Newly Public B2B Companies Continue To Outperform

Although Q1 of 2013 saw fewer tech IPOs (7, using internet & software sector criteria) year-over-year, the number was relatively in line with the previous quarter. In addition, most agree that there’s currently a strong pipeline of IPO candidates likely to price in 2013 (Marketo, Palantir, Tableau, HubSpot, MobileIron and Veeva Systems among others). It’s also worth noting that taking the past few years, there’s no real reliable IPO seasonality; the bigger factors tend to be macroeconomic temperature and pending government actions (e.g. legislation around the sequester might be delaying filings).

Performance of recent IPOs is probably a better measure of public market health. Attached is a quick analysis of filings since the beginning of 2012, broken out by various sector / focus characteristics we like to keep an eye on. While none of the metrics are particularly unexpected—and in general the beneficiaries of good overall equity performance—one does stand out: SaaS companies have outperformed the average of their tech peers by nearly 2x. This fact is especially interesting to note in light of smaller and more numerous IPOs in general, when compared to recent consumer-oriented counterparts. In broad strokes, now is as good of a time as ever for B2B software (and if we had to guess, filings in the second half of the year will reflect that).

Note: This analysis excludes life sciences, biotech and medical device companies (e.g. Tetraphase, Enanta, LipoScience), though it’s worth mentioning that these areas have seen numerous recent IPOs. In addition, I’ve excluded non-software-based cleantech companies (e.g. SolarCity) and certain other companies that are in my view aren’t more than incidentally reliant on internet or software technologies (e.g. WageWorks, Healthcare Innovation, LifeLock). Last, a few companies qualify sector-wise, but are simply too thinly traded for price performance be meaningful (e.g. Digital Globe Services).

SaaS Revenue Seasonality: Fact Or Fiction?

TLDR: While it’s true that SaaS companies generally don’t see much revenue seasonality, there are some notable exceptions to the rule.

We (at Bowery) recently had a few questions pop up around seasonality with SaaS revenues and to what extent there’s an industry-wide trend. The truth is it really depends on the company’s business model, specifically around how much service (especially integration support and training vs. product support, which is often recognized over the course of a contract) revenue and how many non-SaaS product lines the company has.

Traditional software companies can sometimes exhibit a bias, as many B2C businesses do. Oracle is probably the most striking case with nearly half of all revenue recognized in Q1 in 2012. But we should remember two things: (1) almost 15%+ of the Company’s sales come from Hardware; and (2) the Company sells a lot of on-premise software. As they note in their 10-K, revenues for things considered services aren’t recognized upfront: “the vast majority of our software license arrangements include software license updates and product support contracts, which are entered into at the customer’s option and are recognized ratably over the term of the arrangement, typically one year.” However, traditional “software accounting”** covering products like on-premise software where the product can be considered “delivered” allows for immediate recognition (assuming other criteria are met). 

In contrast, SaaS companies (unless they can essentially prove that they are just taking traditional software that’s otherwise on the market and hosting it for someone) offer services, and must recognize revenue over the course of service periods (the contract). As a result, they don’t tend to display much seasonality. Concur and RealPage are good examples; accounting for growth, they’re about flat.
However, there are a couple of cases in which SaaS companies can and do exhibit Q4 preference. Sometimes it’s a bit hard to tell how much of this is growth vs. legitimate uptick, especially with young high-growth companies (i.e. Workday), but DemandWare and ServiceNow for example, do show Q4 revenues ~60%+ higher than Q1. One argument here is that companies tend to be a bit conservative so as not to eat up budgets, but then push to spend any remainder in Q4. But the two that make the most sense are: (1) salespeople are directly incentivized to get pen to paper before the end of fiscal years (ServiceNow is a good example of this); and (2) the company sells into SMBs, which exhibit consumer-like buying behavior clustered around year-end (DemandWare is a good example of this). Other less-likely factors include other product lines that can be considered non-services (e.g. training classes with standalone value), and one-off consulting project, hybrid contract (e.g. software + services or hardware + software), among others.
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** Rules relating to software revenue recognition (ASC 985-605) state that vendor-hosted software and any related hosting costs must be defined as services (rather than software) and thus recognized over the course of those contracts, unless the customer can (a) take possession of the software at any time no significant penalty and (b) host it or a competitor’s software themselves feasibly. See an insanely detailed writeup from E&Y here.

