What does it take to get funded in 2024? Jason Lemkin shares the answer during Workshop Wednesday, held every Wednesday at 10 a.m. PST. Some of this stuff you’ll know, and some of it you won’t. What’s driving VCs today? Let’s find out.
Venture capital is the same as before but different. It’s a weird world where seed valuations are at an all-time high. It’s always been hard to raise venture capital, but if you’re in the group of folks VCs do want to fund, it’s like 2021 in some ways.
You won’t see a new unicorn a day, but insiders are writing their third or fourth check. These unicorns are often different from the 2021 unicorns. We all mocked those 100x revenue deals as the market crashed, especially when the average public company was trading at 5-6x. But those kinds of deals are back and only in the segment of AI.
Why are they being funded? VCs aren’t dummies. They’re bet-makers.
The Index of Top SaaS and Cloud Companies
The Bessemer Venture Partners Index of top SaaS and Cloud companies is shown in blue on this graph, which is a basket of the best. The red is NASDAQ’s top performers. From 2018 to the end of 2021, a weird thing happened. Cloud stocks were on a tear.
Salesforce bought Slack for 27x revenue, which made sense because, overall, SaaS and Cloud companies traded at a premium. That meant that, as a group, they were all great investments.
“Anything with a pulse that could go public in SaaS was a great investment,” Jason says. Even more than that, arbitrage was going on in the public market just by investing in the best SaaS companies.
You could automatically make twice as much as NASDAQ. If you’ve been in SaaS for a long time, it used to be hard and was out of fashion. Around 2018, everyone wanted to be a SaaS investor because there was arbitrage. That’s the gap you see between blue and red.
Then, the end of 2021 hit, and it started to normalize. And then it got inverted. Today, you’re a sucker to invest in the average public SaaS company, even the good ones like Dropbox, Salesforce, and Veeva.
As a group, it’s a sucker bet and trading at half of NASDAQ. This puts a tremendous amount of stress on venture. If you’re a Limited Partner giving money to VCs, what’s a better idea: sticking it in NASDAQ where you can sell it tomorrow or give it to a bunch of VCs that take 14 years to give you your money back?
If you put your money in NASDAQ over the last few years, it’s gone up 24%. In Cloud and SaaS, it’s down 44%. This means that no matter what’s happening with any individual company, we’re in the third year of a downturn in venture.
VCs are Investing, But There’s Stress in the System
One year is no big deal in venture. Everything fell off a cliff in the public markets in ‘22. Hashicorp was the last IPO in the last era, and everyone stopped going public until Klaviyo. People thought it would be a short downturn, and SaaS companies were growing well.
The chart on the left is IRR, the Internal Rate of Return in venture funds. In 2021, it was insane. The top U.S. funds had 80% returns. Who wouldn’t put money into 80% returns? Money flooded into venture, but if you look at the past 18 months, IRRs are negative.
This will bounce back. The average IRR is pretty decent and got bonkers in 2021, so it’s natural for there to be a hangover in 2023. The question is: will it bounce back to 20% IRR levels?
If LPs can’t make 20% in venture, they should stick it in NASDAQ. You have to make 20% net of fees and expenses for venture to make sense for LPs, and it’s not true today.
Are folks still investing? Yes. Because it’s year three of the downturn, some venture investing is ticking up because people ran out of ideas. Redpoint is one of the best out there, and their growth fund made one deal in 2021, 2-3 last year, and now 5-6 in the first half of 2024.
Eventually, you have to invest or give the money back to LPs. Hopefully we’ll come out of it by next year.
Pluralsight
Vista is one of the top mega funds that buy public and private startups at scale. They bought Pluralsight for a billion and a half of equity; the rest was debt. They gave up and are writing off the entire investment because they can’t afford to service the debt.
SaaS isn’t supposed to be perfect, but it is supposed to be a kind of annuity for these bigger private equity and late-stage funds. Overall, NRR in SaaS remains above 100%. It didn’t pan out for Pluralsight. Yesterday, they published that GRR fell into the 80s, so revenue retention and cash flow weren’t there.
“I’ve never seen a private equity firm walk away from a late-stage SaaS company,” Jason said.
Squarespace
On the right, Squarespace went private. Zendesk went private last year for $10B. It sounds good, but you’re only trading at 5x revenue. These companies are going private because it’s hard to be public and keep it going, so you hide from the public markets to re-accelerate growth.
If public markets were working as effectively, they wouldn’t go private. It’s not the end of the world but a sign of stress.
VCs are Mostly Still Hunting Decacorns
What’s going on here? Cloud and SaaS stock is down 40-something percent. NASDAQ is the better deal, but venture hasn’t changed. They’re still hunting decacorns. Many founders ask if a $100M exit is ok today. Can you sell your company for $50M if everyone can make money?
You can, but it doesn’t change the math of turning a billion-dollar fund into $4B. You have to find decacorns.
In 2021, it seemed easy in SaaS. Unicorns became decacorns. The chart in the middle shows great companies worth billions, and most were decacorns before.
