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- [00:00]
A
Hello, I'm Ray Reich, Founder and CEO of Revops Squared and your host of the Metrics that Measure up podcast. We talk to a wide variety of B2B SaaS and Cloud Thought leaders, executives, investors and people just like you to discuss the metrics and benchmarks they use to make metrics informed decisions. Now, on to today's show. Welcome to today's episode of the Metrics at Majorette Podcast. Today we are joined by Janelle Ting, Vice President at Bessemer Venture Partners. We'll be covering four main topics from the Bessemer Venture Partners State of the Cloud 23 report with Janelle. First, recap of the cloud performance in 2022 from an equity value perspective second, current trends here in May 2023 in VC and private equity investing third, some of the key performance metrics that investors are looking at, maybe with a little bit more of a granular lens in 2023 and fourth, the top predictions for the cloud in 2023 from the report. Janelle, please take a moment to give a brief background of your journey to becoming a guest on the Metrics Major at podcast.
- [01:25]
B
Thank you, Ray. So great to be chatting with you today. Hey everyone, I'm Janelle, a Vice President on Bessemer's Growth Equity team, where I focus on Series B to pre IPO investments in enterprise software and cloud infrastructure. I'm a co author of Bessemer's annual State of the Cloud report and also work on the firm's Cloud 100 initiatives. For those who aren't familiar with Bessemer, Bessemer is a global venture capital firm with 20 billion in assets under management. We invest in many areas across enterprise software, consumer and healthcare at all stages from seed to pre ipo. We have a particularly strong track record in cloud investing, having partnered with companies in this space for over two decades now, and we currently hold the record for the most number of cloud IPOs and M&As across all US venture capital firms. So I'd like to say when we talk about the cloud, I think we do kind of know what we're doing here and examples of our past and present portfolio companies include the likes of Shopify, Twilio, Off Zero, Pinterest, HashiCorp, LinkedIn, and Twitch.
- [02:29]
A
Pretty impressive roster there. Janelle and I go way back over 20 years. Even before one of your partners, Byron Dieter, was a partner. I worked with him and he was a founder and CEO of his own B2B company. But here it is May 23rd and people are still discussing dramatic changes in cloud company valuations that happened in 2022, the SaaS occur as we call it. Right. So let's go ahead and spend just a couple minutes with that rearview mirror and specifically looking at things like equity value changes in 2022, but then quickly pivoting to are we seeing a light at the end of that tunnel now that we're in May of 23?
- [03:09]
B
Yeah, it's no secret that public cloud companies really took a drubbing in 2022 and a severe pullback event that, you know, as you mentioned, we call it the Sassacre here at Bessemer. And since the start of 2022 the BVP Cloud Index is down over 40%, which is certainly a more marked decline compared to other indices such as the S&P 500. And a main driver of the pullback was the external shock of hiking interest rates. So as we all know, within the year we moved out of a hyper low interest rate environment really at an aggressive record breaking speed. And this led to multiple compression and a significant amount of macro uncertainty. So in fact today the average forward trading multiple of the BVP Cloud index has not just normalized, it's in fact slightly reset below the trailing ten year average as well as the pre pandemic long term averages and beyond multiples. The macro instability also impacted business fundamentals and we start seeing that in the second half of 2022 where cloud companies faced many headwinds stemming from recessionary fears. So these are things like lengthening sales cycles and tighter customer budgets. But to your question about whether we're seeing glimmers of hope now at the end of the tunnel, we kicked off the new earnings season a couple weeks ago and initial signs do point toward a more optimistic environment. So for instance, Microsoft reported better than expected earnings, pointing to AI as a key area for reinvigoration. And in fact, Microsoft ascribed 1 percentage point of Azure growth to AI services. And a 1% might sound small, but this roughly translates to 400 to 500 million in annualized run rate for Microsoft according to Morgan Stanley. And the company also noted favorable feedback on its AI powered business applications. And even though we invest in software startups, we tend to look at these large tech companies and hyperscale vendors as an index for software and cloud purchasing behavior to sort of see if we can learn any market signals. And so this is all quite positive. And year to date the BVP Cloud index is currently up about 5%.
