Hello and welcome back to our regular morning look at private companies, public markets and the gray space in between.
We’ve dug into churn twice in the last week from an expert and data-based perspective. We’ve also spent a good amount of time talking to venture capitalists about how they are approaching today’s turbulent market.
This morning we’re adding to both conversations by bringing Menlo Ventures‘ Matt Murphy into the discussion. Murphy spent 16 years at Kleiner Perkins before joining Menlo Ventures in 2015. TechCrunch spoke with Murphy late last week, working to understand how startups should plan for what could prove a difficult Q2 and how churn expectations should adapt as the economy changes.
In Murphy’s view, Q1 startup results are likely to come in a bit better than some expect considering the how the quarter finished from a macroeconomic perspective. Q2, however, is a different beast. Murphy expects B2B startup growth to slow, which could make the world much harder for the cohort of startups with less than 18 months of cash; fundraising off slowing growth as valuations broadly dip is not a recipe for an enjoyable capital cycle.
So let’s talk about how Q2 is going to impact startups and how young companies might respond. After we get through the nitty-gritty stuff, I pulled a bit more from our interview as a treat, exploring what the Menlo Ventures investor thinks about the recent Notion deal, and how the firm’s portfolio is set up heading into a possible recession.
Planning for a turbulent Q2
Each year, usually around Q4, startups map out expected growth, spend, and burn for approval by its board. These loose models are used to help companies and their leaders war game, avoiding over- or underinvestment in pursuit of its goals.
Performance is often measured against “plan.” So reaching 50% of plan, for example, would be meeting 50% of expected growth. In normal times, that would be bad. Growing at only half the pace you expected would normally mean that something went desperately wrong (a sudden collapse in pipeline, for example), or a strategic focus shift (towards building new product instead of selling its current offering, for example).
Or the economy can drop out from underneath all startups at once, suddenly making lower performance results more acceptable. After telling TechCrunch that “the early returns I’ve seen from a number of companies in Q1 is kind of like 80 to 90% of plan,” Murphy walked us through how startups should think about their plans heading into Q2:
Q2 is likely to be more like 50% of plan if you’re a SaaS company. And then the question is, well, ‘What do you plan for the back half the year?’ because none of us really know [what is going to happen]. But, we’re assuming that there’s some move back to some level of normalcy. But some people are back in the office. Are we spaced differently? Are people wearing masks? […] The little bit of fear and uncertainty to ‘Okay, here’s the start of our new normal.’ And we’re kind of marching back to […] this new normal and trying to get back to some level of normal business. And so what does that really mean in the second half of the year? Does that mean you get back to 70% of plan? Still 50% of plan? 80% of plan?
Given that growth is going to slow, startups will look less enticing on paper; companies that expected to be on pace to double are now looking at a more modest 50% expansion (or less in some cases). Given that startups trade profitability for growth and won’t magically become profitable if their expansion slows as the economy deteriorates, upstart companies may suddenly become less attractive to investors.
Of course, that only matters if they need to raise capital. After discussing startup planning, Murphy turned to cash and cash management. Here’s what he had to say concerning growth-oriented companies and the balance between hard currency, growth and fundraising:
And then the other cut on it is obviously, what’s your cash position? So, there’s some companies that can afford to be a little bit more, not aggressive in any way, but maybe they can assume the 70% plan, because they’ve got the cash and if they’re wrong, it’s not catastrophic for the company. And there’s some companies where it’s like, ‘Look, if we get this wrong, and we say it’s going to be 70 or 80% of plan, we’re going to be out of cash and out of business by the end of the year, so we can’t afford to do that.’ So from a cash standpoint, we have to do things that are a little bit more draconian than we otherwise would. […]
The general rule of thumb right now is, ‘Hey, you better be able to find cash to last 18 months’ and a lot of companies, as you know, raised a lot of money. And so for some, that’s quite easy. If you just did a 50 or 100 million dollar round, even with a high burn rate, you can probably make that work. There’s other companies that maybe they were thinking about raising money in Q2 or Q3, and the music stopped at the wrong time, you know? It stopped at the wrong time to get capital. And at the same time, their numbers are deteriorating so quickly, that it would be difficult for them to raise money. So they’ve kind of got that double whammy right now that even if their numbers were decent, it would be hard to raise, but the fact that they’re redoing and bringing down the plan and all that, it’s a complicated time to raise to raise money.
