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Speaker Details

Byron Deeter

Sameer Dholakia

Bessemer Ventures

Bessemer Ventures

Session Transcription

0:00 - Ray Rike

Well, welcome to SaaS Metrics Palooza 23. I'm so excited to kick off this event with two of my favorite and what I think most knowledgeable people in the industry. So with that, I'm not going to delay anymore. Here is Byron Deeter and Sameer Dholakia from Bessemer Venture Partners. It's your stage, guys.

00:26 - Sameer Dholakia

Fantastic. Thank you, Ray. I'm very grateful for the time and the opportunity to be here. As you all know, my name is Sameer Dholakia, partner here at Bessemer Ventures. You all know Bessemer has been a longstanding pioneer of how to instrument your SaaS business to really manage it. It is the way in which we steer these rocket ship SaaS businesses and really being diligent about what metrics you're tracking and how we're steering the ship is so critical. And we've been thrilled to partner with Benchmarkit and Ray for a long time now. There's a lot to dig into here. I know Byron spent a lot of time working with Ray on this in the past. Maybe I'll ask him to say a quick intro and then we'll dive right in. Fabulous.

01:12 - Byron Deeter

Indeed. It's in vogue now to talk about metrics and efficient businesses, but a credit to what Ray and the team here have done for many years. We've been collaborating for over a decade on the metrics that matter in cloud businesses. And so today we're going to dive into a framework that's fairly popular now around the rule of 40, which is this interplay between revenue growth and free cashflow consumption and net income to talk about what the efficient growth model can look like. And so we're going to dive into it from not only an investor's perspective, but importantly, an operator's guide. And we'll dive into that in more detail. But maybe just to frame it and to ask the obvious question of why does this matter and why is this so commonly discussed these days? Let's start tops down in terms of the dollars and cents. This drives valuation and not just for optics, but for real fundamental reasons, which we'll get to. But to put this in simple buckets, think of it as the class of companies in the middle here that exists within that rule of 40 framework. And then TEDx premium that they get, which is almost a 2x premium to the businesses not in that rule of 40 framework. It's a massive valuation premium that allows you to be more strategic, invest in the business and be aggressive in ways to capture, share and build long-term value. Now of course, if you're fortunate enough to exist in the rarefied era above even this framework and we'll talk about businesses in that world even more so, you see further compounding of that Delta and you can get into a well into the double digit multiples. Even in this compressed market, companies are trading at a dozen X plus in that world. But what's been interesting is how much of this has changed and how these variables differ as cost of capital and interest rates have changed. The chart on the left here is a look back to 2021. The good old days as some of you may remember when capital was cheap, interest rates were lower, valuations were high, multiples were higher. And what you had was the street rewarding growth almost at all costs. You can run the regressions and mathematically see there's about a six to one ratio where 6% change in growth was equivalent to a 1% change in free cash flow, meaning they wanted you to invest in growth and were willing to reward you out many years. In the simplest sense, think of it as six years plus for a payback curve to get that dollar of revenue. And you can do gross margin adjustments and the like, but think of that as a massive premium for the businesses that were growth minded. And it sort of makes sense. And when you run the economics, it actually mathematically makes sense that when you have low cost of capital, that the future value is something that people will pay forward for and they're willing to forego current income and short term cash flows as part of that trade off. Now, of course, fast forward to present markets, some might say they've overreacted, but when you run the regressions here, it's a one to one ratio. Literally a dollar of free cash flow is equivalent to a dollar of revenue. Now in these subscription businesses, which the vast majority of our audience run or are part of, we'll observe is that, but wait a minute, there's a trade off here where I get this money every year. And so why would I only be investing for a one year payback? And we'll talk about that. But the short answer is that as these market forces have changed so dramatically and as cost of capital has gone way up, the market is valuing current cash flow above all else. And they want to see the proof of cash flow generation and they are absolutely pushing businesses to be more efficient. Not surprisingly, you've seen many operators react with changes in their business practices to adjust. And what's really fun about the upcoming content here and where I'm going to hand it back over to Sameer is that we lived through this together, but I lived through it in the investor chair as an investor in SendGrid. Sameer was our CEO and operator who actually made these decisions in real time and was able to maximize value in a way that not only was efficient with capital through growing the business, but got to a multi-billion dollar IPO and a long standing thriving business that existed through a very volatile and changing market. And so I'll hand it back over to Sameer and let you take it away to deep dive from the operator's perspective and how to actually run a business with this Rule of Forty mindset.