- [05:19]
A
Interesting. And I think the other thing I've been around for a while, I know it's hard to believe that I've seen other down cycles but lived through this in 2001, 2008-2010. And I take a pretty long term picture. As an investor like you, I'm sure you're looking at, you know, that 7 to 10 year horizon, but I looked at the EM Cloud and this was party report and if you take that 10 year horizon, the equity value of those companies is up almost 524% over that 10 year period versus 117% for Dow Jones. So I think we also need to look at context over a longer period than 12 or 18 months, correct, Janelle?
- [05:58]
B
Yes, certainly. Taking a longer term perspective, cloud markets have consistently outperformed the broader market, which I think is testament to the fact that the cloud model with its recurring revenue nature, low marginal distribution costs and strong net dollar retention dynamics, is perhaps one of the most attractive business models to be invented. And investors really do recognize this. And even as an example, even in the last year with seemingly never ending challenges for cloud companies, the average BVP cloud index company still grew twice as fast as the average S&P 500 company. And another fun fact is that in the Last earnings quarter, 90% of BVP Cloud companies beat consensus estimates compared to about 65% for the S&P 500.
- [06:47]
A
Even though we can kind of take this longer term view and you just gave us some great data points about how they're even performing better now than some traditional industries. The other thing I see all the time, and you included a chart in your report, is oh, venture capital funding's at an all time low, or at least an all time low measured over the last five years. Right. 2018 I believe we hit $18 billion of VC investments in Q4 of 22 versus 48 billion in Q4 of 21. So what's your perspective on do you see a little bit more positive momentum in Q1 23 and do you see that picking up in Q2 23, especially with the AI and large language model phenomenals happening?
- [07:30]
B
Yeah, this is an interesting question and we actually have some fresh hot off the press data for this. I think VC funding markets tend to mirror the public markets a little bit. And as we saw with the public market pullback last year, VC funding and private funding also pulled back with Q4 2022 being the weakest quarter of VC funding since 2018. And this, at least in our industry was really quite a stark contrast to the record year of funding deployment in 2021. And we did receive the latest Q1 2023 data from Carta this week which showed that the declining trend is still actually continuing into 2023. So the venture market is on pace for a second straight year of declines. And across this is across all stages, Carta actually logged 906 venture capital investments in Q1, ending a streak of 21 consecutive quarters in which deal count had reached at least over 1000. So that's a 35% decline from Q4 2022 which is the largest quarter over quarter dip since 2016. And I think what that means is there is a little bit of a lag where folks who are investing now it may take a few months or even a quarter or so to announce new fundings. So Even though the Q1 data kind of shows that declining trend is continuing, I do think with a lot of the renewed optimism in generative AI, we might see some of the VC funding pick back up starting perhaps in the middle of the year. So I do think that although the trend is showing declining data, I do think we'll see that perhaps turnaround later in the year.
- [09:08]
A
Okay, hot off the press, the number of venture backed deals in Q1 23 was down. What about the value? We were $18 billion in Q4 22. Was that also down?
- [09:20]
B
Yeah, I think it was also down as well. Yes it was. Oh well, it was closer to about 20 billion which is if you compare it to the same time last quarter was actually a stark decline too.
- [09:32]
A
Got you. Thank you so much. Sorry to ask you something that because you forgot had everything up the top of your head so far. But what was interesting, it's the last rear view looking right? Because I don't like looking backwards. I'm one of those optimistic entrepreneurs. It's going to get better in the future. Just how quickly and you ask, you have 60 kind of professional investors within Bessemer that they do VC investing every day and I think you asked a question, what time period over the next 6 12, 24 months do they think will be kind of the best time to to see a re acceleration of VC investing? Could you share a little bit of what the data told you, Janelle?
- [10:10]
B
Yeah, great question. And this is a top of mind question for a lot of the founders that we work with. Cash Runway Management is top of mind for them since the days of easy money are over and now there is a lot of uncertainty around fundraising outlook for the next round. I think this question is especially pertinent for many of growth stage companies, which is the stage I focus on since exit windows for IPOs and M&As have stalled a bit as well. So managing Runway and sort of thinking about when to raise money is truly a matter of survival here. And to answer this question, we polled our 60% BVP investment team, and to be quite frank, the responses were actually all over the map. So essentially, I think the takeaway is that it is very tough to try and time the market. But what is clear is that we're unlikely to return to the boom times of 2020 and 2021 anytime soon. So if you're waiting for sort of a bubble to reemerge, I don't think that will happen anytime soon. And in general, we're advising founders that the best time to raise money is one, when you don't need money and two, when you can get it. So this way you're really in the most powerful position possible in negotiations and certainly have more optionality in these discussions.