Bowery Capital & What It Means To Us

Preface: Bowery Capital, a new early-stage VC firm in NYC (of which I’m a part) launched yesterday. We’re enthused to be open for business! This posts mirrors one on our blog over at BoweryCap.com, as will some of my future posts here at Imperfect Info. Keep tabs on us there and @BoweryCapital.

When you first visit the Bowery homepage, you see our logo, which looks something like this: B/. The B, of course, speaks to our namesake and home neighborhood (Bowery) here in NYC. If you aren’t familiar with the story, it’ll suffice to say that the area has seen significant revitalization and investment over the last few decades (with some noteworthy developments like CBGB along the way). In its earliest incarnation, however, Bowery served as a path connecting the major settlement of New Amsterdam at the southern tip of Manhattan with farmlands up north (roughly 6th Street today). To abstract a bit, De Bouwerie (since renamed Bowery from the original Dutch) was a conduit between business owners (farmers) and their customers (townspeople). We at Bowery Capital aim to play a similar role in our startups’ early phases. To continue the 17th century metaphor, we don’t grow the wheat, drive the horse-cart or handle the money, but we work to provide sellers (our entrepreneurs) with a whole new ecosystem of buyers (enterprise customers), accelerating growth in the process.

Following the “B” in our logo, you see forward slash that you might’ve dismissed as tasteful designer flair. That little character, however, has a rich history and—with the help of further metaphors—speaks to our passion here at Bowery. The forward slash (fun fact: also known as a solidus) served as the original command-line operation prompt. I’m using “original” a bit loosely, but I had OS/2 in mind. In the nascence of the personal computing era, the prompt served as the primary method for interfacing with operating systems. When one set out to build things using computers in the 80’s, there’s a good chance he / she spent some time staring at a forward slash.

Developer tools, GUIs, operating systems, shells and even some command line interfaces themselves have come a long way since then. But the slash continues to represent—in our minds here at Bowery—a lot more. It’s a blank slate, the place a builder starts, the meeting ground where man and computer work together to build technologies greater than either could alone. That’s a grandiose way to put it, we’ll admit, but it’s a strong parallel to where a founder finds him- or herself on Day 1 of building an idea into a new company. As investors that focus on supporting entrepreneurs in the early days of their startups, we think about “Day 1” challenges perpetually. Giving our all to understanding these challenges and helping founders surmount them is the core of Bowery’s mission and culture. Like hackers started with the forward slash as a first step, our entrepreneurs should start with Bowery as a first resource for tackling their early issues, so they can focus on building great things.

Whither The Small Enterprise IPO?

On the first business day of 2013, the bankers at WR Hambrecht+Co. submitted a memo to the SEC arguing for more streamlined methods of going public for smaller companies. Their motivations as deal advisors are clear but their opening point is valid: pre-tech bubble companies tended to raise money in the public market earlier and in smaller amounts. Adobe, Starbucks, Yahoo, AOL, Peet’s Coffee, Whole Foods, Panera Bread, Odwalla, Intel, Amgen, Oracle and Cisco all raised less that $50M in their initial offerings. Clearly the bubble had an inflationary effect on what companies (and their underwriters) felt was necessary in terms of scale and amount-to-raise to file. Mr. Hambrecht finishes out the point by noting that as a result of recent high-valuation large-float deals, the bar for a worthy IPO keeping getting raised.

