Three Perspectives on SaaS Companies

Transcription

1 Presented at Cooley Godward Kronish October 28, 2009

2 CFO Perspectives Skip Smith & Mary Korn FLG Partners

3 SaaS CEO/Board Issues CFO Perspective What makes a SaaS company? SaaS Revenue recognition primer Multiple elements in sale New accounting next year Capitalization of software State sales and use tax Systems for SaaS companies

4 What makes a SaaS Company? Key attributes: Recurring revenue streams Hosted application software often accessed via a browser Standalone or integrated applications Core systems Accounting or CRM Ancillary systems Travel management or payments Media, gaming, analytics, etc. Fragmented, rapidly growing companies Hard to build from a financial perspective Valuable when turn profitable (begin generating cash)

5 SaaS Revenue Recognition Multiple revenue elements: Subscription monthly, per seat or per transaction booked Implementation/professional service fees If bundled, determine standalone value ( VSOE ) and recognize over expected life of relationship If separately charged, then recognize when deployment is effective (if VSOE for subscription renewal exists) EITF will somewhat liberalize VSOE requirements for new fiscal years (required for years beginning after 6/15/10) Hardware/software combinations: Now driven by software treatment thus recognition spread over useful life of device (SOP 97-2) More up front recognition for mixed hardware (iphone, etc.) coming in 2010 (EITF 09-3)

6 Rev Rec Takeaways Get it right from the start Lock down pricing schemes Develop a standard contract to maintain consistent T s and C s Get auditor buy in early for recognition policy Especially for implementation revenue treatment Restatements are very costly in time and opportunity Adoption of EITF 08-1 treatment will improve pricing flexibility and may accelerate revenue recognition Calendar year companies should consider adoption of EITF 08-1 and 09-3 treatment starting in January 2010

7 Capitalization of Software Capitalization of internal use software governed by EITF 98-1 Essentially capitalize software costs after demonstration of technical feasibility, then amortize over useful life (3-5 years) Write off all maintenance and updates other than major rewrites Track R&D costs carefully for GAAP, management and tax purposes (including possible R&D tax credits) Key Takeaways: Wide ranging practice but be conservative Costs capitalized now are a drag on earnings later Establish a simple timekeeping and project system early

8 State Sales and Use Tax Not an income tax so nexus is much easier to achieve States are looking for revenue a very dynamic area Expanding tax base to include much of digital commerce Active states include Washington, NC, Texas, NY, Wisc, etc. Taxation dependent upon local statues and tax nexus Nexus can be achieved by having employees in state or visits by sales or training personnel or simply having customers in state Tax rates applied at the zip code level Monthly filing and deposit requirements

9 Sales & Use Tax Takeaways SaaS company is responsible for assessment and collection of these taxes regardless of contractual provisions otherwise Get compliant early to avoid expensive penalties and interest Begin with focus on larger transactions Tax issues can delay strategic transactions (FAS 5 issues) Build compliance into systems early Review state level changes a couple of times per year

10 Systems Needs for SaaS Financial reporting system (QuickBooks, MS Dynamics, etc) Simple project capability Database for revenue and contract management Salesforce or homebuilt that scales Manage pending implementations Feed revenue to financial system Feed management dashboards and metrics Key Takeaways Spreadsheets break Build links from operational systems to feed financials Establish firm audit trails

11 CFO Perspectives Operational

12 Operational considerations

13 Right from the Start Sales Build inside sales first Sales comp plans tied to acquisition of MRR Separate hunters and farmers Avoid costly enterprise sales techniques Engineering Architecture Always on QA Marketing Embrace developers Online marketing skills Constantly measure the effectiveness of marketing spend Deploy guerilla marketing techniques Analytics

14 Invest in Lead Generation Marketing = lead generation Measure lead generation conversion Use tools to generate leads & accelerate sales cycles inexpensively Practice guerilla marketing tactics Offer demo accounts and start up kits Frequent e-marketing initiatives Explore segmented marketing Evangelize customer references

