219. Crisis Coverage w/ Tomasz Tunguz – SaaS Strategies, Sector Data, and the $ Ceiling for Deals over Zoom

219. Crisis Coverage w/ Tomasz Tunguz - SaaS Strategies, Sector Data, and the $ Ceiling for Deals over Zoom
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Tomasz Tunguz of Redpoint Ventures joins Nick on a special Crisis Coverage installment to discuss SaaS Strategies, Sector Data, and the $ Ceiling for Deals over Zoom. In this episode, we cover:

  • September of 2015 was the last time we had you on the program…  bring us up-to-speed on major milestones and changes since then?
  • Has your thesis changed at all?
  • Aside from the effects of the pandemic now, what has been the biggest change in SaaS investing since then?
  • Lots of varying advice from so-called experts… some suggesting to deep cuts across the board, extend runway out for a few years… others saying now is the time to lean-in, expand and take advantage of opportunities that are created by the crisis.  You put together a pretty simple two by two decision-matrix for startups.  Can you talk through this and how you’re providing different counsel to startups in different positions?
  • If you’re vetting a startup for a Series A that has benefited from the crisis, how do you disentangle or segregate temporary or non-sustainable revenue sources from the steady-state?
  • Have you adjusted your vetting criteria or expectations around metrics due to the crisis?
  • What’s something you look for and analyze that is less common?
  • What’s your take on situations where there is an agreed MRR but the contract is structured such that the bulk of the contract value is paid upfront.  On one hand is a great boost to working capital but how do you look at that from an MRR standpoint?
  • Any tactical advice for founders/sales teams w/ regards to structuring new customer contracts in this environment?
  • Is there a maximum $ contract size that you think can be closed over the phone?
  • To determine the sectors impacted most by COVID-19, you looked at Roger Lee’s data on Layoffs.  We’ve discussed a lot of the impacted sectors anecdotally here on the show… according to the data, what has been impacted most?
  • Are there some sectors where we’ll see a lagging effect… due to factors like sales cycles maybe we don’t see the effects yet but will over the coming quarter or two?
  • You’ve discussed sectors and categories that this crisis might accelerate… aside from the obvious like teleconference, telehealth, grocery delivery, video streaming, etc… what are some non-obvious areas that may get a big boost?

Guest Links:

Transcribed with AI:

0:03
welcome to the podcast about investing in startups, where existing investors can learn how to get the best deal possible. And those that have never before invested in startups can learn the keys to success from the venture experts. Your host is Nick Moran, and this is the full ratchet.

0:23
Tomasz Tunguz joins us today from San Francisco. Tom is a partner at red point where he focuses on early stage SAS data and infrastructure investments. Tom writes a fantastic blog at Tom Tom news.com. And he’s co author of winning with data. Tom, welcome back to the show.

0:38
Thank you so much for having me, Nick.

0:40
So it’s it was September of 2015. If you believe it last time, we had you on the program. Wow. That’s crazy. Yeah, almost five years. You know, bring us up to speed. What are what have been the major milestones since then, or major changes for you? Oh, it’s

0:55
been good. I guess I’ve hit 12 years in the venture business this man. We sold liquor to Google last summer, it was a great outcome for the firm and just an amazing journey with the founders. Since then, red points come a long way. We brought in two new general partners at the early stage one is a man named Alex Bard, who founded four companies sold the last one the Salesforce then ran a Service Cloud, which was the largest division of Salesforce and then ran a company called Campaign Monitor before he joined us. And then a wonderful woman named Annie Caterpie, who was a TRV, then was an Uber freight help that grow from zero to a couple billion very quickly and then joined us. And so it’s been it’s just been awesome. Working with the team of red point and all the great companies in the portfolio.

1:39
Awesome. So that the looker acquisition, I think that closed earlier this year was that 2.6 billion to Google. Yes, that’s exactly right. Congratulations on that. I remember you talking about Looker, specifically on the show many years ago.

1:53
They all the credit should go to the team. They did a phenomenal job. They had 27 quarters of making a beating plan, recruited an awesome exec team and just built an incredible business from from nothing. So I was privileged to be to have a front row seat and how that all came together. So

2:14
has has your investment thesis changed at all over the past, you know, four and a half, five years.

