The Power of We

  This is not a post about politics, but let me start with something I’ve noticed over the past few weeks in the presidential race, which is Hillary Clinton’s shift from using “I” to using “We” in her speaches. Bernie Sanders has been using plural language for pretty much the entirety of his campaign and it’s been an effective tool for him to make audiences feel that they’re in this with him. On the republican side, Ted Cruz uses this language very effectively (interesting Trump seems to vacillate – sometimes in the same sentence – between the use of I and We). 
It’s a small shift in language but it has a powerful effect – at the same time enrolling the audience and making the speaker seem more humble.

Years ago at Foundry we realized that we were often using I instead of We when talking about our firm, our investments and our thoughts on the market. It was subtle but working against what we were trying to build as a firm and also sending the (wrong) message that whomever was speaking at the time was somehow separate (perhaps perceived as above) the partnership. It took us a while to notice this but eventually we did and it precipitated a great conversation at one of our quarterly offsites. We immediately changed our language and to this day talk about the shift from I to We and how powerful it has been for us. 

Worth checking your own use of pronouns to see how you’re describing your projects, your team and your company.

Entrepreneurial Density

I’ve been throwing this term around for a while and thought it was worth writing about, as I believe that understanding entrepreneurial how density can shape an entrepreneurial ecosystem is very important.

But first, a link back to some ideas around entrepreneurial communities in general. My partner Brad literally wrote the book about this (highly recommended if you haven’t read it already). But the very quick summary is that great entrepreneurial communities are build on the basis of a few key tenets (Brad writes about these in much more detail in the book, which – again – you should read)

Startup Communities Take Time. Think 20 years. And they don’t happen overnight (despite what you may have heard about Boulder – it took plenty of time to develop here too).

Startup Communities Are Led by Entrepreneurs. For some reason I still can’t figure out, many VCs get this backwards. But great entrepreneurial communities are led by entrepreneurs.

– Startup Communities Have Many Leaders And Are Not Hirearchical. Related to being led by entrepreneurs, great entrepreneurial ecosystems have many leaders. They don’t need to be working in a coordinated fashion (but see the next point on being inclusive) but they do need to be working for the greater good of the community. Additionally these communities are meshed in their network structure vs being hub and spoke or centralized. There’s no hierarchy in strong entrepnreurial communities.

– Startup Communities Are Open. It’s pretty critical in any startup community to be open and welcoming. People come to entrepreneurship from lots of different background and bring different perspectives. They’re also working across the stack of petential problems and forming companies that are varied in their make-up, focus and goals.

It’s funny. I thought for sure I had written about this before, but when I looked it turned out I hadn’t. Brad has some great content up (in addition to his book, which I’ve now mentioned 3 times that you really should read). There are a few videos up (see here and here) where I touch on these topics if you’re interested in digging deeper (they’re long but it’s a meaty topic…). Felt like it was worth prefacing the rest of this post with these thoughts on Entrepnreurial Ecosystems and Startup Communities First.

So how does Entrepreneurial Density have to do with this? I’m starting to develop a thesis around the ways in which Entrepreneurial Communities follow something pretty akin to Boyles Law. For those of you that have forgotten high school chemistry, Boyles Law describes the behavior of gasses – it describes how the pressure of gas increases as the volume decreases.

Startup Commnunities can behave in a very similar fashion. The smaller the physical space in which entrepreneurial activities are taking place, the faster those activities happen, the more serendipity emerges and the more that community thrives. This often happens somewhat naturally – startups like to be around other startups for example. But they can also be encouraged to happen – co-working spaces are good examples of systems trying to create density; sometimes enterprise zones can create this effect, often a group in a particular city gets together and consciously tries to create an area of town that’s particularly attractive to startups. I lived this in Boulder without really realizing at the time what was going on. In 2007 Foundry moved from an office park on the highway to the west side of town. There were already a number of startups there (our office formerly belonged to Rally Software, Lijit Networks was upstairs, many more companies were nearby). We moved there because we liked the location and it was near to where 2 of the Foundry partners lived. Over time more and more companies moved to that side of town and we built a little bit of a community within a community where people were constantly bumping into each other on the street, getting coffee, at lunch, etc. In our building alone we’ve had about a dozen portfolio companies have an office at one time or another.

