By Nick Mehta – CEO, Gainsight
[Special thanks to Ajay Agarwal at Bain Capital Ventures, Nakul Mandan from Audacious Ventures, Roger Lee from Battery Ventures, Jeff Lieberman from Insight Venture Partners and Byron Deeter from Bessemer Venture Partners for their feedback on this post]
It’s an incredible time to be in SaaS. I don’t know if a day goes by without another SaaS company announcing a fundraise valuing them at more than $1 billion.
“Unicorn” is a term intended to connote something rare – but now it’s become commonplace. As investors strive to find the next “decacorns,” companies such as UIPath or Snowflake, they are naturally bidding up the valuations of earlier stage SaaS companies, as well.
Today, young startups are getting valued with the assumption that growth will continue unabated. I’ve seen companies at $1M ARR (or thereabouts) getting valuations of $400M to $600M. Those that have made it a bit further (e.g., $10M ARR) are already getting minted as new unicorns.
As this dynamic plays out in the SaaS market, the question is, what is the right “play” for entrepreneurs who just raised a round that is, perhaps, slightly ahead of your company’s reality?
Who Invited This Buzzkill?
Now I know you are currently on a high, having just closed a round that’s probably way beyond what you imagined. Your company is growing fast and you really believe in what you do. Your hypergrowth can continue for a long time. It worked for Shopify and Twilio – why can’t it work for you?
I hope you buck the odds – that you are right! But for now, I’m going to explore all of the potential futures, so you can prepare. As they say, “plan for the worst and hope for the best.” Right?
The New Logo Wall
Remember that not all growth is persistent. Growth rates often slow down.
This happens because all markets have a relatively fixed number of buyers that are “in-market” during any given year. In the early days, you could lack awareness, so your new logo count will rise rapidly, year over year. Eventually, your new logos can hit a wall and flatten out. New geographies, products, verticals, and channels may mask this effect, but it’s still undeniable and real.
If you can’t find those new growth engines and your new logos stall, prepare for a long climb over the wall. As your growth rate drops, your valuation multiple will fall significantly. You might be treading water for several years before you get back to your original valuation.
Who the Heck Are You to Write This?
I am not a venture capitalist. I couldn’t even play one on TV. Besides, I don’t own nearly enough Patagonia vests. As the CEO of Gainsight, however, I’ve met thousands of SaaS CEOs over the years who have gone through the growth journey. And given our role in Customer Success, we’ve seen the analytics close up of most major cloud businesses.
More personally, I have gone through this journey myself. In particular, I became an unwitting friend with the New Logo Wall just a few years ago.
Early on, our target market here at Gainsight was primarily “SaaS companies with CSM teams.” We were “fishing in a small pond.”
As such, while our early growth was strong…
- ~$1M ARR
- ~$5M ARR (5X)
- ~$15M ARR (3X)
- ~$30M ARR (2X)
…eventually we hit the wall when new logo growth slowed. $30M went to ~$48M. We started maxing out in terms of market growth. And we were 70%-ish of the total market for what we do, so we couldn’t grow any faster by taking market share. We were stuck.
Over the next few years, we felt a bit like zombies as we grew into our inflated valuation. We went through leadership changes and tried new go-to-markets. We had trouble fundraising. Potential investors who used to say, “I’ve been following your company for a long time and I’m a huge fan,” stopped replying to emails. It was rough.
Finally, you know what helped? Time. The TAM caught up to us. We started accelerating again. We added more products. We grew our average spend per customer. We weren’t in the hypergrowth phase anymore, and we crossed $100M in ARR. We became the proverbial and cliched “unicorn.” We made it over the wall, though perhaps with some zombie PTSD.
Escaping the Walking Dead
I can speak from experience that zombie life isn’t “awesome.” Some potential side effects include:
- Extra Baggage: Your valuation becomes excess weight to carry, as you know you have a long way to go to live up to it, especially with slower growth than you planned.
- Morale: People inside and outside of the company begin to feel that something is wrong. Employees start looking at their 409a option valuations and wonder if they will ever make any money from their stock. Some may even begin to leave.
- No Exits: Potential outcomes that might be attractive in a vacuum are prohibitive due to preferences and the last round’s valuation. If you’ve raised a large amount of money, and you have no incentive to sell, you might go years trying to get back to a “real valuation” above your last financing event.
- Spiral: Worse yet, you could get trapped. If you burn money like you planned and didn’t grow as predicted, you could have a tough time funding your company. If you go too far into debt, you could lose it all.
So what’s a new unicorn to do?
The Entrepreneurial Plight
The current environment might feel, in some ways, like the famous Kobayashi Maru simulation from Star Trek. Per Wikipedia:
The notional primary goal of the exercise is to rescue the civilian vessel Kobayashi Maru in a simulated battle with the Klingons. The disabled ship is located in the Klingon Neutral Zone, and any Starfleet ship entering the zone would cause an interstellar border incident. The approaching cadet crew must decide whether to attempt rescue of the Kobayashi Maru crew—endangering their own ship and lives—or leave the Kobayashi Maru to certain destruction. If the cadet chooses to attempt rescue, the simulation is designed to guarantee that the cadet’s ship enters a situation that they will have absolutely no chance of winning, escaping, negotiating, or even surviving.