2:20
We’re still investing in lots of the same categories where you know, we invest in about to about 75%, and b2b 25% and b2c, and then within the b2b world, it’s half SAS half infrastructure. One of the things that has changed recently is we’re looking for more and more open source, particularly at the application tier. So open source has obviously penetrated infrastructure and platforms really effectively. And then within the SAS world, you’ve seen this monotonic increase of the cost of customer acquisition, which means it’s increasing every year. And so we’ve been looking for novel ways of acquiring customers for SAS, and one of the one of the Theses is open source, obviously, you know, with Coronavirus, everything’s changed in the car CPCs for online customer acquisition gone way down because nobody’s advertising. And so there’s now a new sort of novel, or not so novel, but just as effective customer acquisition strategy, which is the classic one. It’s

3:18
kind of interesting. I just finished the board meeting before this. And the CACs are kind of all out of whack. Because the digital ad spend is way down, or the the cost of digital ads are way down. But also demand is kind of fluctuating wildly as well. Yeah,

3:36
I don’t think you can really look at numbers now. Meaningless, because like, the gauges, you know, I mean, you have like these. I don’t, I mean, it wasn’t one board meeting where they’ve got like 60% swings, up and down week by week. Wow, you’re kind of, you’re just you’re no longer navigating by instruments. you’re navigating by just sort of looking at the horizon.

3:57
Yeah, right. Right. Yeah, speaking of open source, I’ve probably got a founder. I’ve got one in mind for you. So I’ll have to send that to you. But thanks. Yeah, bring us up to speed on like on SAS investing. I know that you’ve you’ve written a lot about that on the blog. Aside from the effects of the pandemic, at the immediate moment, what have been some of the biggest changes in SAS investing over the past few years?

4:24
I think it’s just gotten hotter. I think there’s more competition. I think people are willing to pay forward like if, if, you know, looking at the public markets that the valuations of the SAS companies, basically untouched through the pandemic, and that because people are starting to understand these companies are super attractive and many more people are starting to understand why they’re super attractive for all the reasons that we’ve talked about, you know, the increasing the net dollar retention characteristics of them and so on. The major sort of product changes are there, you know, even Before the pandemic, there was a real focus on product led customer acquisition and sort of bottoms up. Like, if you look at five, if you look at the top five most valuable SAS companies on a multiples basis for the top five are actually product led growth, like Twilio and zoom and slack. And the fourth one escapes me now. And so people have been really been looking for those kinds of companies where the product basically sells itself and its bottoms up, and then eventually a salesperson comes in and closes either departmental sale or an enterprise wide sale. And so people are looking a lot for those kinds of companies. Another major trend is a thing called Cloud Prem, it’s the way that the software is delivered. So it used to be in the the client server world, you would buy a piece of software, you install a database on the server that you ran in your own infrastructure, and then it would talk to your computer on a local access network. And then Salesforce, put them both together in the cloud. And now what we’re starting to see is bigger and bigger companies actually want to either they want to control the software more, or they want to control the cost of the software more. And so they’re asking SAS Customer, SAS vendors to supply the software on their own V PCs, virtual private clouds. So in other words, if I’m selling software to GM, GM is asking that I deploy that software on GMs AWS account, and that’s causing a bunch of changes in the way that you have to build software and maintain it. There are benefits to it, which are that the gross margins go up because you’re no longer paying for the data GM in that case we paying for it. But that’s a pretty, like a meaningful architectural change.

6:39
What’s the motivation for GM in that instance?

6:42
Yeah, there’s the first is it or in some cases, it’s cost. And a lot of the bigger companies have found a lot of like the fortune 500 have found that cloud is actually more expensive than on prem, for a bunch of different reasons that we can go into. And so what they want to do is, they want to control those costs. And, you know, there’s about like $10,000 worth of SAS spent per employee and a lot of the shadow it is it’s going super fast. And so they just want to control it. The second is for compliance reasons, like if there’s data residency challenges, if I operate like Germany, or other geographies that have really strong regulatory regimes, and I want to be able to ensure that my data is in a particular place. Some companies actually want to see a centralization of data, they feel that, you know, some of these companies have 1000s of different SAS vendors. And so their data is scattered 1000 different ways into the wind. And again, for the compliance reasons they want to be able to, they don’t necessarily, they realize that they can’t necessarily minimize the total number of SAS vendors, but they can limit sort of the number of people who can access the data, who’s storing the data, and who has access to it start to like build policies on top of all those different databases.