15 Sales Learning Curve Set goal of MRR/Sales HC before hiring Use MRR to determine when to hire Restrict sales hiring Use MRR vs fully burdened cost of sales to assess Accelerate sales hiring only MRR justifies Commission plans direct behavior $1 of commission for $1 of MRR = 8.3% rate Inside sales Inside sales Require $60K-75K MRR Field sales Require $80K-100K MRR Stay local

16 Develop an API Strategy Early Adopt an open API strategy from Day One Use APIs to drive integration strategy APIs can drive adoption Right API strategy can lead to new channels Entice developers to create extensions to enhance your product line View developers as a channel

17 How to Measure and Monitor Performance

18 Critical Internal Systems & Processes Allocate funds for internal investment Have nimble & smart internal systems Billing system that supports recurring billing Be flexible & able to process secure payments Be aware of changing regulatory environment Reporting database Partner/developer tracking database Campaign manager tool set Standard contracts Customize only for large accounts

19 Build Programs to Encourage & Track Usage Analytics rule! Know exactly how customers are using your product Measure user adoption Test new features Spot potential problem areas Customize your marketing programs Focus product feature roadmap

20 How to Measure Product design & architecture Reporting system Databases Code & customer account / usage Reporting and metrics Billing BI tools To report, track & measure Analyst resources To assess & compare Internal compass

21 What to Measure Part I MRR: monthly recurring revenue * CLTV: lifetime value of a customer Churn Rate: the % of customers who end their relationship in a given period Retention rate: 1- churn rate Renewal rate Upsell Selling costs Value by year acquired What does this tell you about the customer?

22 What to Measure Part II Deferred revenue: revenue that cannot yet be recognized on the I/S Life cycle of deferred revenue: how long DR hangs out on the B/S Backlog: off balance sheet tracking of undelivered elements Professional services, training, customization GPM: gross profit margin CPNC: cost per new customer Go ahead if CPNC < CLTV

23 What to Measure Part III CAC: customer acquisition cost Many ways to measure Change in revenue/s&m spend Change in GM/S&M spend Bessemer & Hummer Winblad have published their formulas Programs should permit you to track By marketing activity Even by individual customer

24 The Ideal Dashboard

25 What Matters MRR * CLTV Churn Rate Retention rate CAC Cash Value of installed base Value of plan to come from new business Deferred revenue Live cycle of deferred revenue Backlog Avg seats/customer Avg price/seat Customer growth Other marketing costs SEO, PPC, CPA, CPM

26 Projecting and Conserving Cash

27 Vulnerability of Fixed Costs Major spend areas Headcount Facilities Marketing Delivery costs Fixed costs of operations providing response, reliability, security are hard to cut Know your data center costs Colo, rack space, power, bandwidth, maintenance, hands-on admin Public SaaS companies have long climb to profitability Major cause of losses was high S&M expense Watch marketing effectiveness & manage sales team costs

28 Cash Management week rolling forecast Inflows Outflows Cash flows from operating activities Annual budget Forecast cash flow through end of fiscal year SaaS may consume $30M before CFBE occurs Runway Know when it ends at current spend Know what to do about it

29 CFO Perspectives Thank you

30 The Legal Perspective: Key Issues in Software-as-a-Service Contracts Robin J. Lee & Diane Savage Technology Transactions Group Cooley Godward Kronish LLP October 28, 2009

31 What we ll talk about today Software license agreements and SaaS contracts have some similarities, but differ in some fundamental ways Consequently, due diligence intuitions developed in a world of software contracts are applicable to some issues, but for other issues need to be retooled for a SaaS world VCs and other investors performing due diligence on SaaS companies need to be aware of the differences that matter

32 What we ll talk about today We will cover ten common topics in SaaS contracts that are of unique legal concern: 1. Type and enforceability of subscription agreement 2. Third-party components 3. Upstream hosted/managed service providers 4. Confidentiality & security 5. Service level agreements 6. Constant improvement model 7. Warranties and limitations of liability 8. Financial and accounting issues 9. Insurance 10. Term and termination rights

33 What we ll talk about today To put the problem in context, we ll take distinct roles: Diane (the SaaS company trying to run a business): How should a SaaS company proactively address these issues to maximize value? Robin (the grumpy but practical investor): How should an investor view these issues from a due diligence and valuation perspective?