As wild as it is, none of these companies don’t make sense for investors today. You can’t do deals with great companies like Bill, Zoominfo, Braze, Box, or Asana because they aren’t big enough.
Where do you find the decacorns? It seems like the only way to do this is in AI. You have to find the OpenAIs. When you look at the amount of revenue OpenAI has in the amount of time it has, that’s what you must chase as a VC.
The Best of the Best are Still There in SaaS
Maybe 70% of folks are growing more slowly than two years ago. Databricks just said they crossed $2.4B in revenue, growing 60%. Does AI partially fuel this? Sure. Canva is around $2.3-2.4B, with 40-60% growth. That’s wild. These will IPO for more than $10B.
The Box and Brazes and Zoominfos and Bills were worth 10s of billions and now are single-digit billions. It’s not what it was at the peak. They’re still there, though. Is Snowflake still worth $150B today? No, it’s worth $52B. Atlassian is still worth $43B.
It looks a lot harder, but the net effect is that massive amounts of capital will flood companies like Monday or Hubspot.
100x ARR is Back for a Subset
Perplexity is in the headlines for a lot of reasons. Recently, they crossed $20M ARR and are valued at over $3B. That’s over a 100x deal. “My guess is they went from $1M to $20M in one year,” Jason shares.
It’s not free, folks. Expecting 464% growth isn’t an easy thing to achieve. If you can go from $20M to $100M in one year, then $100M to $300M, are you worth $3B today? Maybe, if that happens. These crazy 100x ARR deals in AI are expecting OpenAI-like growth.
Why AI is Already Big Money
Are people nuts? No. While the average Cloud company has radically underperformed, look at the big guys. Azure’s net new ARR fueled by AI shows 83% growth. Google Cloud is 175% growth. The chart on the right is the biggest beneficiary of all: NVIDIA.
Is this an AI bubble? When you see numbers like this, it’s why VCs are excited about AI: because it’s a massive amount of money. If you’re a little guy and part of this trend, you can be a rocket ship.
How a $2B Fund Makes Money
One thing to share is how venture funds work. It’s hard now, and many founders don’t understand the math. Let’s look at two examples: a $2B fund like Redpoint and a seed fund. Why a $2B fund?
Say you raised a seed and want to raise a Series B. The average fund check size will be 1-2% of its size, so if you want to raise $ 20M-$30M-$40M for B, you probably need a $2B fund because they’ll take that kind of risk.
There aren’t many funds at $2B. Even so, a $4B exit isn’t enough. Assume that this $2B fund averages 15% ownership, and the truth is, it will be lower today. One company is worth $10B. How much do they make? $1.5B.
They haven’t even paid the fund back. For VCs to make any money, they must first pay back the money they’re given.
So, you sell one for $10B, which doesn’t get you back. Then one sells for $4B, like Braze, Box, and Zoominfo, and you get $600M. That’s only $2.1B. You’ve barely broken even on the fund.
Then, $2B and $1B and other small ones add up to $2.685B, and you’ve only made 1.34x your money back. Net of expenses and fees, it’s probably only 1x.
VCs don’t expect big funds to have as high a multiple as small funds but expect 2.5x-3x gross.
Now, imagine you’re a VC at a $2B fund. You’ve had a couple of unicorns, and now one is worth $200M. One went under, and the other is doing great, but it’s unclear if it’ll IPO. You’ll be feeling your job is at risk.
How $100M Seed Funds Make Money
In the old days, $100M was a large seed fund. Now, seed funds are at $10M and $15M, and if you’re YC, they’re $23M, so it’s harder. Say you have a $100M seed fund and invest super early. You’re lucky if you have a $1B company; it’s not enough in today’s world.
First, everyone ends up with smaller ownership stakes in seed, and there’s still a lot of dilution because there are a lot of rounds. So, you buy 10% in the seed fund, and by the time you IPO, you own 5% on average.
Imagine you have three $1B exits. Then, amazingly, you have three other 9-figure exits. If you multiply these by 5%, you end up getting $395M. That’s 4x gross. It’s good, but LPs expect 4x at a minimum.
How many of you are doing this today in seed reliably? Not that many because there’s stress. VCs have to hunt for fund-returners, 4x with seed and 2.5-3x with growth. VCs must believe you’re a fund-returner before they write that first check, or they’ll make no money.
Big Funds Tripling Down on Winners
When you see all these rounds in the media, a lot of them are fueled by AI. They’re looking for 5x growth at scale. Not $10M to $18M, but $5M to $25M to $125M to $300M. A lot is in AI, and a lot of these are inside-led. Grafana Labs was an inside round, for example.
Big funds have a lot of capital, and they have to put it somewhere. The average SaaS and Cloud company is doing worse than in 2021, so if you’re in the top decile of their portfolio, they will flood it with capital.