7:57
So ultimately, it’s a it’s a control. It’s a

8:00
control. Yeah, it’s a control. And then a cost issue, depending like if the more regulated you are the more control issue. And the more you spend on cloud, and you can see the keggers you know, most of them are public, it’s like 30 to 40% a year. The more the to class, it’s

8:15
interesting to think of the the cloud compute as a as an asset, that some may want to control more than others. Interesting, you know, Tom, there’s lots of varying advice right now from so called experts, some suggesting deep cuts across the board to extend runway for a few years. Other saying, you know, now’s the time to lean in, expand, take advantage of opportunities that are created by the crisis, you put together a pretty simple two by two Decision Matrix. Can you just talk us through at a high level? What the matrix is and how you’re providing different counsel to startups in different positions? Yeah,

8:57
so it’s not one size fits all? Guidance. So if we published a two by two matrix, on one axis, is the balance sheet of the company? Does it have a little amount of capital does have a lot of capital? And on the other axis, is customer demand? Is the customer demand slow? Or is it ravenous? And the idea is like, if you’re in the category where let’s just take the extremes, I won’t walk through the four of them. But if you when we walk through through three of them, if you’re in the lower bucket, which means you don’t have a lot of runway, and you don’t have a lot of customer demand, that’s when getting into profitability as fast as possible is really good advice, because the first order of business is survival. You know, if you’re, if you’re in the upper right quadrant, you don’t need any advice for being super aggressive as possible. That means you’ve got plenty of cash and plenty of customer demand. If you have plenty of cash, but not very much customer demand, then it’s time to retool the product. And you should think about reducing costs to the extent that allows you enough runway after you finished retooling the product. To take it to market effectively. And then if you have a lot of customer demand, but you don’t have a big balance sheet, then the strategy is mostly around how do you increase that balance sheet by can you ask customers to sign it for multi year deals that they’ll prepay? Can you go raise venture debt on the back of their own base equity. And what’s been surprising is the equity markets are open, particularly in the growth stages, and particularly for companies who are benefiting from the pandemic in some shape or form growing really fast. I have to say, I’ve been totally surprised at the valuation multiples. And the ability of founders to command premium prices, particularly in the growth stage is basically unchanged relative to Wow.

10:42
Have you guys made any commitments since the crisis hit? We’ve

10:46
made one you know, I think we’re diligent getting seven to 10 companies this week. But we have made one commitment. I think we’re at a point now where it’s different, but we would be comfortable issuing a term sheet, purely over zoom. I think we’re trying to there’s one piece that a lot of people have talked about one component of the diligence process is like the dinner. Yeah. What like the, you know, sort of the touchy feely, how do I get to know, yeah, the founder, but I think we’re all getting more comfortable, predominantly, because we’re all having dinner over zoom and playing board games of resume that you should be able to get not 100% Fidelity, but close enough the investment decision.

11:24
Yeah, we’ve we’ve got two offers out at the moment. And one was, we spent a lot of time with the founders before everything broke. And the other one was purely zoom, which was really tricky. But

11:37
anyway, makes you wonder what the first board meeting is going to be like, Thank you somebody’s hand and say, Hey, is it nice to meet you? It’s not really that, you know,

11:45
yeah, I can’t even imagine, the first time you meet somebody in person is after you. That’s so strange. You know, speaking of which, when you’re making a commitment to a startup that has benefited from this crisis, their business, for whatever reason, is, is positioned with the quarantine to succeed. How do you disentangle or segregate? or unwind the temporary and non sustainable revenue sources and boost? You know, from the steady state?

12:17
Yeah, totally. You know, it’s kind of, there’s two questions there. The first is, how long do you think the boost is? And if it’s more than two years, you know, will they be able to benefit from the fundraising environment? And the second is, what should the valuation ought to be? Because what is the base rate? Like? What is the the steady state level of growth? I think what we try to do is look at historicals, to get a sense of what is that base rate of growth? But a lot of times, you can’t, you can’t forecast it. And so the mental model we use is, you’re basically just sort of accelerating demand, or demand acquisition, likely generation and capturing it forward. So, you know, my sense, from what I’ve seen, particularly happen as a growth stage is that people are valuing those businesses as if those trends were at least for now. Wow. Really?