05:35 - Sameer Dholakia

Fantastic. Thank you. Thank you for the TF fire. That makes great sense. And that Rule of Forty framework was really powerful for us at SendGrid. This was a chart. I've got this two by two here up on the screen that you'll see that is basically showing you on the vertical axis, you've got long term free cash flow margin and the break even line being zero. And then you've got the growth rate on the X axis, which is your long term, last 12 month revenue growth at 30 percent being the break line, oftentimes described as hyper growth above it, less less below it. And as I was first joining SendGrid, we were moving perilously close to that bottom left quadrant where the growth rate has had decelerated and was heading towards sub 30 percent growth while we were still burning a lot of capital. And clearly, as Byron indicated, these are all decisions as operators you all need to be making over a multi year time frame. What we tried to share with all employees, and we really did put this chart up in front of all of our gridders, as we call them, to help them understand that this is how investors think about the valuation of our business. And as individuals, the equity that they held in our company, the options that they had been granted, the value of those were highly, highly determined based on where on this two by two we would fall. And the basic message was, look, we can make a whole set of decisions at any moment in time to optimize to be in three of these four quadrants. You could be burning money but growing above 30 percent because you're investing for forward growth. That'd be the bottom right quadrant. You could be a slower growth company that was making money. That would be the top left quadrant. You'll see a lot of very mature at scale businesses in that quadrant. The best companies on the planet often are in the top right quadrant. As you would imagine, those that are growing really fast and making money, that's a great place to end up. Where you can't go, where we would say good companies go to die, is in that bottom left quadrant, where you are growing less than 30 percent and you're starting to burn capital. We could share with our teammates and say, guys, we love this company. We want to keep building it for many, many years to come. We can't allow for us to go this way. That helped, I think, frame for the company and all of our teammates why it was so important for us to get focused on efficiency and growth that we could then use the efficient dollars that we found by getting more optimized to reinvest in the growth. I'm going to talk about that in a second. Let me just talk about a handful of things that came up here for us. The first was, as we shared this model with the whole company in this two-by-two, all of a sudden, everybody understood how important every new incremental hire was, because that was adding to our cost structure. Unless there was a very clear ROI for the people we were bringing in and that they were going to be raising the bar, the average talent of the company was going to be going up, we were pretty stingy with those new hires in those early days, until we started to see the efficiency change. The company really got religion around that. It also allowed us, frankly, as we slowed some of that hiring pace initially, to really onboard all the folks that we had hired during the go-go days, when it was an environment that was less focused on efficiency and more on, as Bayer described, the growth-at-all-cost mindset. That was really helpful for us. I would say probably the biggest thing that we did was, frankly, just sharing this model, this visual, that two-by-two with the whole company, to really convey the message that driving efficient growth and efficiency in the business wasn't just the job of the C-suite. It wasn't just the CEO's job or the exec ELT team's job. It was the entire company. I remember to this day, we had an amazing teammate in our finance organization, Courtney Potter. Courtney said, I'm going to go drive an initiative that is called Save to Reinvest. It was all about finding optimizations and savings across the company. We went and found nickels and dimes in the couch cushions, the proverbial saying goes. That allowed us to literally save millions and millions of dollars over the course of the upcoming three, four quarters. It was in lots of different places. I'll talk about where you might find them in a minute. But getting everybody's participation in that, we would literally have teammates, employees on the team that say, hey, I think there's an opportunity to go save some money here. We could consolidate X or we could do Y. That really helped getting everybody involved. The last thing I'll say that Courtney's name was genius, which was it wasn't simply about driving efficiency. We're talking about driving efficient growth. You cannot cut your way to growth. You have to be, as an operator, if you're a CEO out there listening, you've got to be thinking multi-years out. Law of large numbers is a real thing. If you're not making investments