Top Questions From CEOs on B2B SaaS Investing

Software Equity Group recently convened a group of private equity investors to understand what they are looking for in potential SaaS investments, the metrics that matter most, and how the market has adapted to COVID restrictions.

In Part 2 of our coverage, we discuss the four top questions SaaS executives were interested in hearing from our panelists.

Speakers Included: 
1. How much flexibility are investors giving in their assessment of numbers with respect to COVID in 2020? How are you thinking about budgeting for 2021 and are you doing anything differently with respect to the current environment?

(See Response in Webinar)

Chelsea Stoner: COVID has definitely put a wrench in a lot of businesses. On the flip side, we have seen the increased transition to digitization as a tailwind for some of our cloud transition stories.

Of all of our businesses, roughly 80% had a budget decrease of about 50%. So if they were planning to grow $5M in 2020, the budgets have been peeled down to $2.5M. What we found is, it hasn’t been that dire, which is the good news. And things seem to be rebounding. But if you took a COVID hit, like a lot of folks did, we just need to understand the details.

2. Does customer concentration play into how you evaluate potential investments. Is there a maximum percentage that you get comfortable with what from any particular customer? 

(See Response in Webinar)

Adi Filipovic: The first investment I was ever involved with had nearly 100% customer concentration and we made a phenomenal return. I spent eight months of my life during the first financial crisis being consumed by this one entity. Clearly, more customer concentration means it’s more of a binary bet you’re taking, when it’s a customer concentration with a customer, a channel partner, or ecosystem.

I know private equity 101 is diversification, and I get the benefits of it. But I’ve also kind of had the experience to be trained and to think about what’s behind it and whether this is worth underwriting. Maybe it’s a little bit of an atypical answer, but we’ve been involved with 20%, 30%, and 40% customer concentration. Contractual protections help if it’s a real contractual protection, such as multi-year contracts, noncancelable, and termination for convenience. Longevity with a customer and understanding the value prop also help.

We’ve been on the on the more creative side of willing to entertain customer concentration. But there’s no doubt that when you have 3,000 customers and no customer over 2% of revenue, that’s wonderful, too.

3. How has your process around completing deals changed during 2020 and do you expect any major adaptations to stick?

(See Response in Webinar)

Jeremy Holland: I think a lot of adaptations will stick. We previously spent a huge amount of time on airplanes, because we really value the face to face interaction. I look forward to when we can do that again, but the reality of the situation is we don’t get to sit on the sidelines. Our investors have tasked us with deploying this capital and if you can’t do it, they will find someone else who can. And so we had to get creative and certainly zoom and similar services have played a big part in that.

What we’ve often done is the face to face as final confirmatory at the very end of the process along with customer calls that you waited to the 11th hour on which was kind of blasphemy a year ago. You’d always want to get out there because we inherently love business and getting to know entrepreneurs, but we have to do what’s practical and what’s safe. So, I think a lot of that will stick.

Also, with our board meetings, a lot of our high performing portfolio companies. We are flying all over the place, all the time for board meetings. I’d be shocked if they go back to being 100% in person. I think there will be a mix, and it’ll be more efficient with everyone’s time to do some of those virtually. When you’re in year five, and everybody knows each other well and you’re in a really great rhythm, I think that there there’s going to be a lot more virtual meetings. What’s been amazing is how much investors are adapting. We’ve completed more than two or three dozen investments during the pandemic and have a full pipeline to go.  

4. Do you have any metrics that you would look for as it relates to the efficiency or effectiveness of product and development teams?

(See Response in Webinar)

Phil Cunningham: In the simplest terms, what we try to do with product development is think about the product roadmap. We go through a process with our companies where we look at five years, then three years, then now. When we get to what we need to do now, we’re not looking at every little bug fix and feature functionality but focusing on the big modules the business is looking to build.

We go through a business case and we look at: What do the competitors offer? What are they pricing it at? Why don’t we have it? Are we losing deals because of this? It’s more of a business case calculation than a metric. The calculation is this: we have an ROI of X because we believe if we build this widget, we will penetrate X% of the market every year and gain a certain amount of competitive share, resulting in certain type of return.

Is there an ROI or business case around what you’re building? Often, we find that smaller businesses are building what they think the largest client or the loudest salesperson might want, but it may not be the thing that actually returns the most profitable revenue to the business.

Watch the full webinar and read the recap here: SEG Panel: Expert Private Equity Perspectives on B2B SaaS Investing