13:11
Yeah. Hmm. Okay. Interesting. Yeah.

13:15
Well, the argument is like, look, there are some subset of workers that are going to work from home for a much longer time than other sets of workers, right? Like the white collar. knowledge worker, is going to work from home for a much longer period of time than say, the person who needs to see people. And if you look at the polls about people’s willingness to want to go, like, I was reading a poll in Bloomberg, I think about Americans desire to keep shut down versus reopen, I was surprised to see that most people would actually prefer the country to take a more

13:50
majority.

13:53
It was like, I’ll pull up this, Doc, I still call me on the number. He was much higher than I thought, wow. Yeah, if you’re a small to medium business owner, you’d be rushing. But anyway, in this particular polls, like I want to say like somewhere between 30 to 50%, preferred and more conservative. Wow. And I want to say something like 30 to 35% of people could work from home for like, an extended period of time. And so if that’s the case, you know, that that, that circle of concentric circle of those two different populations, if they can work from home for one to two to three years, I mean, you know, I hope it’s much shorter than all that, but let’s, then then you should be able to justify an investment that, you know, that’s gonna continue. And we just did a survey of the, you know, some subset of the Fortune 500. And the biggest increase categories spent is remote collaboration. And, and they don’t really see that changing. I mean, even for executive, most of the people within the company. They’re all sort of setting up the infrastructure. So that is something like this. You know, unfortunately to happen again, they would be much better equipped next time,

15:04
right? Well, I most of these people that probably don’t have five kids like you do that want this to keep going forever. I guess there’s good and bad, right? There’s trade offs, I have a young son, and we’ve spent more quality time together over these past few weeks than than ever, which has been amazing. But it’s also it’s crazy, because my wife works as well. So you know, it’s like, as soon as he goes down to bed, we’re back back to work, you know, as late as we can possibly stay up. And it’s like, the level of overwhelm that I see in my, my wife sighs I don’t think he’s ever been this high. It’s

15:44
a very stressful time. I think first, you know, the, you can see it in the oil markets, you can see it in your wife sighs like, it’s just, it’s just highly, highly unusual time. And, you know, they’re, they’re pros, like, I agree with you spending time with family. You know, when you have young children, everybody tells you spend as much time with them as you possibly can, because it goes like that. And so in that way, it’s been a gift that all of us are able to spend much more time you know, on the other hand, the screaming child living that famous BBC interview, yep, almost every day. But you know, it humanizes people to hear all those background noises and like somebody’s making lunch, or flushing the toilet or whatever it is, like, it just kind of, I think it’s, it will make the world a little bit more casual and a little less formal. Yeah, that’s a good thing.

16:37
So back back to, you know, making decisions, and it’s this situation, have you guys adjusted your criteria? Or expectations at all? Due to the pandemic?

16:52
No, I don’t think so. I mean, even one of the questions that we were asking for about two years before the pandemic was, how would this company fare in a recession? Like how high on the priority stack for the buyer? Is this particular service or product? And we still ask that I think there is. I think there’s maybe a bit more skepticism and plans. But what’s been amazing is founders are really candid. They’re like, Hey, listen, I this is what I grew in q4, this is what I grew. And q1, your guess is as good as mine for the rest of the year. You know, and so you’re just, you’re just kind of all in it together making a bet on the unknown. And it’s not that you weren’t making a bet on the unknown in the future. It’s just that you had like, you know, some gauges to help you. And like I said, before, you’re just kind of betting on horizon, or

17:42
are there? Are there any metrics or criteria that you look for specifically, that you think is less common? net

17:50
dollar retention, I think is a really important metric. A lot of people look at NPS. I think that’s a good one, too. We look at other ones that are really important. We look a lot at Pipeline a quarter ratio, which is the total amount of qualified pipeline divided by the quota of the account executives. Okay. And that basically gives you you know, ability, a confidence in the company’s ability to hit next quarter next half plan,

18:20
based on the number of reps. Yep. Got it. Like it like it a lot. What’s your take on situations where contractually you know they agree on and MRR with the customer, but they’ve negotiated for the bulk of that contract to be paid up front? You know, on one hand, we like it a lot, because we see it as a great boost to working capital. But is that does the Do you still give the same equal credit to the MRR? Do you find higher, higher churn or blower attachment on those types of agreements?