34 1. The Subscription Agreement Two basic forms of subscription agreement Online click-to-accept agreement Negotiated brick-and-mortar agreement Due diligence tips: Enforceability problems Clickwrap vs. browsewrap Geographic scope Privacy Is there a privacy policy on the website? Data privacy in the EU

35 2. Third-Party Issues: Software Components SaaS companies (like most) are likely to make use of software licensed from third parties Many software license agreements contain contractual prohibitions on remote, ASP, or service bureau use May also require pass-through restrictions Special open-source software issues Due diligence tips: Understand what third-party software is used in the SaaS offering Review for compliance all third-party software license agreements

36 3. Third-Party Issues: Hosted Services SaaS companies frequently contract with a third-party service provider to host the service This creates a critical upstream third-party dependency Ideally: hosted services agreement and SaaS s own contracts with customers should contain back-to-back terms Due diligence tips: Perform comparative analysis of hosted services agreement and Subscription Agreement Identify gaps Identify pass-throughs

37 4. Confidentiality & Security Issues The SaaS model involves much more sharing of the customer s sensitive/proprietary information As a result, SaaS agreements often include robust contractual provisions regarding information security Security audits/inspections SOX compliance/sas-70 reports Due diligence tips: Look for: Unlimited liability for security breaches Standardized reporting and remediation for breaches Retention policy Security breach notification liability

38 5. Service Level Agreements Appropriate performance measurements (uptime guarantees, throughput, mean-time-torestore) Exclusions! Due diligence tips: Does company have a baseline SLA? Remedies for breach Customer duties and responsibilities Beware of customer-supplied SLAs Redundant systems/disaster recovery Historically, has the company been in compliance with its contract commitments?

39 6. Constant Improvement Model In a service model, maintenance is often built in The SaaS company wants all customers on the same version Customers often object to forced upgrades Configuration vs. customization Due diligence tip: Watch for burdensome one-off agreements that require specific versions for specific customers, which can erode the economics of the SaaS model

40 7. Warranties and Limitations of Liability In principle, similar to software license agreements, but: Watch for general limitations of liability at fees paid under the Agreement, as these will increase over time Additional exceptions to consequentials waiver/direct cap Warranties: can argue that the SLA should be sufficient, but customers will often insist on some kind of performance warranty Due diligence tips: As usual, understand the worst-case exposure for breach of agreement What if there s a security breach? What if the service goes down?

41 8. Financial and Accounting Issues Financial strength of the SaaS company is obviously a key concern of its customers Therefore, SaaS contracts may contain assurances related to the financial condition of the SaaS company Access to private financial records Termination for insolvency Access to backups Source code release on bankruptcy Due diligence tip: Disclosure provisions in customer contracts are generally okay, but watch for provisions that create revenue recognition issues

42 9. Insurance No problem, we have insurance for all of that! Beware: many insurance policies do not cover all of the risks that SaaS companies face Cyber-insurance policies can be pretty limited In the end, need to carefully review the applicable policies Due diligence tips: Review the actual policies Consider inquiring into insurance held by third-party hosted services provider

43 10. Termination Issues Many may assume that the customer is locked in for the term of the SaaS contract But virtually all SaaS contracts have early termination rights Can the customer terminate for convenience? What constitutes cause for termination purposes? Are there burdensome termination assistance obligations on the SaaS company? Due diligence tips: Review all termination rights Inquire into historical experience with respect to customer terminations and renewals

44 Summary In some ways, SaaS contracts look like software license agreements In other ways, the SaaS model creates unique business and legal liability exposure that often prompt very different contract provisions Both SaaS companies and their investors need to understand these contract provisions and their purposes, in order to make an intelligent assessment of: what it makes sense to accept (the SaaS company) how it impacts the value of the business (the investor)

45 Questions?

46 A Capital Markets Perspective October 28, 2009

47 SaaS In The Capital Markets How are SaaS companies valued relative to traditional perpetual license software companies? How have they fared in this turbulent market? Is there an active M&A market for SaaS companies? At what prices? What do we see on the horizon?