To be clear, it’s not that density is required to build a great entrepreneurial ecosystem (and I feel passionately about the virtual community that’s connecting entrepnreurs around the work – perhaps with this new lens, creating virtual density as well). But community building is about creating the environment that allows for the entire system to thrive and creating density in a community is an important way to help speed up that process.

An important credit to end this post. I first starting thinking about density a number of years ago when Brad Burnham mentioned it to me. I doubt he remembers that specific conversation but, like many conversations I’ve had with Brad over the years, it was an impactful one. 

What the current markets are and are not telling us

In response to a comment to my post earlier this week about the Profit Imperative, I rattled off some ideas about the current state of the markets. I thought it was worth sharing as a full post (I’ve edited and expanded on the original comment).

There are clearly headwinds in the markets – I’m not at all suggesting that there aren’t. And we may be in a period of strong negative pricing pressure in both the public and private markets. As you know, markets tend to perpetuate themselves and pendulum. This cycle of overreacting is how business and market cycles seem to work. Without a doubt we’re in an environment of increasing volatility and that volatility alone may spook some investors.  Price shifts at the top of the market, starting with the public markets and quickly spreading to the public market investors who had been dipping into the late stage private markets and continuing from there, will and are clearly changing pricing across all stages of private market financings.

I’m generally of the view that we’re not in a bubble (see my post on that from last September here). While there’s no functional definition of an asset “bubble” that people seem to agree on, let’s at least agree that they’re caused by a fundamental imbalance between the actual “value” of an asset and the way the markets are pricing that asset. We saw this clearly in the housing market when the access to cheap capital created run-away housing prices that weren’t sustainable by any historical measure of actual underlying value. We’ve certainly seen this in the public and private markets as well (for example in the 2000 crash where truly unsustainable levels of funding were driving too many bad ideas into the market and the perception of market value and future growth and profit potential was completely out of balance with reality).

I’d differentiate this from what we saw in 2008 in the private markets where prices contracted – in some cases relatively dramatically – but where there wasn’t a true bubble bursting in the way we saw in 2001. The private markets in that case were reacting to the larger trends in the public markets (the US consumer was in a painful process of shedding debt and readjusting their balance sheets after the housing bubble broke) and to a supply and demand change in the availability of capital. That so many great companies were started in this period perhaps suggests that the venture capital markets over reacted to what was taking place in the public markets (and that’s just one measure of the over-reaction). 

When I look at the fundamental value of public comps, we’re already well below historical averages (and weren’t even at the top of those averages when the markets started correcting). When I see the drastic proclamations of arageddon I think they’re unjustified by the current actual market conditions. When I look at the US economic data I don’t see anything justifying the wide sell-off in the market. When I see companies announce 1-time tax hits and drop 40% of their value overnight, I see a market that’s overreacting.

There is clearly plenty of negative sentiment in the marketplace and this sentiment tends to be self fulfilling – we will see a contraction at Series A and (especially in my mind) at Series B. Capital will retreat, companies will have a harder time raising money and pricing will adjust (however to be clear, the rise of seed rounds in the past year is nothing like the overfunding of Series A and B that we saw in 99′ – and some might argue is good for the overall ecosystem as more ideas get enough legs to test whether they have merit and those that do go on to raise their A rounds). This is a bit of an oversimplification but to some extent we live in a bifurcated world. There’s a big difference in market behavior at the high end of the markets where there has been a “bubble” around so called unicorn companies who were chasing that billion dollar valuation. This led to aggressive valuations, to aggressive terms and to aggressive expectations on growth that I think are about to come home to roost in that market segment. But to be clear, I thought this long ago and well before the public markets started reacting. 

Which all leads me back to my most important business mantra:

1) don’t panic

2) gather information

3) make informed decisions

As always, the order here matters a lot.

 

Welcome to Foundry

welcomeI send a note to each new company that I work with at Foundry that sets up what I hope will be the key tenants of our working relationship. I thought it might be fun to post it publicly – I think it gives meaningful insight into how all of us at Foundry work with the company in which we have an investment.