18:58
We love the annual prepay. That’s awesome. And then multi year prepay is even better. I think the greater fraction of the year or monthly, the more you would expect to see a higher churn and the reason even for the same product. The reason that is is that a customer is making a renewal decision 12 times a year as opposed to once a year. And so you have to sell much. Yeah. Typically you’re selling much more often. But yeah, no, we love annual prepay. I think it’s it’s one of the great it’s basically you know, it’s customers lending you money at 0%.

19:33
Yeah, no, I love it as well. I heard from another VC recently that he discounts that from an MRR standpoint and I was confused as to why but Tom, any tactical advice for founders or sales teams with regards to structuring customer contracts and selling in this environment? Yeah,

19:52
I think the best advice I think I could give is have a long term view. Everybody’s kind of going through a lot of tumult and the Most important thing is to keep the customer relationships even if you have to discount, or sort of furlough payments or whatever that or come up with novel ways of exchanging value, I think it’s, it’s really important. It’s times like these that you can really build an impressive brand and a deep trust with customers, like when people are down, you know, who’s got your back and who’s in your corner? Yep. And so we’ve seen some companies give software, we for free like zoom, and one of our portfolio companies is giving away free upgrades. It’s called customer, giving everybody enterprise level upgrades to be able to do that. So I think you can engender a lot of goodwill, particularly if you’ve got a big balance sheet and kind of take the short term cash flow, impact and, and then the other thing to do is to spend a lot of time with customers and improving the product. And then the third thing I’d say is for companies with really large balance sheets, it’s a awesome time to be acquiring companies. And so if you want to broaden out your product portfolio, and you can find a great team to come join us. I think that’s a good strategic option to pursue.

21:06
Do you think that there’s, there’s a level of agreement $1 level, that where we hit a point where these things can’t be closed remotely? Virtually?

21:20
No. So I was talking to one CEO, I was talking to one CEO who has told me, okay, so this was six years ago, he was he was a salesperson at a company, and he had joined the inside sales team. And the largest contract that has ever been closed over the phone was 15 J. And they had a bet on who could get the 20k. And then two weeks later, he closes a 50k deal. And then a week later, somebody closed 100k deal. And then the next week, somebody closed 150k deal. And then they got to the point where they were closing the hit close, like a million and a half dollar deal over the phone, never having met. And you know, I asked him what changed, right? Like, everything’s closing no more than 15k deals. And he said, confidence, it’s just the ability to engender confidence over the phone.

22:08
I think the official ceiling.

22:11
Yeah, it’s just a mental thing. It’s a mental block. But there’s no reason. I mean, there’s no reason you can sell like Slack or zoom or million dollar deal over the phone. Like it’s not that not just that the company is going to be there that there may be issues in in software where there’s a fair amount of like consulting or professional services or configuration. And, you know, some of the buyers that we’ve talked to, has sort of hesitated to buy those big upgrades, because they’re just not sure how to get people the right levels of access, without seeing them face to face or hand them a laptop or badge and those kinds of things. But I think those are all solvable problem.

22:46
It kind of reminds me of the I think it was the four minute mile. Nobody thought it could be done. They didn’t think it was humanly possible. And then as soon as it was broken then

23:00
every week oh, that’s fine. Yeah. So

23:02
So to determine on the sectors that were most impacted by COVID-19, I noticed you looked at Roger, Roger Lee’s data on layoffs. We’ve discussed a lot anecdotally on the program here about sectors. Can you give us a sense according to the data, which have been impacted most? Yeah,