Taking a look at US internet, software & mobile IPOs in 2012, you’d probably not only agree with that point, but also conclude that B2B companies are particularly prone to waiting for large IPOs of late. Or that they now require more capital to reach IPO-readiness, which would in turn drive up valuation expectations (even excluding Facebook, the average enterprise valuation was $890M vs. the consumer average of $655M). Of 29 companies that went public in 2012, 13 netted proceeds of >$100M, a whopping 11 of which were enterprise-oriented, 5 of which yielded multi-billion-dollar valuations. While Facebook out-raised the nearest peer by an order of magnitude, other consumer deals (e.g. Yelp, Trulia, Cafepress) were in the more reasonable $50-100M proceeds ranges. So is B2B on a bubble trajectory? Is the smaller raise reminiscent of Cisco and Oracle’s approach dead?

Let’s reserve judgement and compare IPOs in the same sector in 2011. Of 21 companies to price in that year, 8 saw net proceeds of >$100M. Of those, just 2 were B2B companies: Jive & Cornerstone onDemand (as I define them at least). The big raises were hot consumer plays: Zynga, Nexon, Groupon, Pandora & HomeAway (LNKD as well, though with its recruiting business it’s become somewhat of a hybrid). The top 5 IPOs by proceeds were all consumer plays, representing nearly $3B in capital raised from the eager public (enthusiasm that died down rather quickly in most cases). Enterprise companies composed most (70%) of the 16 remaining smaller deals. The higher-valuation consumer companies tipped the average net proceeds in that year to $218M, a record year in recent times (~$100-150M most years back to 2007).

The point is here that despite great enterprise traction in 2012, there were still a good number of smaller deals that did occur, which wasn’t in fact a departure from 2011 (in that year, B2B just got overshadowed by frothy consumer IPOs). Even stepping back further we see plenty of precedent for the reasonably-sized enterprise IPO: Constant Contact, MediaMind, Quinstreet, BladeLogic, comScore all brought in <= $100M between 2007-2010 (nearly 20 sub-hundred deals in 2007 alone).

In large part thanks to As-a-Service billing models, enterprise vendors now more often provide a level of financial visibility that makes it easier for the public to understand even younger players. This of course applies to the successes too; Palo Alto, Workday and Splunk have all continued to trade well post-pricing, suggesting their popularity was warranted. But I’d be surprised if the flow of earlier or more modest enterprise IPOs didn’t continue on in a very strong way. It’s still a mixed bag (your 13’s vs. your 6’s), but average time-to-IPO is steadily shrinking annually as capital intensive packaged software businesses are losing market share. The JOBS Act should provide a nice tailwind, too.

Enterprise Startups: Hype vs. Reality

I find it simultaneously strange and predictable that the current hype around enterprise startups began in earnest only in Q2 of this year. Several things to clarify about that statement: (1) “strange” because favorable endemic trends supporting enterprise were clear well before this year; (2) “predictable” because the larger media / tech community only really gets going on a topic once the public markets and acquirers seem to “weigh in”; and (3) “hype” because this fervor has been driven largely by the journalistic community.

Let me be clear that I’m not denigrating venture / tech thought leaders for chiming in on a topic now that eyeballs demand it, nor tech-coverage bloggers for doing their job. A number of VCs have been presciently focused on the space for years (cf. Kevin Spain of Emergence & David Skok of Matrix). And many tech bloggers have sounded off on the space with valuable insight. But a few hundred SAI / TechCrunch articles a true market trend does not always make. I think today, a good deal of recent enterprise infatuation is shallow or misplaced.

Looking back on IPOs over the last year or so, and roughly categorizing them into enterprise vs. consumer, it’s clear why we’re now so sweet on the former. Let’s take a look at some IPOs and their performance as of about a week ago:

Maybe not the definitive list, but the point is clear. The divide in performance is staggering. Kayak is about the only winner in the consumer category here (reinforced by its recent sale to Priceline). And even that company is somewhat of a hybrid, with nearly half its sales driven from rev share deals with OTAs. Combine this with $20B+ in enterprise M&A activity YTD and you can see why enterprise favoritism in the media was a foregone conclusion. This leads us to our central question: How much of this excitement is well-placed, and how much of it is truly hype?

