which I first introduced here and later elaborated here.  I am including the webinar presentation (click on the slide below) and the notes because they elaborate further on Insight as a Service and provide some examples.

4Q11 was a Late-Breaking Quarter for Trident Capital’s SaaS Portfolio

The typical 4Q budget flush that most IT companies have learned to expect didn’t come in the same extent this year.  As a result, public and private SaaS companies had a tougher quarter than they expected; certainly a much tougher quarter than 4Q10.  We are still not seeing as much exuberance about the economy as some of the recent reports would have you believe.  Certainly during 4Q11, based on checks I made with some of the prospects and customers of our SaaS portfolio companies, I got the sense that the SMB sector has not yet fully recovered. But, pleasantly, I have started seeing more evidence that the larger corporations (Fortune 500) are starting to fully embrace SaaS (more on that later).  Our SaaS portfolio companies did a little worse than planned with 85% of them achieving their revenue and booking targets (compared to 90% during 3Q11). 

The public SaaS companies appear to have faced similar market conditions during the quarter, i.e., they had harder time making their numbers.  None pre-announced (positive or negative) but a couple missed their numbers (Realpage, SciQuest), with the rest, e.g., Netsuite, comscore, Concur, Cornerstone onDemand, Kenexa, reporting inline results. The big acquisition news for the quarter were Oracle’s acquisition of Rightnow (Oracle also announced the acquisition of Taleo but that’s a 1Q12 transaction), SAP’s acquisition of SuccessFactors were the really big news.  IBM’s acquisition of Demandtec, the leader in SaaS pricing optimization solutions, added another analytic application to IBM’s portfolio.  Salesforce’s acquisition of Rypple demonstrated the company’s continuing strong interest in social applications. 

Positive conclusions from our SaaS portfolio performance:

1. The annual growth for the SaaS companies continues to surpass that of the on-premise software portfolio companies.  During 2011 our SaaS companies experienced 30-150% yoy revenue and bookings growth.
2. Renewal rates remain steady at 85-95%.  Upsell rates were at 20-45%.  This was better than expected and a good indication that customers are finding value and good ROI from the use of SaaS applications.
3. Most of our SaaS portfolio companies were able to increase their license pricing 10-20% during the quarter; another indication of the value customers experience.
4. Discounting remained at 20-25% for multi-year deals and 5-8% for 1-year deals.  Upfront payment terms held steady with customers paying 1 year in advance for the multi-year deals and 1 quarter in advance for the annual deals.
5. Analytics-driven applications, social applications, and mobile applications with vertical focus continue to be in high demand.
6. The portfolio is seeing accelerating demand from large enterprise clients (Fortune 500 including Fortune 50 companies).  I’m sure this was one of the major reasons that Oracle, IBM, and SAP have started acquiring SaaS companies.  Our companies have continued to receive strong inbound interest for their solutions from foreign companies (Australia, New Zealand, Singapore, parts of Western Europe).
7. System Integrators (SIs), including several of the large ones, are becoming more interested in providing services around packaged SaaS applications.  This is something that I couldn’t have imagined a year ago.  However, with the increasing interest of F500 companies in SaaS applications it should have been expected that the larger SIs would come calling.  The question is whether they will use their traditional model (calling for services that cost 5-7x the licensing cost) to deliver services around SaaS applications or whether they will create a new model.  It will also be interested to see the SIs will be able to change their customer onboarding model and make it more compatible to the fast onboarding models used by SaaS companies.

The characteristics my partners and I didn’t like from the quarterly performance of our SaaS companies include:

1. While large enterprises are starting to adopt SaaS applications more regularly they expect a sales process that is more similar to the on-premise enterprise software sale, rather than to what we have been typically seeing with the sales of SaaS application software to SMB customers and mid-upper enterprise customers, i.e., a 2-4 month sales process.  The longer and more expensive sales process (requiring field sales people with enterprise experience, more demos and pilot projects), has a negative impact on margins.  This is an issue we plan to work on with our relevant SaaS portfolio companies during 1Q12.
2. The monthly sales targets were not achieved according to plan.  For our SaaS portfolio companies we would like to see 20% of the quarterly target to be achieved during the first month of the quarter, 30-40% during the second month, and the remaining the last month.  During 4Q11 we saw a new pattern.  During October and November the companies were able to achieve only 20% of their quarterly target (10% each month).  Another 10% was achieved during the first half of December.  The remaining 70% was achieved during the last two weeks of the quarter.  This is the reason some of our SaaS companies run out of “runway” and couldn’t get all of their contracts done, resulting in some to miss their quarterly targets.  Sales productivity slipped.
3. Hiring was difficult during the quarter because the SaaS companies have a high demand for the same type of people as Internet companies: engineers, sales people, product managers, services people, and data analysts.  If this trend continues, it will negatively impact the aggressive growth plans our companies have for 2012, as well as their costs and margins.

Some additional observations from the quarter:

1. Once again customers showed that they don’t care about the SaaS solution’s “purity,” i.e., is the solution multi-tenant, is it built on a single technology stack, but they care about the solution’s ease of deployment, overall economics and the time to ROI.  If a solution’s purity leads to faster deployment, better economics and faster ROI then they are all for purity.
2. IT organizations are finally taking SaaS seriously.  They are starting become very involved with SaaS licensing decisions.  In addition, they are also starting to worry about how to instrument their corporate IT infrastructure so that they can better monitor the performance of such applications and improve their performance.

Looking to the next 12 months, I’m expecting a more muted 2012 with flat budgets for IT solutions (compared to the 3-5% yoy increases we had seen the last couple of years) and tougher sales cycles, decreasing contract values and more discounting.  While I expect continued strong M&A interest in SaaS companies, I don’t foresee more blockbuster acquisitions like the ones we saw with Rightnow, Taleo, SuccessFactors and Demandtec.

Related articles

• Cloud War Heats Up As Oracle Buys Taleo for $1.9B (wired.com)
• SaaS valuations: off the charts and staying that way (gigaom.com)
• SaaS Trends in 2012 (clean-clouds.com)