23:22
most b2c categories, discretionary spend b2c categories. So travel fitness, those kinds of categories have been have been really impacted. E commerce has actually certain categories benefiting enormously. within the enterprise. I mentioned, we surveyed the fortune 500, the big categories of spend. That where it’s being cut, one is around machine learning infrastructure, and spend. And our hypothesis is that machine learning and artificial intelligence projects tend to be tend to have much longer periods to repay. You’re probably doing like six, nine months, maybe 12 months of research before you actually see a big, big return from those projects. Yep. You know, the other one is obvious is like a new marketing initiatives. So and then the last one was RPA. Actually, no, really surprising to us. Yeah. The the biggest, the category of software that we asked about that had the most, the largest number of respondents who said they were going to meaningfully cut their spend was an RPA. Yikes. And I think it’s mostly, you know, looking through the comments, I think it’s more about license rationalization and that they, they bought a lot of licenses and maybe weren’t using them, as opposed to saying, Hey, we’re not going to do RPA that’s, that’s our current hypothesis, but we’ve got to do more digging. I

24:50
wonder if that would be exclusive to RPA though or if that would, you know, there’s, there’s a variety of different subscription software, tools and products that Large organizations buy lots of licenses to and then it failed to use them at the rate that they expect.

25:07
Yeah. And that’s why, you know, this category of the SAS cost optimization companies or the SAS asset management companies like silo and productive and blissfully, and BetterCloud, and bunch of others, I think, are really going to benefit from all this. Because they can go on and instantly, sort of rationalize those licenses and figure out which vendors you’re spending too much whether we should renegotiate,

25:29
or are there some sectors, we’re going to see a lagging effect? Like due to long sales cycles and some other factors? We’re not seeing them hit yet, but in a quarter or two? It’s like,

25:40
Yeah, I mean, you saw SAP, you know, SAP, I think, is predominantly on premise software company. Last quarter, 75% of their bookings were cloud. And that’s because effectively the on prem business went to zero. So the upgrades of like, really heavy, deep software is definitely going to slow. So when he does like, multimillion dollar deployments, that’s, and that’s what we saw on the data as well. You know, other categories, I’m trying to think of the survey results when he’s pulled them up, where things are going to slow. That was the one that really stood out. That was the one that really stood out.

26:18
What about sectors and categories that the crisis might accelerate? You know, aside from the obvious leg teleconference and telehealth and grocery delivery, you know, video streaming, what maybe some non obvious areas that could get a big boost?

26:33
Yeah, one that was surprising to me was around cloud infrastructure. So in our survey, we found that the buyers were actually if you were thinking about moving to Kubernetes, or moving your infrastructure to the cloud, you’re going to accelerate it. That was surprised to me, I wouldn’t have thought it. But they said, a lot of people viewed as a cost cutting effort to sort of modernize the second, you know, connectivity. That was really important. Yep. Those are the two big areas.

27:04
Yeah. Tom, what’s one thing you know, you need to get better at?

27:09
My gosh, where do I start? One thing I would really like to get was one of my partners, Alex is incredible at building deep relationships. And so I’m working on learning from him how to build deeper and deeper and stronger and stronger relationships. Because I think one of the criterion for success in my life is looking back and having built very, very long term friendships. I think if you can look back in your life, at 75, or 80, and have a collection of the relationships that you got either through your hobbies or through work that you really value. And that’s a successful life.

27:51
What investor is influenced you most probably one

27:53
of my partners, Scott Rainey, I was fortunate enough to work with him from the very beginning and the way that he thinks about companies I have a lot of admiration. You know, he’s been able to find some great companies like Stripe and Hashi Corp, and LaunchDarkly and, and a bunch of others, and I really admire the way that he looks at companies.

28:14
And finally, Tom, what’s the best way for listeners to connect with you?

28:17
Oh, Thomson reuters.com. My email address is right there. It comes to me doesn’t go through a filtering or anything like that. There

28:25
it is. He is Thompson goos. The blog is tom tom goos.com. The book is winning with data. Tom, as always, thanks for all your contributions, especially during the crisis. And thanks for joining us today.

28:37
Thank you so much for having me on Nick. Really appreciate it.

28:45
That will wrap up today’s episode. Thanks for joining us here on the show. And if you’d like to get involved further, you can join our investment group for free on AngelList. Head over to angel.co and search for new stack ventures. There you can back the syndicate to see our deal flow. See how we choose startups to invest in and read our thesis on investment in each startup we choose. As always show notes and links for the interview are at full ratchet.net And until next time, remember to over prepare, choose carefully and invest confidently thanks for joining us