48 Performance: Perpetual v. SaaS Software SaaS Much More Levered To The Market (Indexed) 300% 190.4% % 100 (0.9%) /01/05 01/01/06 01/01/07 01/01/08 01/01/09 Perpetual License Vendors SaaS Vendors NASDAQ Source: Per FactSet Research Systems as of October 16, Note: Perpetual License Vendors include: EPIC, INTU, JDAS, LWSN, MANH, MSFT, MSTR, ORCL, QADI, SAP, SPSS and SY. Note: SaaS Vendors include: ARBA, BLKB, BBBB, CNQR, CTCT, TRAK, KNXA, N, OMTR, RHT, RNOW, CRM, SDBT, SFSF and TLEO.

49 Multiples: Perpetual v. SaaS Software SaaS Companies Enjoy Consistently Higher P/E (Price / NTM Earnings Multiple) 50x x 26x 30x 28x 28x 31x 32x 32x 33x 35x 34x 33x 33x 30x 26x 27x 27x x 21x 18x 19x 20x 20x 20x 19x 20x 20x 20x 19x 18x 15x 15x 15x 21x 24x 24x 14x 11x 14x 16x 0 Jan 2005 Jul 2005 Jan 2006 Jul 2006 Jan 2007 Jul 2007 Jan 2008 Jul 2008 Jan 2009 Jul 2009 Perpetual License Vendors SaaS Vendors Source: Per FactSet Research Systems as of October 16, Note: Perpetual License Vendors include: EPIC, INTU, JDAS, LWSN, MANH, MSFT, MSTR, ORCL, QADI, SAP, SPSS and SY. Note: SaaS Vendors include: ARBA, BLKB, BBBB, CNQR, CTCT, TRAK, KNXA, N, OMTR, RHT, RNOW, CRM, SDBT, SFSF and TLEO.

50 The SaaS Premium It s Real And Expanding (Price / NTM Earnings Multiple) (SaaS Premium) 40x 100% 35x 34x x 32x 33x 33x 33x 31x 30x 30x 30x x 28x 26x 27x 27x 26x 70 24x 25 24x 23x 60 21x 21x 19x 20x 20x 20x 20x 20x 20x 18x 19x 19x 20 18x 50 15x 15x 16x 15x 14x 14x x /01/05 04/01/05 07/01/05 10/01/05 01/01/06 04/01/06 07/01/06 10/01/06 01/01/07 04/01/07 07/01/07 10/01/07 01/01/08 04/01/08 07/01/08 10/01/08 01/01/09 04/01/09 07/01/09 10/01/09 SaaS Vendors Perpetual License Vendors SaaS Premium Source: Per FactSet Research Systems as of October 16, Note: Perpetual License Vendors include: EPIC, INTU, JDAS, LWSN, MANH, MSFT, MSTR, ORCL, QADI, SAP, SPSS and SY. Note: SaaS Vendors include: ARBA, BLKB, BBBB, CNQR, CTCT, TRAK, KNXA, N, OMTR, RHT, RNOW, CRM, SDBT, SFSF and TLEO.

51 SaaS IPO Activity Only Two Offerings Since 2008 (US$ in millions) (a) Per FactSet Research Systems as of October 16, Pricing Amount Offer Price Date Company Raised to Current (a) 07/01/09 LogMeIn $ % 06/25/09 Medidata Solutions Average 17.4 % 12/20/07 NetSuite $161.2 (35.9)% 11/20/07 SuccessFactors /01/07 SoundBite Communications 41.6 (61.3) 10/03/07 Constant Contact /09/07 DemandTec 66.0 (25.1) 02/15/07 Salary.com 59.9 (69.5) Average (20.8)% 06/27/06 Omniture $ % 06/15/06 Synchronoss Technologies Average % 12/13/05 DealerTrack Holdings $ % 12/07/05 Vocus /29/05 Taleo /24/05 Kenexa Average 58.1 % 09/28/04 WebSideStory $42.5 NA 08/05/04 RightNow Technologies % 07/14/04 Phase Forward /25/04 Motive 50.0 NA 06/23/04 Salesforce.com /18/04 Blackboard Average %