In other words, it can feel like a no-win situation. If you don’t raise money at these incredible valuations, you might pass up a chance to take your company to the next level. If you do raise money but end up hitting a growth wall, you could end up stuck.
The answer, upon reflection, is clear. Take the money. But be prepared to game plan for lots of potential scenarios in the quarters ahead.
Team: Build the Team to Grow Into Your Valuation
Your company is now priced and poised for perfect execution. As such, you need the team to execute flawlessly. Practically, this means your leadership needs to scale the business many times to grow into your new funding status. The typical question might be, “Can this VP handle a team double the size?” Now, you should think, “Can this VP handle a team 10X the size?” You need to think even larger than average in terms of executive expectations.
Scoreboard: Pick the Metrics to Look Ahead
Right after your big round, make sure you have the metrics in place to see if you are about to hit the wall. From a fundraising point of view, you might want to show your company’s amazing growth of total ARR. I will confess that I focused on total ARR growth for too long myself. But the leading indicator of a potential stall is “new logo ARR.” How much ARR are you adding from new logos each quarter? Is that continuing to grow rapidly? Note that, in our experience, solutions with fast time to value tend to scale in logos quickly, while those with longer adoption cycles might have a slower path to logo growth.
In addition, customer expansion, tracked in the form of Net Retention Rate, becomes even more critical with a high valuation. Is your NRR continuing to scale as your business does, or Is it flattening out or, even worse, dropping? If new logos slow, NRR is your best hope.
Finally, remember that the only way to destroy a SaaS company (besides running out of money) is to mess up on retention/churn. I’m biased since I run Gainsight—and I’m right. If you don’t get Customer Success right, that’s one of the few surefire ways to take your company from a hero to a zero. Luckily, this is something we focus on a bit at Gainsight!
Gameplan: Don’t Spend It All In One Place – Or In One Year
With your new pile of money, I have one critical piece of advice: don’t spend it. The most dangerous thing you can do is to deploy all of your hard-won capital too quickly and not get the growth to show for it. At that point, if you want to raise money again, it will be challenging. And the situation will be dire if the capital markets have softened. The truth is that no investor will want to follow a late-stage hedge fund who invested in your company at a sky-high valuation if your company isn’t crushing it.
Offense: Start New Growth Engines Early
Most companies’ first products cap out at some point in terms of new logo acquisition. As such, forward-thinking entrepreneurs create “second acts”—new engines of growth. This movement could involve adding new products, making acquisitions, addressing new segments, or going after new markets. If you wait too long, the new bets are too small to affect your company, and you end up running out of time. So, start early. For Gainsight, our multi-product Customer Cloud strategy became an extensive part of our acceleration strategy.
Defense: Be Proactive If Growth Slows
If you see the slowdown coming, proactively pull in spending to be more aligned with your new growth. That way, you always have a trove of cash, and you won’t get stuck. Luckily we were able to navigate this well by mainly holding expenses flat for several years.
At some point, if growth starts getting into the “high” versus “hypergrowth” scenario, build a path to profitability so you can get to the “Rule of 40.” Companies with good growth (e.g., 20%+) and some profitability can still trade at very high multiples of revenue. For example, as of this publication, publicly-traded cloud contact center company Five9, with a rule of 40 score of 41 and 33% growth in the last 12 months, is currently trading at 23.1 times forward revenue.
Special Teams: Culture and Patience Are Key
There is no doubt you will lose employees if you hit the wall. The folks who are optimizing for the same wager as investors will (and should) go to the next early-stage company. There they will put more “chips on the table” in the “decacorn” gambling game. But some of your teammates won’t focus purely on the speed of the outcome. Some will believe in your culture, your product, your customers, and your mission. Take excellent care of those teammates above all others.
And take care of yourself.
Sometimes, Twitter can make us feel like everyone else is racing past us. There are undoubtedly near-overnight success stories in tech—Coinbase, Zoom, and the like. But there are 100 times (or more) businesses out there who are slogging it out each day. Everyone’s success from the outside might look like it was “up and to the right.” From the inside, most entrepreneurs feel like Sisyphus pushing the rock uphill every day.
While Gainsight has been incredible and satisfying beyond words, it was certainly a grind sometimes, especially in the middle years. But I constantly asked myself the same set of questions. One, in the future, will customers of our vendors have more power or less? Two, in the future, will these companies need to focus more on Customer Success or less? I always came up with the same answer—our future is inevitable. We just had to be around when it happened.
To Win the Super Bowl, Stay in the Game
I don’t want this post to be a buzz-kill. If you are early stage and getting offers at crazy valuations, raise the money and be proud. Maybe you are the outlier. Perhaps you will be the next Twilio or Shopify.
No matter what, you have a chance to build a terrific company—even if it’s not the all-time highest-growth-ever one. Hopefully, the learnings and insights I offer you help you attain your goals, regardless of if it takes longer than planned. If you believe in the destination, be patient, and you will get there.