I’m psyched to be moving forward with our investment! I thought it would be helpful to send a few thoughts on working together – I do this with all of the new companies I work with. It will take a little bit for us to get a natural cadence going but the thoughts below frame my thinking on how to work with me/Foundry.
I work for you. This is core to our operating philosophy at Foundry. Treat me like someone on your team.
Communication is key. The more information we share the better we can work together (for example, I’m happy to have access to your admin dashboard and pull the data or have you (or an internal system push it to me).
You can’t send me too many emails. Let me do the filtering, not you. Send me anything/everything you think is interesting/relevant. If I have something to say I’ll respond, if not I won’t (I generally avoid “thanks” kind of responses – you don’t need that filling up your inbox). If I don’t respond it doesn’t mean it wasn’t good information to have – just means that I didn’t have anything more to add.
Leverage my partners. You should feel free to reach out to Jason/Brad/Ryan any time you’d like. We don’t silo at all at Foundry and everyone is available to you. Copy me if you want, or not – up to you. Assume that information is completely fluid on our end so anything you tell them I’ll be up to speed on as well.
Leverage other Foundry companies/execs. We have a ton amazing people in the portfolio. I’ll suggest specific people to reach out to sometimes to leverage what they’ve already learned. More importantly, you guys will be a part of 2 Foundry mailing lists that are very active: 1) FoundryExec – about 400 executives from all of our portfolio companies; this is the most active list – ask them anything – they’re eager to help; and 2) FoundryCEO – for you to connect with the other CEOs in the portfolio. Less active than the Exec list (the CEOs are all on that list as well) but a great resource.
Help me understand how I can be most helpful. My natural inclination is to listen in “problem solving mode”. It’s hard for me to break out of that sometimes, so let me know if I’m jumping in to quickly to “solve” something that doesn’t need to be solved (for example if you’re simply calling to vent about something). If you need me to help with something or you’re stuck on something just ask – I’ve seen a lot of crazy stuff over the years and hopefully I can help you avoid some of the mistakes that other companies have already made.
My mobile number is xxx-xxxx. That’s the easiest way to reach me (text or voice).
I use Voxer a lot with others that like that communication method – let me know if you’re on that.
My Twitter handle is @sether
Excited to be closed!

The Profit Imperative

With the markets crashing around us and the sky once again falling I thought it was time to revisit a few fundamentals and perhaps more importantly share some what what we’re now seeing in the private funding markets.  

Growing Profitably. Let’s start with what I labeled the Growth Imperative a few months ago in a post, where I pointed out 1) that investors were (over) valuing growth and 2) that when this changed it was going to change quickly (and in a separate post said: “when the growth imperative shifts to a profit focus, companies with high burn and weak operating metrics can get stuck in the lurch.”).  It always amazes me how quickly the markets can shift and how rapidly investors change their mind set. But they do, and they are right now. We’re seeing lots of market data points that suggest that the private markets have shifted dramatically to a Profit Imperative, overnight eschewing high growth/high burn with no line of site to profitability and favoring companies that are growing more slowly but doing so profitability or with a clear path to profitability. There’s an increased focus on key metrics – especially those core metrics that drive the spend/growth curve such as LTV/CAC and months to pay back CAC. 

Valuations are Down. As the public markets have fallen, so have the private markets. No surprise here, but the drop has been rapid and it’s been dramatic. In the public markets public SaaS valuations (EV/Revenue) are down 33% since January and 66% since their high in January 2014. This is true across other markets and has quickly worked its way down into the private markets (btw, the current EV/Rev multiple for public SaaS is 3.2x). Different sectors of the market have seen varying levels of decline, but overall the private markets are off similarly to the public markets. I’d point out that this is especially true for companies in the Series B stage.

Flight to Quality. Just as we’ve seen this in the public markets (with Google, Facebook and a few other giants suffering stock losses much less than their smaller peers), the private markets are quickly differentiating true market leaders from the rest of the pack. And while there are plenty of markets that aren’t necessarily winner take all, investors aren’t buying the story for why a 2nd or 3rd player can break out.

Product vs. Company. There seems to be a growing realization – especially in the B2B SaaS market, but also across others – that many of the companies that have been funded and have seen reasonable growth are really products, not companies. And that at some point their growth will flatten out as their product saturates the market. I think this is coming through in subtle ways as investors evaluate companies (I’m not hearing people talk about it explicitly) but behind some of the comments is clearly this question and all companies that are in the market to raise capital should recognize this bias.

