SaaS Musings

“Software as a service”

This is the direction tech has been heading for a while. Software as a service (SaaS) is pretty much exactly what it sounds like – software is sold by subscription and delivered to the user on-demand. This is as opposed to the traditional, product-based method of selling a single piece of software (i.e. the actual executable) to users, with updates coming months (or years) apart. SaaS is generally accessed through a web client, and centrally hosted on the provider’s servers – also known as cloud-based software. It’s not an entirely new idea, but it’s one that’s recently taken off – big time.

SaaS businesses have many admirers, both among entrepreneurs and investors. The idea that you can sell a subscription and have a generally accurate forecast of your revenue and cash flow has been attractive to buyers like Thoma Bravo, in their recent acquisition of T2 Systems. There are, however, downsides to SaaS businesses – as there are with any business.  If a company is aimed at enterprise selling, as is the case with much SaaS, it can be a complex sale and a very long sales cycle, and one quite unfamiliar to many founding teams.

At the end of the day, we at Sway Ventures always put teams first when we think about investing.  Great companies come from great teams – not business models or markets.  We also spend time looking at the tech M&A space, which SaaS businesses have been in large part responsible for accelerating. In 2016, we saw 764 deals in the SaaS space – up nearly 30% from 2015’s 601. A part of this push for larger deals could be that more established companies are looking for ways to ensure they stay ahead of the shift to cloud computing – the way the software world works is changing, and if the big guys don’t get on board, they’ll be left behind (just like good ol’ Kodak). We saw Oracle buy NetSuite for $9.3 billion at a 10x multiple on revenue. Verizon also bought Fleetmatics for just over $2 billion – a 7x multiple on revenue.  So what is Google doing in the SaaS market? According to Forbes, they’re becoming much more aggressive in the cloud. Their Google Cloud Platform has been estimated to be drawing $750 million in revenue, and their recent acquisitions and integration of cloud platforms Orbitera and Apigee show their commitment to staying ahead in the field.

I always get questions from great founders about what factors come into play when larger companies make acquisition offers.  Really the question is this: if the founders and shareholders have agreed to sell, then how do you maximize shareholder value on exit?  We’ve seen the highest multiples when the seller had a technology or engineering team that was simply exactly what the larger company happened to be looking for, considering their bigger picture. While it isn’t a SaaS business, it’s helpful to look at Oculus.  When Facebook bought Oculus, this was really not about the acquisition of revenue.  This was about the platform that will hopefully over time be the leader in VR.  Eugene Chung, founder of Penrose Studios, a “Pixar-esque” VR production studio, was formerly at Oculus – and it’s been a pleasure for me to see him take the lessons he learned from Oculus to think about how to create the next generation of storytelling.  As another example, RelateIQ was a SaaS business acquired in 2015 by Salesforce for close to $400 million. We had the opportunity of being an investor with that team.  This company was something that was fun to watch – great teams just going after a vision. They knew that mobile was something that was lacking, and that Salesforce was too cumbersome for small to medium sized businesses.  Salesforce paid a premium on revenue for that team and their approach to solving hard problems.

If I were to summarize things that could be important to eventually building and selling SaaS business – first and foremost, always focus on team. Build the best engineering culture you can.  Building a team and an engineering culture that will sustain is HARD, and the public markets and acquirers will reward you for that.  Second, focus on the white spaces that larger companies are not solving, or especially those that personally frustrate you. This could end up being a must-have for a larger company.  Finally, the type of business you have can mean a lot. I think you can build a great business focused on any vertical, but the Internet of Things (IOT) is a fast growing vertical.  Seamless machine-to-machine communication will drive a lot of change in the coming 5-10 years.  We are also extremely bullish in the developer tools space; it still fascinates me that the core of the current technology revolution revolves around building great software. Engineers need better tools and resources to help eradicate the inefficiencies and disrupt industries.