- [11:23]
A
And I encourage everyone to go read the State of the Cloud report. But what I found very interesting, Janelle, was that 45% other people said that second half, 24 would probably be the best time to raise money. And that's still a little over 12 months away. And a lot of the customers I work with, which are early stage, kind of series a, Series B CEOs and CFOs, I talk about operational efficiency and the metrics that kind of both measure historically what you're doing and the leading indicators that can get you in a better position six 12 months from now. So I'm like, don't worry too much about what the value and ability to raise money if you've got 12 to 18 months. Runway, let's focus on increasing operational efficiency because when you do go out to raise money, the venture capital is going to look at this and say, wow, you really decreased your CAC payback period. You've increased your nrr. But that's where I wanted to go next. Are there or what are the metrics right now here in 1H23 that Bessemer is really looking at to say make sure you have your house in order and understand how these operating metrics are performing?
- [12:31]
B
Yeah, we aspire to be long term partners to our founders. So our philosophy and the metrics we look at really tends to be quite consistent in terms of what we look for in good times as well as bad times. So we're looking for category creating businesses that will define the next century of how we live and work, and companies that have demonstrated really sound fundamentals around capital and operational efficiency. And I know you, you lead a podcast called Mechanics Metrics that Measure Up. So I know you care about, you and your listeners really care about metrics. And we define fundamentals very specifically using a few key metrics such as ARR growth, CAC payback, CLTV to CAC retention and efficiency score. And I like to dive a little bit deeper on efficiency score because I would say following the Sassacre of 2022, the cloud world really has shifted from the age of excess to the age of efficiency. So the paradigm of growth at all costs, which was quite popular in previous bull market years, is now certainly over. And we've seen companies be more concerned about efficient growth, which means growth at optimal costs. And at Bessemer, we define efficient growth based on a metric called efficiency score, which we define in two ways, really based on the stage of the company. So for earlier stage startups under 30 million in ARR, we look at net new ARR over net burn and the best in class benchmark there is over 1.5. And so for companies over 30 million ARR, we look at ARR growth plus your free cash flow margin with a combined percentage of 40 or more as the target benchmark. And this is commonly known as the rule of 40 in the world of SaaS. And so you'll notice in both definitions we look at a growth component in relation to a profitability component. We really do this to contextualize the relative trade off between growth and burn for cloud companies. In some ways it's unfair to harshly judge fast growing startups, especially sort of category creators early in their growth journey for being cash consumptive rather than cash generative, since they're actually making real fundamental, foundational long term investments to help them scale. But it is important even for startups to observe whether your growth in top line revenue effectively reflects the dollars funneled in the business because you want to make sure that your business really is growing along an optimal frontier.
- [14:56]
A
Yeah, I really like the efficiency score because that's looking at your kind of operating cash flow in a way too, even though it's not a pure cash flow. It's interesting. Rule of 40, right? I'm a founding member of the SAS metric standards board and we're just getting ready to publish the Rule 40 standard. And it's like, do you use ARR growth or GAAP revenue growth? Do you use EBITDA or do you use free cash flow percentage? So you're using, let me make sure, ARR growth plus free cash flow percentage, correct?
- [15:26]
B
Yes, that Is correct. And you know, there's a lot of controversy, I think around that free cash flow metric for profitability. I think in some ways we, a lot of us understand that metric can be fudged a little bit whether using, you know, a stock based, remember we stop or adding back stock based compensation. And it also is dependent on your cash billing cycles of when you recognize cash in your contracts. And so I think it can be fudged a little bit. But I would say free cash flow margin is very important for startups because it really does demonstrate that if you have excess dollars there, you can funnel these back into investing. And as you mentioned, if you are negative free cash flow that impacts your cash Runway, which again impacts your survival and when you might need to raise again. So as a sort of high level rule of thumb, we like to use free cash flow margin for our fast growing startups versus I think for more public companies or more mature companies. You might be using a different kind of profitability metric.