There’s no silver lining with which to end this post (other than that I personally think the markets – public and private – are overreacting; but that doesn’t mean they’ll necessarily correct back any time soon). Hopefully you took the opportunity in the past few quarters to shore up your balance sheet. If you didn’t it’s time to be careful. Plenty of companies will continue to get funding, but beware of the market dynamics that I describe above.

Introducing Foundry Group Next

This was also posted on Brad Feld’s blog and a similar announcement is up on foundrygroup.com as well.

Over the years at Foundry Group we’ve built an extensive network of companies. While we’ve invested in some of these directly, this actually represents the smallest set of companies that we are involved with. We have also invested indirectly in many others through our investment in Techstars. Yet another, and much larger set of companies, come from our investments in other venture funds.

In 2013, we started thinking hard about the future of Foundry Group. When we started Foundry in 2006 we were very clear that we were not going to build a legacy firm. There would be no generational planning, no transitions to younger partners, and no senior partner hold-outs who would hang onto economics well after they had stopped working. Simply put, when we are done investing, we will drop the mic and shut off the lights.

During these discussions, we reflected on the incredible collection of early stage VC firms we’ve invested in personally over the years. We’ve been investing as individuals in venture firms going back almost 20 years. The four of us have served as mentors, and in a number of cases, formal advisors to funds around the world. In 2010 we started making the majority of our fund investments together through a common entity. While we never thought hard about this activity, over the years we’ve amassed a very strong track record through these fund investments. It’s also been fun – a great way to get close to new managers, build lasting personal relationships, and see deal flow for our Foundry Group investing activity.

In late 2014 the four of us got together to talk formally about the future of Foundry Group. We had each taken a month off in 2014 – well needed breaks after what had been a seven year sprint since starting Foundry Group. We were clear at that point that we wanted to continue to make early stage investments through a new Foundry Group fund, which we subsequently raised in the middle of 2015 and started investing at the end of the year.
At the same time we discussed our later stage investment strategy. In 2013 we raised a fund called Foundry Group Select. The strategy behind Select is to make late stage investments into successful companies where our early-stage funds had previously invested. The strategy has been a good one and with two early exits (Gnip and Fitbit) we’ve already returned significant capital.

As a result of our extensive networks, we constantly see other potential late stage investments. We’ve stayed away from these investments, not because they aren’t interesting, but because with the Select fund strategy we had limited ourselves to investing in existing Foundry portfolio companies. We broke this rule recently to make an investment in AvidXchange, a business run by an entrepreneur who I have known for over 20 years. The conversation around AvidXchange brought to light the magnitude of the opportunity we have to invest in interesting companies outside of our early stage portfolio.

We also had a long conversation about our GP fund investing strategy. It is clear to us that we enjoy investing in other VC funds and working to support the GPs. When we looked carefully at our track record, it became clear to us how lucrative this activity has been.
As we discussed the confluence of our fund investing strategy, our current Select strategy, and our interest in acting on our unique later stage deal flow, we realized that there was an opportunity to wrap these three ideas together into a single entity that would encompass not just what we had previously called our Select strategy but would also institutionalize our fund investment strategy as well as leverage those and other relationships to invest in other later stage opportunities in our broader network.

The critical ingredient for bringing this all together was finding the person to help us execute our GP fund strategy. Fortunately we knew exactly who we wanted to work on this project.
For the past 13 years, Lindel Eakman has been the head of UTIMCO’s private equity group. He’s created an incredible portfolio of investments in venture capital funds, including Union Square Ventures, Spark Capital, True Ventures, IA Ventures, Techstars Ventures, and Foundry Group. In April 2007, Lindel committed to be our largest investor in our first fund in 2007, taking 20% of the fund. This was a bold move, as we only had one commitment at the time.
Lindel – through UTIMCO – has continued to be our largest investor. He has been on our advisory board and for the past eight years has been a key advisor to us. Over the years he also has become a close friend.

We’ve been discussing this strategy with Lindel for most of the last year and have started calling the initiative “Foundry Group Next”. The Next strategy will not only allow us to continue making direct investments in high-potential startups, but will also scale-up our ability to support venture firms and funds whose vision and values align with ours. Through this activity, we hope to spread the Foundry Group values and DNA further into the overall venture and startup ecosystem.

