Weekly Update: Activists Take a W in SaaS
Weekly Update: Activists Take a W in SaaS
Highlights from SaaS & VC & Markets from the week of 2/27
It was a good week for the markets, ending a three-week losing streak. The WCLD rose 5%, closing at $29.69.
Although I’m puzzled as the economic news indicated that the economy continues to run hot:
Data this week showed continued labor-market resilience in the US, supporting the case for the Fed to stick to its tightening policy, a theme that had pushed almost every major asset into the red in February.
Higher rates ought to be a negative for asset prices & markets, but that relationship was not evident this week. It’s worth noting that rates are already quite elevated. Yields for 10-year Treasuries stand at 3.958%, approaching highs last seen at the market lows of last November. Yields on 2-year Treasuries are 4.861% — this week they reached levels not seen since 2007.
The Fed is likely to continue hiking, but by how much? Former Treasury Secretary and inflation hawk Larry Summers is advocating a 50 basis-point hike:
It’s hard to imagine that markets would stay buoyant if the Fed takes such a hawkish stance at their next rate-setting meeting, scheduled for March 21-22.
The slings and arrows of macroeconomic fortune have dominated public SaaS stock price movements over the past year. This week provided a welcome respite, as micro factors such as quarterly earnings results drove stock performance.
On a positive note, Salesforce.com announced a strong “beat and raise” quarter, boosting the stock 14% on the week. Altimeter Capital’s Jamin Ball provided a great summary:
Salesforce’s quarter & the market’s reaction proved a big win for oft-maligned activist investors such as Elliott Management, Starboard Value, Third Point, Inclusive Capital and ValueAct. They have been building a large position in Salesforce, pressuring CEO Benioff to make big changes.
While I don’t think activist investors are always in the right, I think it’s usually a mistake when CEOs fight them. To his credit, Salesforce CEO Marc Benioff has worked to engage with the Activists at the Gate, even praising them for being helpful. In what is probably a first in the history of the universe, Benioff compared the activist investors to ice cream flavors:
“It’s kind of like going to an ice cream store,” Benioff told Barron’s Andy Serwer. “They’re all different flavors. And they all have different kinds of characteristics. They have different levels of expertise.”
Benioff is arguably the greatest marketer in the history of the software industry. He’s still got it.
Another public SaaS company with a legendary CEO is Snowflake, helmed by Frank Slootman (more in Podcast Rec section below). Unlike Salesforce, Snowflake had a lousy quarter, which pushed their stock price down 6% on the week:
Even with the stock price down, Snowflake is still valued at 14.5x forward revenue. Which seems reasonable given their remarkable combination of strong growth & cash flow.
Given economic concerns, Snowflake’s usage-based pricing model has been under pressure. Many of their enterprise customers have been pruning usage to lower costs. In contrast, Salesforce relies largely on a seat-based pricing model - which appears to be more resilient to cost cuts.
This has inspired debates about the merits of usage-based vs seat-based pricing. Shomik Ghosh of Boldstart Ventures (a great Twitter follow) had an insightful discussion on the topic in a recent podcast interview with the aforementioned Jamin Ball. I think Shomik’s take is spot-on:
Deal(s) of the Week: AI Startups Funded at Ludicrous Speed
Pre-revenue AI startup Character.AI is raising $200m+ at a $1b valuation from Andreesen Horowitz.
There is an expression in investing called “playing the AUM game.” This means that an investment company, such as a VC firm, has raised so much money across multiple funds that it can make bazillions from management fees alone. A16Z, for example, has $35b+ under management. Applying a typical 2% management fee, that’s $700m+/year in revenue. Even with A16Z’s large team (565 on LinkedIn), they are making hundreds of millions of profit every year before they get a dime from performance-base fees (ie carry, the income that comes from making returns for their investors, the LPs in the fund).
Let’s compare Character.AI’s round with another hot AI startup’s fundraising. Langchain, which has rapidly built a huge following for its open source AI tooling, is raising what’s rumored to be a 10m round from Benchmark at a 50m post-money valuation.
Like A16Z, Benchmark Capital is a top-tier VC fund. Unlike A16Z, Benchmark has resisted the opportunity to raise more and more, larger and larger funds. Their recent fund is $425m. They have a single fund that is for early stage investments. They have no crypto funds or growth funds or AI funds or MIA funds etc.
Given it’s a lean partnership, I’m sure that Benchmark partners make a comfortable living from management fees. I’m also sure that Benchmark partners expect that the vast majority of their compensation will come from carry.
It will be interesting to see which AI startups do better, the ones that raise pre-revenue mega-rounds or the ones that raise modest rounds at the pre-revenue stage. I’d bet on the ladder.
It’s also curious to me why more founders don’t seem to notice when their VC investors will make a windfall just for showing up by playing the AUM game. Personally, I would rather have investors who are more strongly motivated to focus on generating big returns for their LPs.
Podcast Recommendation of the Week: Doug Leone on Invest Like the Best
Doug Leone is one of the true legends of the venture capital industry. He was co-lead partner of Sequoia for 16 years, then the sole lead for 10 years, stepping down in 2022.
This podcast covers his compelling personal story of overcoming a tough immigrant background to find success in tech sales and then at Sequoia. But what I enjoy most from the interview is his perspective on what makes for successful founders & startups. One theme he emphasizes is the importance of simplicity. For example, startups should be able to concisely describe what their product does - ideally in just a few words. The majority of seed stage startups that I speak with have yet to find simplicity in their messaging - it’s not easy!
Leone also talks about some of his all-time favorite CEOs, such as Frank Slootman, CEO of Snowflake (formerly of ServiceNow). For those not familiar with Slootman, please give this a read.
Reading Recommendation of the Week: OnlyCFO on Tricking VCs
OnlyCFO has a gift for writing with clarity and humor about somewhat esoteric accounting and financial topics. This also makes OnlyCFO a great Twitter follow.
Despite the facetious title about “tricking” VCs, the post from this week offers many helpful insights for SaaS founders who are not interesting in deception:
How GAAP calls for capitalization of software sales commissions and how this can artificially inflate profit, particularly for high-growth SaaS startups
Expense categorization of customer success - should be in COGS (hurting gross margins) or sales & marketing (hurting CAC efficiency)?
A big takeaway for SaaS founders is that it’s critical to know the basics of GAAP accounting applies to software businesses and how it differs from cash-based accounting.
Also, I would add that GAAP can be downright misleading for truly understanding the health of a high-growth software business. For early stage startups, it’s much better to be running your business off a cash-based mental model of accounting. But it’s also important to be familiar with GAAP, given its status as the accounting law of the land. Subscribing here is a good place to start.
