Getting through the downturn: a few thoughts for SaaS companies planning their 2009 budget

A few days ago, Bessemer West Coast SaaS Practice - David Cowan, Byron Deeter and myself, hosted a CFO Dinner for our SaaS portfolio at John Bentley's in Redwood City. A couple months ago, when we started planning this dinner, we thought we would use most of the time to debate SaaS metrics, the business model as well as our recent update on the "Bessemer 10 laws of SaaS", but, in the meantime, the macro-economic climate changed drastically and we decided to focus the discussion on the impact of the current environment on 2009 planning. Fifteen CFO's participated - about half of them from Bessemer portfolio SaaS companies (Cornerstone On Demand, Intacct. Lifelock, LinkedIn, OneStop, Perimeter and Retail Solutions) - among a total audience of about 25 people.

Overall, it was interesting to see that the economy had not affected this peer group overall, with strong results for Q3 and a healthy pipeline shaping for Q4. Despite these currently strong numbers, the attendance was very cautious: it is unclear at this date if we are going to see a budget flush supporting Q4 or if the contracts are going to sit on the CFOs desk and never close, but in any case, the consensus was that we are heading towards a difficult environment in 2009 and it is time to plan accordingly.

To start the discussion, we presented a few data points on how our SaaS 13 Index (13 public SaaS companies) has been affected by the downturn - and unfortunately, the hit has been pretty hard, with the Index losing 60% year to date as illustrated by the chart below:

SaaS 13 Index (Jan. 1st 2008 = base 100)

This number compares to the Nasdaq reaching a low point of -46% and currently showing a -40% drop year to date. The fact that SaaS valuations are being more affected by the downturn than the Nasdaq can be surprising given the supposed resiliency of the SaaS model (recurring revenues) but it translates the public investors belief that SMB software spend is going to be hit very hard by this recession. With this decline, the average EV/08 rev. multiple fell down to ~2.2x and unfortunately no one has been spared. The lowest drop in the Index is Concur at -35% and the highest is Salary.com at -84% (SLRY is trading very close to cash now!). This drop in public valuations basically means that private companies lost half of their value in a comparable way and therefore the cost of capital doubled in the past month, pushing much higher the hurdle for any additional investment, be it in sales, marketing or R&D.

How long will the downturn last? It is difficult to say, but if we look at the time required for the Dow Jones to recover after a crash since the early twenties, the answer is likely to be years, not quarters. It is also intriguing to see that the market bottom was reached only two years after the start of the decline for the 1929, 1973 and 2000 crises, so we might need another year before the market reaches it lowest point.



So were do we go from here? Here are a few strategic thoughts that might be helpful as you plan for next year:

1. Cash is King…and scarce: if you are in a funding cycle, raise as soon as possible and as much as possible. If not - plan to cash flow breakeven with what you have left. Preserving cash is your #1 priority

2. It is time to fix your key SaaS metrics:

• P&L: MRR = MRE: you control your destiny when your monthly revenue equals your monthly expenses
• Sales & Marketing: Your cost of capital doubled, so if a CAC ratio > 0.5 was OK a few months ago, the hurdle is now higher and should be close to CAC>1 – Keep only reps making quota and cut marketing activities with lower ROI
• Customer Lifetime Value (CLTV) >0 – Adjust operations, RD and GA to make your business model profitable
  

3. Be realistic on valuation: the best public SaaS companies lost 60% of their value on average, so it is likely your valuation is down too!

4. Watch for cheap MRR (M&A, Other structure to avoid buying assets?): you will soon be able to buy failing competitors. Volatility creates opportunities

5. Don’t wait for the slowdown to hit you, it will be too late


In addition to these high level comments, you might consider also consider some of these more tactical moves:


Sales& Marketing

• Focus on your farmers: account management is critical to keep your churn low and improve “up-selling”. Monitor account activities and be proactive
• Trade-off pre-payments for MRR by increasing pre-payment discount and sales bonus
• Review sales comp structure: more commission less salary
• Keep you voice up in the market: customer need to know you are still alive!
• Rethink vertical segmentation: Healthcare? Is Government a good idea?
• Review your marketing media allocation: offline media prices will go down and could generate attractive ROI, tradeshows might have less impact due to travel restrictions…

G&A

• Manage your DSOs tightly – they will go up! And check for payment that can be deferred
• Wisely manage debt: finance your A/R and leverage only when needed to extend runway
• Chase and implement “quick wins”: shut down all retained searches immediately, renegotiate services contracts and leases, limit travel…

R&D

• Review product roadmap: what new features are absolutely necessary?
• Move R&D offshore

Operations

• Follow your customer growth, don’t grow data center and support capacity ahead

That said, I would like to close this post will a couple of more cheerful comments. Firstly, keep in mind that chaos creates opportunities and there will be a huge prize for the companies able to navigate carefully through this downturn (competitors will disappear, you will be able to hire great talents...). Secondly, SaaS companies are much better positioned in this downturn than other companies given the recurring nature of the business, the lower upfront cost for customers (no need for financing in a difficult credit environment) and the overall lower total cost of ownership. So hopefully, this recession will accelerate the shift from on-premise offering to SaaS. This was one of the premise of our investment thesis and we will see if it proves to be true!

Here is the full presentation if you want to dive deeper:

Bessemer 5 Cs of SaaS Finance

View more presentations from Philippe Botteri.