We are pleased to welcome Lindel to Foundry Group Next and are excited to start this new chapter with him. And to make the the lawyers in our lives happy, we need to say that in no way is this blog post an offer to sell securities or an advertisement of us raising a new fund. We have yet to announce anything regarding any new funds that we may raise in the future.

Boulder needs to VOTE NO on 300 and 301

Below is from a post we just put up on the Foundry blog. It’s critical in this election that the business community in Boulder takes a stand for progress and against closing the doors to the city. The two issues below are of great importance to the city of Boulder. So is electing a strong and reasoned City Council. I’m supportive of OpenBoulder’s approach to that and they have great information on the candidates they’re backing. In particular I’ve been helping my friend Bill Rigler with his campaign and would encourage you to be sure to include him as you vote. He’s a thoughtful, progressive leader who will bring great energy and mindfulness to our city.

 

300-301-01

This year’s local election in Boulder is a critical one. The city that we love risks shutting its doors. While the business community in Boulder has contributed immeasurably to the vibrancy, charitable contribution base, economic development, and success of our community, there is a faction in Boulder that feels that our city should stop moving forward and instead should live in the past. This faction believes in a less inclusive Boulder and aims to achieve this goal by literally shutting the doors to our city.

This is what is behind propositions 300 and 301 which are proposed amendments to the city’s charter.   

This faction is well organized and well funded and the slogans make it sound reasonable.  But make no mistake:  the goal is to immediately freeze all development of all types around the city by enveloping the city a bundle of political red tape.  

In the coming days, Boulder residents will be asked to vote on the following:

#300 – Neighborhood Right to Vote on Land Use Regulation

#301 – New Development Shall Pay Its Own Way

These initiatives must be voted down.

While innocuous sounding, the names of these initiatives completely misrepresent their intent and the dire consequences that would result if they are enacted. The truth is that neighborhoods already do have a say in projects that affect them, and developers already do pay some of the highest fees and taxes in the country.  

Effectively, these proposals will create 60+ neighborhoods in Boulder.  Can you imagine what would happen if we had that many homeowner associations that had the power to hold special elections and veto land use changes approved by city council? The smallest of those neighborhoods would be comprised of just 19 houses. That’s not “local control” (which already exists), that’s a deliberate attempt to create gridlock.

These initiatives will immediately freeze important infill development, including affordable housing, transit-oriented development, neighborhood serving retail, social service centers, and day care centers. The city manager has stated that the city will stop issuing permits of any kind for at least six months while they figure out what these initiatives mean and how to implement them. Once they do start reissuing permits, these initiatives will force the city to levy such high taxes and fees that development will effectively stop in Boulder. This will stop our city in its tracks and greatly exacerbate an already expensive housing market.

These measures are opposed by six former mayors, all nine City Council members, numerous former city council members, Boulder Housing Partners, The Daily Camera, and numerous civic groups like Open Boulder, the Boulder Chamber, Better Boulder,  and others.  Open Boulder executive director Andy Schultheiss has called them “among the worst pieces of public policy I’ve seen in almost 25 years of observing and participating in local policy-making.”

It’s critically important that we defeat these measures. To do that we need to get the word out to those in our community who want Boulder to continue to be a vibrant city. The sad irony is that those promoting these measures have the time and organization to put towards pressing their backward and closed agenda while many who oppose it are busy helping keep Boulder prosperous by creating jobs and economic growth.

This is a battle we can’t afford to lose. Please take a minute to help us get the word out. Send it to your friends via email and social media. Urge your neighbors to vote and make sure you vote yourself. With ballots mailed out this week many in our community will be voting in the next seven days (over 50% of ballots are returned within a week of their being sent out).

#keepboulderopen

Seth, Jason, Brad, Ryan

_______

Below are some suggested tweets or Facebook posts should you chose to share them:

Click to Tweet: i agree with @foundrygroup. 300 and 301 will have devastating effects on boulder. VOTE NO on both! #keepboulderopen http://bit.ly/1RdPv4K

Click to Tweet: i stand for keeping the doors to boulder open. VOTE NO on 300 and 301. #keepboulderopen http://bit.ly/1RdPv4K

Click to Tweet: in boulder’s upcoming election we’ll decide if we want to live in the past or continue to thrive. #keepboulderopen http://bit.ly/1RdPv4K

This may not be the bubble you’re looking for

At great risk of wading into a debate where there’s no winning, I thought I’d present a few pieces of data that suggest that we’re not exactly in a market bubble right now.  Massive caveat here: I’m not trying to predict the stock market. I’m just following my own advice. Plus I agree with my partner Brad, who said recently, “I think everyone will have an opinion and no one will have any real idea,” about what’s going to happen in the stock market (this in an article that appeared after just two days of  a down market). But the data are important, so let’s at least pay attention to what’s actually going on. From there you can form your own opinion.