now to support that future growth, you're going to be in trouble. You're going to see a decelerating growth rate out in the future, which nobody wants. The to reinvest part of the name that Courtney came up with was critically important. Then we really did take those savings and put them into a handful of growth initiatives, not all of which turned out to be spot on, but enough of them did that it allowed us to, in fact, re-accelerate our growth rate even faster so that we ended up pushing on that two-by-two graph further to the right. Very, very important lessons for us at Sangre. For the operators that are listening out there, I'm sure there are a number of you wondering, okay, well, let's talk through the P&L here. What are some specific things that we could do to drive efficient growth? Well, let me start on the top line, on the revenue line, back to the growth. In the Sangre example, we made a whole bunch of changes around pricing and packaging as one. This was an area that we spent a lot of time looking at. When you make those optimizations, pricing improvements, if you get a reasonable take rate, can fall straight to the bottom line. In our particular example, we were underpriced on one of our package lines. We did a whole study. We talked to a lot of customers. We did raise our prices after we added a bunch of functionality. I would always counsel you to add capabilities so your customers don't feel like you're just gouging them on price. But you're adding capability, you're adding value. We raised the prices out of, I think it was at the time, nearly 50,000 paying customers on this one package. I think we had 180-some-odd customers who churned out of 50,000, meaning 99.x% of them felt like it was a reasonable price increase. We had millions of dollars from that drop straight to the bottom line that was very, very helpful for us, both in terms of growth rate and getting rid of some of the big burn that we had. We also, as a result of these efforts to go find the savings, that we could reinvest more in our second act. I would encourage you all, if you're at a certain scale and you have the ability, if your core product line isn't delivering outsized growth—when I say outsized growth, I would say if you're sub-50, sub-75 million in revenue and you're not growing 100%—be thinking about, what is my second act going to look like? Because those are going to take three, four years to really build into material businesses. We invested a big amount into our second product line. From an email API service, which many of you may know Sengrid for, to an email marketing product, that second product ended up having outsized growth for us, 100% plus growth for us for many years, which helped, of course, drive up the overall growth rate of the business. So that's on the top line. Let's now move down into the expense areas of the business. First off, on gross margin, we got very focused around optimizing our spend on infrastructure. We looked at, in our case, our AWS bill, our Colo bills, and we would look in our software stack. What are the most expensive or consuming pieces of infrastructure software we have, and we literally would rewrite them to be more efficient. In so doing, when you're at a platform as big as Sengrid's, we were processing literally half a trillion emails a year on behalf of many tens of thousands of customers. Those optimizations ended up netting us significant savings in our infrastructure spend, which, of course, really helps your gross margin. That was a big deal. We looked at a lot of services that we were providing to our customers, and a lot of it was at a loss. We were offering it for free that our customers really valued. I would have customers tell me, hey, I love that you all are doing this for us, but honestly, we feel kind of bad. We'd be happy to pay for that service. You all deliver us such expertise, and so we introduced a set of service offerings. It took what was a negative service P&L impact and actually neutralized it and really helped our overall gross margins. On the sales and marketing line, we really were focused around unit economics. For efficient growth, you've got to be dialed into your CAC payback periods, your LTV to CAC metrics, and if you don't know exactly what those things are, please go to Vestiver's website and look on our Atlas. We have countless resources for you there to learn about all the most important SaaS metrics that'll help you navigate this particular area around go-to-market sales and marketing metrics that matter to drive efficient growth. But for us, we were really focused on, hey, it turned out in our case, we were too good. We were too efficient in our CAC payback period, which meant that we had the opportunity to invest more dollars in go-to-market, in our marketing and in sales, so that we could accelerate growth. We literally doubled our marketing budget, and that led to both increase in spend, yes, but also an increase in growth, which was very important for us. Those are just a couple examples on the sales and marketing side. I'll go into R&D. We