In my view, about half. To look at exits / stock performance over the past year and write off consumer startups (not uncommon in some form these days) is where  enterprise fanfare has simply departed from reality. There are a number of factors we can point to in explaining the success of recent enterprise exits. Usually, demand for enterprise services is signaled with cash rather than usership, obviating lengthy pre-monetization user base building periods. Often this cash comes in via recurring monthly contracts, which offer better visibility to both legacy tech players freshly acquisitive in an effort to maintain market share and public market investors (and underwriters!). Most of the time, even uses of proceeds (e.g. R&D for the frequent feature updates that SaaS products need) are clearer. These features, however, aren’t so new and have come with some trade-offs (e.g. lower margins vs. software, more frequent update requirements, etc.). Nor do they protect from many of the issues that have plagued recent consumer IPOs: a few glossed-over business flaws (Groupon, Zynga) or the harsh shift from private to public valuation (Facebook).

The truly exciting enterprise trends are defined by emerging technologies hitting stride, new blood in the corporate board room and an aging oligarchy of IT giants. The endemic trends supporting enterprise today are just now coming into full force and warrant the enthusiasm they’ve received. Reduction of development costs due to cloud infrastructure, the incorporation of faster data storage & processing technologies, the corporate need to chase both consumer & employee into new platforms like mobile / social, and the list goes on; these are the reasons I believe the next decade will be a special time in enterprise investing.

Are “Large Enterprise Sales Forces” Bad Bets?

Interesting thought from Dan Primack’s Term Sheet this morning:

Boris on micro VCs focusing on enterprise: “I think most micro VC’s (including myself) have already shifted part of their attention to B2B/enterprise software in the past year as there are better investing opportunities in that area right now (relative to consumer) - but most of that attention is given to investment opportunities that have a scalable marketing/sales approach (e.g.inbound sales teams) and do not require investment in large enterprise sales forces.”

Yes, we’re facing a “democratization of the enterprise” as line-of-business employees become enterprise services stakeholders & SMBs enter the mix as SaaS consumers. But the large corporations that control a huge chunk of enterprise spend (and not just in media & tech) aren’t going to start switching to “cadillac” tools at $100K - Millions / year on a self-serve model. I can think of one exception to this rule off the top of my head (Google AdWords), but that took the reinvention of an entire industry (online search) not to mention time.

Consider this reflection on the evolution of Business Process Management (BPM) (which most enterprise startups seek to disrupt in some way) from Phil Gilbert, VP of BPM, IBM:

A new approach to governance is the answer. How do all these tools, and the disparate assets they create or leverage, integrate in a common and comprehensive way? If we get this right, we make a huge difference to the industry.

Large enterprise consumers today (and for the foreseeable future) have a need to understand how new products will fit into their stack, and to feel that they have appropriate support during integration; enterprise sales forces (even if “large” or “expensive”) usually fill that role. I 100% agree (as Jon, another Term Sheet contributor, mentions) that capital intensiveness, deployment times and implementations costs are dropping. But when you shoot for a high ASP (Average Sales Price), you’ll usually be looking at a high CAC (Customer Acquisition Cost). Take a look at BazaarVoice, Workday & Tableau: three successful high-ASP enterprise companies at different life stages, built by experienced founders (previous CEOs / founders of Coremetrics, PeopleSoft & Beeline, respectively) who knew that selling big products into big companies required pro sales teams.

I don’t see any reason to shy away as soon as a startup mentions high-touch sales teams, commissions or outbound: they just need the right product and the right founders.

Enterprise Startup Sales Strategies: Toyota vs. Cadillac

A key, but often glossed-over concern for enterprise startups is defining method of market entry (and committing to the corresponding sales strategy). From my perspective, there are two basic models for success: we’ll call them the “Toyota” and “Cadillac” models. “Toyota” = high volume, low ASP, low CAC. “Cadillac” = lower volume, high ASP, higher CAC. There are certainly examples of companies that have blended the two, using multiple product lines, value-added services and customization (e.g. Atlassian, SalesForce). But successful, new-to-market individual product suites tend to (and I believe must) align with one or the other, due to the necessity of a linear relationship between cost of customer acquisition cost (CAC) and average selling price (ASP). 