Thought 1: What happens in China isn’t all that important to the US stock market. From some of the reporting you’d think that the US and Chinese markets are tied at the hip. They’re not. Not even close. For sure, the US is a huge importer of Chinese goods. But a weaker Yuan just increases our buying power. Yes – China is a large trading partner, but if you look at its effects on the overall US market, we’re not likely to see a large, near-term effect from a drop in either the Chinese stock market or their currency.

Thought 2: August is historically a volatile month. Maybe it’s the Hamptons air traders are breathing while on vacation in August, but for whatever reason, August tends to be volatile. And 4 of the last 5 Augusts have been down months (despite an overall strong market environment). Of course the only month historically more volatile than August is September, so the wild ride may not be over (to say nothing of the FOMC decision coming up, which will move markets no matter what they decide to do).

Thought 3: The TED spread is still reasonable. This is an interesting one to watch. The TED spread measures the difference between the 3-month LIBOR and the 3-month T-bill. It’s important because a rising TED spread has actually been a pretty good indicator of a US market that’s about to fall. The first graph below shows this – you can see big spikes in the spread leading up to the 2000 market collapse and the 2008 market collapse (the spread continues through each of those two events, but the initial rise pre-dated the markets falling; btw, this also occurred before the ’87 crash). To be sure, the markets can fall when the TED spread is inside of 50bp (considered the top end of the “safe” range). But large market disruptions are typically proceeded by a spike in the TED. It’s rising a bit (see chart 2 below which shows a close-up of more recent TED activity) but is still well within a reasonable range. I’ve also included the VIX index in the charts below to show that volatility isn’t always connected with an increasing TED spread.

ITEDS_^VIX_chartITEDS_^VIX_chart (1)

So there you have it. At least three pieces of data worth considering when thinking about the current market environment. All this doesn’t mean that you should ignore the current markets. Certainly volatility can lead to uncertainty in both the public and private markets. And as I wrote about last week, when the growth imperative shifts to a profit focus, companies with high burn and weak operating metrics can get stuck in the lurch. But in my view, it’s always a good time to shore up your balance sheet and watch your key metrics. After all, that’s table stakes for running a successful business.

Charts of the Day – The complexity of raising Series A

The charts of the day comes from a new Mattermark report on the current pace of financing. Both relate to the pace of seed funding in the US and the challenge of raising Series A financing. The first chart shows the pace of deals (measured by number of rounds) by category:

Funding

Pretty hard to miss the huge blip in Seed/Angel deals in 2013 (but really from 2011 and continuing through 2015, with a peak at 2013). Most of you already knew this intuitively, but seeing it in black and white (at least for me) was eye opening. And while there are more Series A deals being done every year, they’re not even coming close to keeping up with the pace of Seed deals. From an ecosystem perspective this is both what you’d expect and ultimately a good thing. We’ve certainly seen markets where too many companies passed through each funding stage and ultimately that had terrible consequences for the market, for investors and for founders. The best markets are those that are acting rationally and efficiently. We may even be running a bit hot from that perspective (subject of a different, upcoming post, by the way). From the perspective of a Seed funded founder, this should be a clear warning sign that it’s not going to be easy to raise your Series A. In fact, if you look at the trend line of Seed companies “graduating” to Series A, you can see in stark relief the challenge ahead of you’re a Seed funded founder.

grad rates

We’re clearly seeing this here at Foundry. Our deal flow is always pretty robust, it feels off the charts right now. The number of things that we’re turning down that are interesting, have solid traction and that will ultimately get funded (or should be funded) is unprecedented. I think that’s a direct reflection of the trend described in the charts below. Lots of companies raised Seed rounds, many performed solidly in their seed period and there are a large number of Series A opportunities in the market right now.