had to really get disciplined around project prioritization. When you're focused on efficient growth, you have to be disciplined about choices you're making. You can't do it all. And in a go-go environment, when capital is free, as Byron said, and you're being rewarded for growth at all costs, you can build everything and just keep hiring engineers. In an environment like we are currently operating in, here, as I record this in the fall of 2023, I tell you, that's not the environment we're in, and you have to make hard trade-offs. Sometimes you'll find that that prioritization actually is beneficial for your engineering teams and your product teams. You'll drive, actually, both job satisfaction for them, but also impact for your customers, because you'll focus your efforts on a handful of product initiatives that are actually going to move the needle forward, as opposed to 15 or 20 small things that may not. We focused that in the R&D area. That made a big difference for us. G&A, this is an area where it takes a lot to support a rapidly growing company. In our case, we went through that line by line and tried to figure out where we could drive efficiencies. We had offices, for example, in Boulder and in Denver. We said, hey, we got to bring these two together and get some economies of scale. We did that. That was pretty disruptive to a lot of our folks who lived close to one office or the other. We did a lot to make that more seamless for them, but it also yielded an awful lot in savings. For example, in that case, we took some of the savings from that consolidation of real estate, and we put it into a shuttle bus that would take the folks that lived in Boulder and take them to Denver in a pretty easy way. You can do things like that when it comes to operationalizing these efficiencies. If you're getting savings, figure out where you can invest to make some of those savings more palatable to the people impacted. I'll also mention on G&A, sometimes you got to get into vendor line items and look for opportunities to save money. In this environment, they won't be surprised to hear you say, I need a little bit of help in this environment right now. They're often willing to do that. The last thing I'll say on efficient growth tactics as leadership teams looking at this stock-based compensation is unfortunately not often thought of as a real expense, but I promise you it has real economic costs. Be very diligent about granting those next set of options, those next set of RSUs if you're close to getting public. I will tell you that dilution and its impact on the value of the shares is really meaningful, especially when you compound that out over a multi-year time horizon. If you're a young startup, trust me, the cost of issuing a lot of equity every single year for five or six years in a row, just as there is the power of compound interest to the upside, the power of compound stock-based comp at a high level can be really detrimental to the economic cost. So I'll leave that there. I'll simply say here in terms of we talked a lot about rule of 40, this chart here has a set of metrics that we think about that are metrics that we think are kind of North Star metrics, metrics that independent of rule of 40 are for you to be a fundable business, a going concern for a long time to come for you not have to worry about, do I have enough on the balance sheet or will venture capitalists like Bessemer be interested in investing in our business? If you have strong unit economics across the metrics that you're seeing on this page, and you can see we've actually put up here what we think of as good, better, and best across CAC payback, net burn ratio, how much net new ARR can you bring into your business for the burn that you have in a given year? How much runway do you have? What growth rates can you have at different scales? Logo retention, gross dollar retention, and of course net retention, net dollar retention. These are all critically important to being able to sustain a great business for a long time to come. I'm sure you all are focused on these already. If you're not, please do. And if you have any questions about these, as I said, please go back out to and find some of these educational pieces we've got on how to run a great SaaS business. All right. Well, with that, hopefully that session has been useful for you to hear not just how rule 40 is a great framework to use to think about your own business, how that has changed over time in terms of how people weight it, but how you could actually operationalize that in your own business, working with your executive teams, importantly, working with all of your teammates to get to a more efficient growth model. And I think Byron and I would agree that as you think about the future, continue to have a bias towards growth. I think that is what will ultimately drive future value, but getting a little bit more efficient, use this time as an excuse to go get a little bit more efficient, take those savings, reinvest it for growth, and you'll be happy that you did in the years to come.