Of course, one way to grow faster is to lose fewer customers as you add more. Leaning on the traditional analogy, it’s easier to fill a bucket with fewer leaks than it is to top-off a porous pail. How many holes might SaaS’s bucket spring? Well, here’s Murphy:
What I’ve seen is most companies upping their churn rate by 20% as a rough, rough math. Let’s say you were 90% retention, now you’re going to assume 70. You can also think about it as a net retention number. Just lower it by 20 points to kind of say, ‘I know more shit’s coming, I don’t know how much. But I can kind of live with 20 for now and kind of see whether I’m wrong or right.’
A 20% boost to churn alone would cut growth by a fifth at startups hoping to double. That’s a big miss on plan. Toss in a market slowdown and that 20% can become larger rather quickly. That is the hill that startups now face as they hope to keep enough growth alive to stay attractive to external capital while conserving enough cash to survive. It’s a different world today than it was just a few weeks ago.
Venture focus, the Notion deal, and Menlo in today’s market
Now a few odds and ends. I had our entire interview transcribed, so I’ve pulled out a few more segments for your reading enjoyment. One of the best parts of my job is the ability to talk to lots of folks who are pretty plugged into what’s going on. So, a bit more from the conversation, as sharing is caring.
Here’s Murphy on present-day VC focus:
No matter what anyone tells you, the vast, vast majority of venture capitalists’ time right now is being spent on the portfolio. And it’s not triage. That’s really a draconian and brutal way to look at it. It’s really more just like, ‘What do we need to do?’ So, every company is its own snowflake relative to their particular situation. Even within SaaS, some companies are going to outperform others and so forth. So you really have to take a look at ‘Okay, what’s the overall macro impact?’ and then ‘Are we plus or minus that?’ So kind of a crude estimate that a lot of people are doing is like Q1’s going to come in a little bit stronger than the market, than the environment, really suggests, just because enough deals were far enough along, all the CFOs haven’t come out yet and whacked all the budgets. So, the early returns I’ve seen from a number of companies in Q1 is kind of like 80 to 90% of plan.
During a discussion of “nice to have” versus “need to have” in the world of SaaS products, TechCrunch asked Murphy: What percentage of B2B SaaS do you think falls into the bad category of selling to smaller companies while also being more of a nice to have? Is that 5% of the market, 10%?
A lot of SaaS now has grown up on selling to other mid-stage venture-backed companies just because they’re the aggressive ones who appreciate tooling and modern ways of doing things, so they’ve been some of the best buyers. So for a lot of the venture ecosystem, it’s much higher than you’re suggesting. The other thing is that a lot of companies these days in SaaS, they grow up with, like, ‘Hey, we want to start off with a high volume transactional model.’ An ACV of 30k to 50k to 80k, [so] the decision bar is lower. And then as we mature the product, mature our sales process, the market matures, then we kind of move more up to the high end market. So some of this just depends on where you are in your evolution as a company. But, given the concentrate–given where most startup SaaS companies start off, I do think it’s going to be pronounced for a lot of people.
Moving to a close, here’s Murphy on the state of Menlo Ventures’ portfolio now that the world has suddenly changed and it’s a risk-off world instead of a risk-on environment:
We had a good fundraising cycle. So the majority of companies, vast majority of companies, are really well funded. And so at least you’re not like, ‘Oh shit, somebody’s going to hit the wall in the next three months.’ But, anybody in anybody’s portfolio, they’re always a few companies that got hit a little harder when the music stopped. And then every company needs to really go through and rationalize their burn. So it’s not the most fun part of venture. There’s not a lot of highs through these days. But hey, imagine being a CEO or an entrepreneur right now fighting for your life. So that’s always humbling in this business when we go through these cycles. It’s been such a momentum go-go-go environment where everything seemed easy and the job was all about courting entrepreneurs, access-winning, and now it’s about really company building and showing your value and being side-by-side with that entrepreneur through some tough times, both emotionally as well as just operationally for the companies that this is what the business is all about. It’s been too easy lately, and it’s going to be a little bit too hard for now. But, we’ll see where things settle out.
And finally, a few words from the investor on the the Notion deal which saw $50 million invested on a $2 billion valuation:
You’re basically saying that you believe that the company can be worth $10 billion. Because net of carry and the way venture math works is right now, even from here, you got to get a 4x to even get to a 3x net. And if you’re not paying your LPs at least a 3x net, then you’re not doing the job that we all strive to do. So I’m sure they did some modeling and figured out like, ‘Hey, here’s why we believe it could be that.’ Then there’s upside to that. If you believe it’s the next… what’s Slack’s market cap now? [Alex: $13.5 billion] So, you’re kind of underwriting it to that level.