1) “Toyota” Model

Primary Audience: Employees & Group Heads

Pricing: Tiered, sometimes freemium; higher-end usually caps out around a few thousand / month for all (or say 1/10 of that if by head); other models allow free usage until defined usage limits / types

Sales Methodology: Low-touch, self-serve, 1 or 6-mo. contracts w/out SLA, no sales team, paid adv.

Key factors for success: excellent marketing strategy (educational content, email, word-of-mouth), consumer-friendly UI and purchase path (to obviate need for sales / service calls), if any sales reps are needed they handle many customers / on-boardings, freemium / free trials, little / no need for live support

Examples: Yammer, Hootsuite, Zendesk, Hubspot, Asana, Webtrends Social, Chart.io 

2) “Cadillac” Model

Primary Audience: CXO

Pricing: Billed as “custom” & not shared on website, but generally $100K / year for licensing / sub + at least 2x that in 1-time implementation costs + (usually) “support” fees of 10-20% subscription cost
Sales Methodology: High-touch, longer sales cycles, longer contracts (usually with upfront payment)

Key factors for success: Access to top CXOs (founder has prior high-lvl. roles in relevant enterprises), well-connected “pro” sales heads w/ commissions, usually a highly developed technical product, sophistication tech / customer support staff to provide integration + ongoing support to clients

Examples: PivotLink, Passkey, Innotas, CapitalIQ, NetSuite, Marin Software, OpenText

I’m sure some exist, but sticking to one product suite, I simply haven’t seen exceptions to the rule amongst successful companies. In short, to try to do both Toyota and Cadillac, or to have an undefined plan, is asking for trouble. Enterprise startups need to choose a model that aligns their sales strategy (CAC) and target customer base (ASP), and the array of factors that drive them: technical complexity of their product, development costs, the amount of VC they plan to raise, pricing, contract types, hiring plans, firm culture, etc.

What Differentiates “Next-Gen” Enterprise Services?

The answer seems intuitive. But it is a real question for CXO’s with billion-dollar spends weighing what kind of impact new software / infrastructure / marketing tactics will bring their company, how much disruption integration will cause, etc. And the answer frames my thinking around why we’re in the midst of the rise of an unprecedented class of enterprise services.
As the status quo, “legacy” market leaders are less incentivized to completely overhaul systems that are already bringing in billions in revenue, or to tear large chunks of their teams away from their already popular solutions to focus on new age solutions. While a consumer company like Apple knows that no one will buy a new iPhone 5 three years from now, an enterprise company like Concur has long-term deals in place (e.g. recent $1.5B 15-year contract with GSA). One might call this “legacy inertia.” This leaves innovation gaps in the market that are naturally solved by startups that focus on points that complacent older players miss, driven often by:
  1. The need to address whole new consumer / employee behaviors (e.g. mobile, social, local, cloud storage, ePayments)
  2. Efficiencies enabled by recent technology (e.g. big data, machine learning, location-based tech, SaaS / software rentability, new APIs)
  3. Pure whitespace due to legacy hesitation to leap into a brand new, potentially unprofitable space (i.e. why didn’t MSFT, AmEx or Google develop the first Jive, Square or Millenial?)
In the past, it was very difficult for startups to compete with dominant enterprise players in large part due to the capital-intensive nature of developing these solutions. But the cloud stack has created an environment in which software companies can dramatically reduce startup costs, renting increasingly powerful IaaS & PaaS services to develop their own solution more quickly. In turn, these new Enterpise startups can now rent their solutions to big companies on a SaaS model, making it easier for them to try & integrate new products. In other words, both startup and switching costs are down across the board.
So “why are these new solutions better than the old”? They enable enterprises to address markets & leverage technologies that “legacy” players have either overlooked or failed to master, in a cheaper (generally) and more flexible way.