52 SaaS M&A Transactions Multiples Consistently High Exit Values Average Revenue Multiples by Quarter (TV / LTM Revenue Multiple) 8.0 x x 7.3 x x 6.1 x 6.0 x 5.9 x 5.8 x 5.6 x x x 3.6 x 3.6 x 3.8 x x 2.5 x Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 NA Source: Per The 451 Group, FactSet Research Systems, SDC and Thomson One Banker as of October 16, Excludes transaction values below $20 million.

53 SaaS M&A Transactions Volume Still Relatively Low In Terms Of Absolute Totals Transaction Volume and Aggregate Value by Quarter (US$ in millions) $2,500 $4, $2,243 2, $1,746 $1,611 1,500 $1,458 $1, $1,037 1,000 $822 8 $549 $ $310 $396 $ $88 $64 $33 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q Aggregate Transaction Value Total Number of Transactions 0 Source: Per The 451 Group, FactSet Research Systems, SDC and Thomson One Banker as of October 16, Excludes transaction values below $20 million. Note: Target company logos represent announced deals with transaction values greater than $400 million.

54 SaaS M&A Transactions Top Transactions Last 5 Years (US$ in millions) Estimated Announced Transaction TV / LTM Date Acquirer Target Value Revenue 03/15/07 Cisco Systems Inc. WebEx Communications $3, x 09/15/09 Adobe Systems Inc. Omniture Inc. 1, /14/07 Microsoft Corp. Tellme Networks Inc NA 10/08/08 Symantec Corp. MessageLabs Ltd /09/07 Google Inc. Postini Inc /11/08 Microsoft Corp. Danger Inc /23/04 Ariba Inc. Freemarkets Inc /25/07 Omniture Inc. Visual Sciences Inc /03/07 Autonomy Corp. Zantaz Inc NA 04/08/08 Nuance Communications Inc. escription Inc Source: Per The 451 Group, FactSet Research Systems, SDC and Thomson One Banker as of October 16, Excludes transaction values below $20 million.

55 SaaS M&A Transactions Top Acquirers Last 5 Years (US$ in millions) Estimated Announced Transaction TV / LTM Date Acquirer / Target Value Revenue Blackbaud Inc. 05/29/08 Kintera Inc. $ x 08/06/07 etapestry.com 24.8 NA 01/16/07 Target Software / Target Analysis 60.0 NA DealerTrack Holdings Inc. 01/23/09 JM Dealer Services Inc. (Inv. Management Solutions) $32.5 NA 06/06/07 Arkona Inc x 01/18/07 Curomax Corp Google Inc. 07/09/07 Postini Inc. $ x 07/02/07 GrandCentral Communications 50.0 NA 05/24/07 FeedBurner Inc NA Intuit Inc. 09/14/09 Mint Software Inc. $170.0 NA 06/02/09 PayCycle Inc x 11/26/07 Homestead Technologies Inc McAfee Inc. 07/30/09 MX Logic $ x 10/30/07 ScanAlert Inc /08/07 SafeBoot BV Nuance Communications Inc. 04/08/08 escription Inc. $ x 10/02/07 Commissure Inc /22/07 BeVocal Inc NA Omniture Inc. 10/25/07 Visual Sciences Inc. $ x 09/07/07 Offermatica Corp /14/07 Touch Clarity Ltd Source: Per The 451 Group, FactSet Research Systems, SDC and Thomson One Banker as of October 16, Excludes transaction values below $20 million.

56 Conclusions Investors clearly place premium value on the growth and predictability of SaaS High beta works both directions Relatively few public market plays M&A market still developing including buyers