There’s no easy advice here if you’re a founder looking to raise your Series A. Obviously, start with building a great business and stand out because of your metrics. But that won’t be true of every business – many good ideas take time to develop market traction. So it’s important to recognize that in the current environment there’s a ton of competition and you’ll need to design your financing process with that in mind (be deliberate in who you target, make sure you’re showing exactly where you’re outpacing the rest of the market, build a larger list of prospective investors, etc.).

The growth imperative (but beware)

First off, a note of apology. It’s been months since I’ve posed here. Not for lack of desire – more about some combination of crazy busyness and lack of proper prioritization. I miss it and am going to try to step it up.

This is a post about the importance of growth, about the current market environment and a note of caution if the growth imperative changes rapidly to the profitability imperative.

A few months ago we held a “SaaS Summit” for about 130 people from across the Foundry Group portfolio. It was a great chance to compare notes, meet far flung colleagues (“cousins” as we sometimes refer to employees at different portfolio companies) and discuss a variety of topics effecting companies selling with a recurring revenue model. As the organizer of the event I pulled together the morning briefing to kick things off – basically a bunch of data from a variety of different sources talking about the state of the SaaS markets. There was some juicy stuff in there, but one set of facts clearly stood above the rest. At the moment, growth is THE single most important factor when considering the value of a SaaS company. Let’s start with some data and then we’ll parse through what it means.

The data below are a mix of things I came up with as well as a some key data points borrowed from my friends at FirstMark, who undertook an extensive analysis of the SaaS market. The full methodology here isn’t worth stepping through in detail, but essentially what the study did was try to separate companies into “leading”, “lagging” and “middle” SaaS companies. This was a reflection of their trading behavior, not an assessment of their underlying business (i.e., we relied on the market for the determination of leading vs. lagging). It’s important to note that there weren’t material differences in revenue size, geography, target market, etc. between these companies.

First the cold hard trading facts. “Leading” companies trade at significantly higher multiples than their peers.

trading stats

 

 

 

 

 

No huge surprise there – that’s pretty much the definition (in this study) for a “leading” company. But helpful to show the stark difference.

So what causes this massive difference? We looked at a bunch of different factors, but as I give away above, the single most important factor for valuation of a SaaS business is growth.

growth rate

 

 

 

 

 

The “growth effect” was highly statistically significant. In fact, a 10% (meaning 30% to 40%) increase in growth rate translated into a 3x (3x!!) increase in revenue multiple. That’s highly significant. And interestingly if you look at factors such as Gross Margin and EBITDA Margin they weren’t predictive at all. Nor was recurring revenue (meaning the % of revenue that was recurring vs. services). Below is another graph looking at the core correlation between growth and multiple (simply another way of showing the results I discuss above).

rev growth

 

 

 

 

 

If I’d been on the ball a few months ago and posted these data back then, this would have been the end of the story. Markets value growth and growth above everything else (at least at the time). But, of course, the markets have changed since then and it’s important to note a few things because of this.

I have another post I’m working on describing why I don’t think we’re in a “bubble”. But even if that’s true, it doesn’t mean that the markets won’t go down, and more importantly for many of the people reading this, that the private markets won’t start shifting their focus from growth to other factors (i.e., profitability). We’re already seeing this in some markets such as security. And we’ve certainly seen in the past that when the markets shift their focus from growth to profitability they do so pretty quickly (briefly in 2011, before that in 2008 and dramatically in 2000/2001). Unlike some, I don’t actually have a view on how drastic a correction we’re headed into (as I said at the start of this paragraph, I don’t think we’re in a bubble to begin with, but we’re clearly experiencing turbulence, nonetheless; however the sky isn’t falling and I tend to agree with what my partner Brad Feld said in the article linked at the beginning of this sentence: “I think everyone will have an opinion and no one will have any real idea,”).

Much more on this in my bubble post upcoming, but I didn’t want anyone walking away from this note saying “Seth says grow at all costs!” I’m saying the markets are valuing growth to a degree that surprised me when I looked at the numbers, BUT that one should take that with a grain of salt given the current market conditions and the tendency for markets to quickly shift their focus. Smart growth is the right strategy (I said this months ago at our Summit as well). The best businesses are sustainable and grow at a pace and in a manner that sets their burn rate at an appropriate level relative to their funding and matching things like CAC to LTV in sustainable ways.

More soon…