It’s tough out there, so existing companies are getting the capital. The money is real, but it’s not outside, brand-new money. So, are the valuations real? If it’s an inside round, it’s a sign that the company is doing well, but it’s not external. It’s different. It’s capital you can’t access unless it’s a second or third check, which creates confusion in the media and markets.
Come to San Francisco Bay Area to Raise Venture Capital
This chart shows that the Bay area is taking more venture capital again in every round. Almost all of us live in partially distributed or hybrid worlds, so it’s different from pre-March 2020.
VCs, for the most part, are happy to invest in founders in any major tech center. To raise money, you have to be there. People don’t want to write checks over Zoom anymore.
Growth is Still King
VCs don’t care if you’re profitable. To some extent, do you need to be more efficient? Yes. Do public markets expect you to be efficient? Yes. As you go public, you have to be free cash flow positive, if not profitable. But all VCs care about today is growth.
No, they don’t want you to burn so much money that you run out, but no VC cares if you’re profitable. Being profitable doesn’t get you to a $2B outcome. Even seed funds need you to be $2B.
If your growth has fallen 30%, but you’re profitable, will that get you a valuation? No. You have to have the same growth as in the past but be more efficient.
Triple Triple Double Double Still Rules
Do you get a pass from VCs because you’re in an impacted category like sales or marketing? No. Not everyone is in a downturn, and if you are, you can’t get a pass because VCs need that $2B outcome to make any money.
You have to triple, triple, double, double at minimum, or you’ll never get there in the 10-14 year lifetime of a fund. You’ll never get big enough to be worth $10B.
Today, you probably have to do close to $500M in revenue to have a good IPO. But let’s say you could do it at $300M. You can do it earlier, but it’s harder today. 40% IPO is likely the slowest you can grow and have a decent IPO.
You might feel intimidated by this chart. You won’t get there if you don’t triple, triple, double, double after a million. If it takes a decade to reach a million, that’s a long time. Although, UiPath took a decade to get to a million.
Growth Slowed?
What’s happening? Emergence Capital gathered data from the best seed funds and all the data on their companies’ growth. They aggregated this data into the elite of business software companies.
The top quartile is growing 100%, which is good, but it’s not triple triple double double. Then it’s falling off a cliff. At $5M ARR, they’re growing 58%. That’s still plenty to compound into something huge, but does it get you to the numbers you need? No, it doesn’t.
You need to grow 40% to IPO, and this top quartile at $20M to $50M is only growing 38%, then falling to 22% at $100M.
80% of VC-backed startups aren’t growing fast enough to raise another round. As a founder, you have to ask your investors if you’re fundable. Only 10% of VC-backed startups are on this fund-returner path. So, be aware that it gets harder here.
If you do raise capital, don’t assume the next round is coming.
Calling Yourself AI (Probably) Isn’t Enough
AI washing or labeling isn’t enough. Logan from Redpoint said he was seeing some deflation in VC activity for these crazy AI rounds. In these three examples, you can see that C3.ai went early on AI, but most people don’t know what they do. They have real revenue but are down 76% from their IPO.
Salesforce’s projected growth will fall to 7% next year, and they’re real AI. Zendesk’s home page says it is an AI-first service, so the fact that AI matters isn’t lost on anyone. But calling something legal AI isn’t enough to fundraise.
B2B2C, Vertical, Security: Downturn?
While sales and marketing are incredibly impacted, most B2B2C aren’t in a downturn. Zoominfo said NRR is falling to 85% from 110-120% in 2020. In 2024, folks are still getting together in the room to cut more sales and marketing tools. It’s brutal out there. But the rest of the world, the Canvas and Databricks, are doing pretty well.
Samsara sells fleet management software to the real world, growing at 39% at $1.1B. They’re also aggressively hiring. Klaviyo is growing 42% at almost $800M in revenue. Toast is selling to normal restaurants with 32% growth at $1.3B. Monday is growing 34%, coming up on a billion in revenue.
All of the folks selling to the real world are doing pretty ok, even if sales and marketing are in a weird place.
B2B2C Bounced Back Fast
Revenue Cat manages 30% of all consumer SaaS companies in the mobile economy. The consumer is faster than B2B, and if you squint, you can see a massive slowdown in consumer SaaS.
In 2023, it came back. Now, they’re having a record year. Consumer is usually 2-3 years ahead of B2B, so if consumer SaaS has reignited growth, maybe classic B2B2B will get there. The consumer pattern provides a reason to be optimistic.
Stress Will Remain Where Multiples Are Low
To summarize the stress in venture, look at the median multiple for public companies. Public SaaS companies are like the NBA. Not everyone is Lebron James, but they’re all really good. The average NBA player or public SaaS company only trades at 6x, and the top performers at 9x.
Until they’re 20-30% higher, it’s hard to make money in venture. If the median is 8-9x and the top is 15-20x, everyone can make money in venture. It’s easier to fundraise when everyone is making money.
The post What it Takes to Get Funded in 2024 with SaaStr CEO and Founder Jason Lemkin appeared first on SaaStr.
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Amelia Ibarra, Khareem Sudlow
