Pattern Recognition, by Ian Sigalow

Capital efficient software investing

Introduction

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Ian Sigalow

Ian is a co-founder and partner at Greycroft Partners in New York City. He has been a venture capitalist since 2001.


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Capital efficient software investing

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When I started writing this blog I put together a list of topics, and one of them was making bold predictions about a new, capital-efficient software model taking over the world.  But as often happens when I write these posts, the story took a different turn and I found myself writing about two different software business models.  There is no industry jargon for the business models I am mentioning below, and I am not attempting to coin new catchphrases, so I am using SAAS 1 and SAAS 2 for lack of a better term.  For the uninitiated, SAAS = software as a service, which is a fancy way of saying that the software is not installed on a customer’s computer but rather delivered through a web browser.  It is all the rage in software investing for a lot of reasons I can’t fit here.

So what is SAAS 1?  In a nutshell, it is a software company with the following features: large applications with deep complexity, direct sales teams that either cold call (inside sales) or directly sell customers, large account management teams, real integration requirements, 6+ month sales cycle, and customers “locked in” to annual contracts at $100K/yr price points.  Most of these companies have customers that pay about 45 days after receipt of invoice, so at scale they have real working capital constraints.  The distinction I am making is more about business model and product than underlying technology, and you can build this sort of business on any technology stack you want. 

The thing I have noticed about SAAS 1 companies is that they take an incredible amount of capital to get to scale.  Most of them don’t generate free cash flow until they get over $20mm-$30mm in revenue, and at that point the investors have likely put in $50mm in cash.  Funds like Greycroft have a hard time with companies that burn cash like Joker in Arkham Asylum.  So I am spending my time looking into other types of SAAS companies.

They companies I am most excited about today have the following features:

1.) Customers pay via credit card

Over time having zero days A/R saves companies a tremendous amount of capital.

2.) Zero integration/implementation expense

The time and cost required for implementation is the silent killer for start-ups.  This is a blog post in itself. Salesforce.com really nailed this with their AppExchange, and I am starting to see other companies use APIs creatively to drive efficiency here.

3.) Zero sales cost

B2B software marketing is starting to look a lot like consumer marketing.  This means that prospective customers see an ad, go to a website, and sign up without ever talking to a sales person.  As you can imagine this works particularly well for products that are a.) very simple, and b.) affordably priced. I have also seen an increasing number of software companies using viral marketing, just like consumer applications.

4.) Simplicity

Think back to when you signed up for Facebook – did someone from Facebook call you and offer a four day training session to on board you?  I don’t think so.  It is so easy to use that anyone from a 13 year-old to a 90 year-old can figure it out.  Good software products are built the same way, including self-service tutorials to walk customers them through the product.  Product complexity not only increases the costs of support and training, but it also increases churn, which is the biggest killer of subscription businesses.

If you are setting out to build a software company today, and you have the option to choose a path, I would encourage you to choose SAAS 2.  It will make your life easier, and given the low capital requirements chances are good that you will be able to keep a larger ownership percentage and make more money over time.

profile

Ian Sigalow

http://sigalow.com

Ian is a co-founder and partner at Greycroft Partners in New York City. He has been a venture capitalist since 2001.

Comments
  • user

    AUTHOR briancarroll

    Posted on 11:53 pm March 14, 2011.
    Reply

    I tend to think that companies in the SAAS 2 category eventually grow up to become a hybrid of the two. As you start going after Fortune 1000 customers with deeper pockets and more custom needs, you have to start developing professional services offerings, hiring B2B sales staff, and maturing the product. Part of your business becomes SAAS 1. So start with SAAS 2 baby steps, plan for SAAS 1. Phase 3: Profit.

  • user

    AUTHOR jgannon

    Posted on 11:13 am March 15, 2011.
    Reply

    You could boil all 4 of these features down to just one — #4 (Simplicity). The product must be easy to use and install in order to drive a frictionless sales and implementation process. Clearly easier said than done. 🙂

    Although you discuss SAAS here, some enterprise software companies are starting to adopt this model, with great success (e.g. Solarwinds).

  • user

    AUTHOR AustinClements

    Posted on 10:32 am March 20, 2011.
    Reply

    @briancarroll It seems that many (if not most) of the startup companies that fall under the SAAS2 category these days aren’t interested in customizing their product for large enterprise. There’s a whole generation of founders who fit the SAAS2 bill described above want to create a great product for the masses at lower pricepoints. This grassroots trend is being further fueled by the guys over at 37signals in the book “Rework.” Quite honestly a lot of these teams are actually avoiding VC funding, though I think that trend will change for other reasons. Two SAAS2 companies that come to mind are Sliderocket and GoMockingbird. They provide a web based PowerPoint replacement (doesn’t sound exciting, I know but check it out) and a wireframing mock-up program, respectively. They also have the 4 traits Ian named down.

  • user

    AUTHOR IanSigalow

    Posted on 11:09 pm March 22, 2011.
    Reply

    @jgannon congrats on the new job at AMZN. EC2 is the ultimate example of SAAS 2.0.

  • user

    AUTHOR IanSigalow

    Posted on 11:21 pm March 22, 2011.
    Reply

    @AustinClements @briancarroll It is hard to scale a SAAS company without any outside funding. There are a few examples, but they all took a long time to get to scale. And I cant think of any of them that got to $100mm in revenue.

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