22:41 - Byron Deeter

And I just want to underscore Sameer's comments on the other content available. So much of the fun of being in this industry is working with the great executives that are watching this and within our portfolio. We've been privileged to work with now dozens of great founding teams that have taken their cloud businesses public, including Sameer and the SendGrid team, and now he's paying that forward as a board member and investor advisor. But there's a wealth of resources available that we've tried to pull together, ranging from data from our work with the public companies in the BVP NASDAQ Emerging Cloud Index, our work each year with the Cloud 100. There's a benchmarks report online that's available for that. And as Sameer alluded to, if you go to slash cloud or hit it from the top navigation, there's a whole atlas of this content, which includes the state of cloud reports, these benchmark reports. Our colleague Janelle Teng is going to do the 2023 State of the Cloud right after this with SaaS Metrics Palooza. So I encourage you to watch that. And she'll go into some of these examples where we also do white papers on the stages. So scaling from 1 to 10, from 25 to 50, up to 100. And you can map into where you are in that lifecycle journey and find the metrics and sub-details that are relevant for you at your various stages, which we hope you'll also find helpful. So thanks again for the support, for listening, and we welcome the feedback, which we do hope you'll share back with us.

24:09 - Ray Rike

Sameer, Byron, thank you so much. Do you mind if I just ask a couple of quick questions?

24:15 - Sameer Dholakia and Byron Deeter

Of course. Fire away, Ray. Don't be shy.

24:16 - Ray Rike

Sameer, as an operator at Sendgrid, with all that great success, when did you seriously get focused on Rule 40? Was it at $10 million? Was it at $20 million? Was it at $50 million? When did you start using that as a core guiding metric?

24:32 - Sameer Dholakia

Yeah, I would say the company was probably focused on it from pretty early days, not the least of which is because we had great investors like Bessemer on our board encouraging us to do so. Certainly, we got really focused on it around, I would say, $25 million to $30 million of revenue was about the time that we started to have some challenges on the growth rate. And so, as I mentioned on that two-by-two chart, if you start going left on that chart on the growth rate, all of a sudden your burn rate becomes a lot less palatable and it just doesn't work. And that's when I think we got really disciplined about it.

25:14 - Ray Rike

Okay. Then the last question is, everyone's talking about balance and efficient growth, and you gave the two-by-two. But if you're a $50 million ARR B2B SaaS company and above, is $30,000, $10,000 better than $20,000, $20,000? Is $35,000 and $35,000? Do you have any guidance for the balance of that?

25:34 - Byron Deeter

Yeah. So, I mean, it's a hot topic, especially at the various stages. Companies looking at going public are debating these trade-offs. There's a couple of things. One is, we do think that somewhere in between the six-to-one ratio and the current one-to-one ratio is actually the sweet spot over a longer-term arc and a normalized interest rate and all of that. I think the easy rule of thumb is to think of it as two-to-one, where you've got essentially a two-year payback on that investment for revenue generation. We get a little more nuanced and we do gross margin adjustments and free cash flow looks and things like that. But for the hack, think of it as two-to-one. And then there really is a magic cutoff point for later, larger companies at this 30% growth rate. And that is the public investor mindset around hypergrowth. And what you're going to see in 2024 and probably 2025 is that companies are working hard in that IPO cohort to be above the 30% growth rate and at least slightly cash flow paused. And so that trade-off, we think, will be made more and more. And certainly, if you look back historically in our portfolio, companies like Shopify were posting a rule of 70s and Quileos and others, and certainly that's possible. But we think in the new norm, hypergrowth will be defined still in that 30% plus and right around the free cash flow break-even point will be the magic crossover.

26:54 - Sameer Dholakia

It couldn't agree more. And Ray, I'd only add that if you're at that small, early stage, a $15 million startup, you are likely to be investing more for growth, and you're probably burning more. And that's great. Then that's when you go to that North Star set of metrics we had on that last slide, the unit economics, our CAC payback periods, our LTV to CACs. Is the machine working? Is my net burn ratio? Am I bringing in enough net new ARR? If those are all looking healthy, go, go, go. Keep going. Keep investing because you're creating value for your business and your shareholders.

27:34 - Ray Rike

What a great way to kick off SaaS Metrics Palooza at 23. Byron, Sameer, I cannot thank you enough and have a great rest of your day. Always a pleasure. Cheers for a great event. Cheers, guys.

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