- [16:23]
A
Janelle, you said something. I just want to make sure I clarify this for the listening audience because people often ask me when's the rule of 40 really a relevant metric? Right. So what I heard you say is it's more relevant to greater than 30 million ARR companies. From your perspective, is that accurate?
- [16:41]
B
Yes, because I think with the smaller companies under 30 million error, we then as we talked about tend to use net new ARR over net burn because at the time those companies are a lot of them are still investing in foundational things to build their business. And so they tend to be negative free cash flow at that point. And it's hard to there's such a small scale where that number can actually distort their rule of 40 score which is why we use a different kind of metric but it still measures the same thing where it is contextualizing growth to profitability. Trade off.
- [17:13]
A
Yeah. The best way to have a rule of 100 is be a 1 million AR company growth 250%. You can lose 100%. You're still good. Exactly. So I knew we couldn't do this in a 30 minute session. So I'm going to ask you one more question about growth versus profitability. We're going to end this first half, then we're going to go ahead and do a second episode. You okay with that, Janelle?
- [17:33]
B
Sounds good.
- [17:35]
A
So you used a phrase that honestly I don't think I ever want to hear it again. And that is growth at any cost. Right, because you know, everyone talks about it but you did an analysis and a report that I really love. And it looked at the balance of growth and profitability and its impact on really company value, enterprise valuation. Can you share with the listening a little bit about how that trended? I think you look back at like late 21, late 22, and then today and show how you may be thinking you knew what was going on six months ago, but it's already changed.
- [18:11]
B
Yeah. Cloud leaders, including many folks listening to this podcast, are now really carefully balancing the trade offs between investing in growth or driving towards that path to profitability. And so we came up with a heuristic to help our founders really contextualize the trade off. And this heuristic is mapped to public market sentiment. So at the height of bull market exuberance, so this was at the end of 2021, we saw that a 1% improvement in revenue growth had the same impact on cloud valuations as a 6% improvement in free cash flow margin. So what that meant is that revenue growth was more important from a valuation perspective than profitability by a factor of six. So I think it's hard to blame operators then for saying, yes, I'm going to drive growth at all costs because I'm rewarded six times more than if I had driven profitability. But then as we know, the market really turned abruptly and just within the year in late 2022, this ratio moved closer to one to one and even tipped slightly in favor of profitability at some points. And today, with more macro stabilization, this ratio stands at 2 to 1 still in favor of growth. So a 1% improvement in revenue growth has the same valuation impact as a 2% increase in free cash flow margin.
- [19:31]
A
Well, thank you for sharing that because I think for the entrepreneurs out there, yes, we want to get rid of growth at any cost, but we also can't have profitability at any cost because growth now is already back to that 2 to 1. And it's interesting, we look at the R squared, which is logistic regression kind of coefficient, and a year and a half ago, the enterprise value impact of rule 40 was like a 0.08 to 0.12. So and growth was 0.52. Now the rule of 40 is about a 0.42. So it's still very important. It's just a different way to look at what you just looked at. But what we're going to do here, Janelle, we've talked a little bit about what has been happening and the investment look for the future. But what I really am looking at forward to is getting involved in the top five predictions that you made in State of Cloud 23. So we're going to wrap up this episode and we're going to have another episode. We're going to talk about that. So thank you for coming back to the next episode. Awesome.
- [20:31]
B
Thank you, Ray.
- [20:32]
A
And to our listening audience, thank you so much. It would mean the world to us. If you're enjoying the conversations we have with great guests like Janelle Tang at Best of Our Venture Partners, go ahead and subscribe to the Metrics Major at Podcast in your favorite podcasting app. Go ahead and give us that five star rating. And the reason we're asking for that because it amplifies the distribution so your colleagues and peers can also hear some of this great content like Janelle shared today. And please come back to this next episode with Janelle where we're going to be talking about the top five predictions from the Bessemer Venture Partners State of the Cloud 23 report. Thank you everyone. Thank you Janelle. Thank you for listening to today's Metrics to Measure up podcast. If you would like to learn more about B2B SaaS, metrics and benchmarks, please visit revopsquared. Com.