Note: We’re A/B testing headlines for this post. Content is still the same.
There’s a massive shift happening here at Silicon Valley. 15 years ago, since the last dot-com bust, Wall Street started to reward tech companies going public on growth. Over the past two years or so, public market investors started to skip the middle man and start to value growth even more by investing directly into the private markets and driving up valuations.
They opted to reward on growth because rewarding based on pure eyeballs or buying a .com and a paper napkin idea wasn’t enough (as the first bubble showed), but rewarding based on profitability was too hard (because let’s face it, a profitable Internet business was still hard to come by).
If the last few months are any indication, it has become clear that growth alone is not enough for companies to go public any longer. You have to have strong business metrics. Shockingly, you have to make money. You have to be profitable.
Our goal here at ToutApp has always been to build a solid, long-term, self-sustaining business that changes how selling is done for every sales team on this planet.
In this post, I’m writing to declare that ToutApp is focusing our business strategy to aggressively pursue profitability, so that we can become a solid self-sustaining business in this new environment vs. a grow at all costs business.
This focus comes from companies (some of which are customers of ours) that have inspired us in how they’ve built their businesses and thrived including but not limited to Atlassian, Qualtrics, WebEx, ProCore and Ultimate Software.
Through the rest of this post, I’ll explain my reasoning and why this is going to be great for us, our customers and the broader sales software industry.
The change in Silicon Valley
Recent posts by Bill Gurley about overvalued unicorns and Fred Wilson’s post on negative gross margins plaguing startups are both confirmation that the rules of the game are changing. In case you don’t trust the internal Silicon Valley echo chamber, another data point to consider is Fidelity writing down its investments into private companies — no longer supporting the “grow at all costs” mantra.
For most of the world, this is not a novel idea. For Silicon Valley, this too isn’t a novel idea. In fact, in Peter Thiel’s CS 153B class, he expressly talked about the importance of long term sustainability vs just measuring the typical growth at all costs that plagues Silicon Valley.
So if you are trying to analyze any of the tech companies in Silicon Valley, AirBnB, Twitter, Facebook, any emerging Internet companies, all the ones in Y Combinator, the math tells you that three quarters, eighty-five percent of the value is coming from cash flows in years 2024 and beyond. It’s very far in the future and so one of the things that we always over value in Silicon Valley is growth rates and we undervalue durability.
Growth is something you can measure in the here and now, you can always track that very precisely. The question of whether a company will be around a decade from now, that’s actually what dominates the value equation and that’s a much more qualitative sort of a thing.
Our pledge is to get to cash flow positive as fast as possible and turn a profit by the time we IPO.
The days of IPOs based on growth and top line numbers are over. Box’s IPO which barely eeked through may very well have been the last one. Do you know how many tech IPOs happened last quarter? Zero. Zilch. None.
I believe that the next 10 tech IPOs are going to be profitable businesses with long term sustainability – and that means company building in Silicon Valley must adapt. Similarly, Founders and VCs must adapt in how they run their companies.
Why wasn’t profitability a priority in the first place?
So you might ask as I asked myself. Why not grow at a slower clip, and take in less cash, and build a really strong sustainable business at the onset?
Here’s the thing. In a vacuum, it’s very easy to focus on fundamentals, build a strong foundation, and grow at a pace that you can handle.
Ironically, I feel that the single thing that plagues Silicon Valley’s misaligned incentives around growth is Silicon Valley itself: the free flowing availability of VC cash not just to you but to three other entrepreneurs that are willing to chase the same idea.
Before we took on a single $1 of venture capital, ToutApp reached cash flow positive. With the influx of our $3.3m cash in our Series A from Jackson Square Ventures, we stepped up the burn a bit but we still managed amazing employee to revenue ratios and grew nearly 300%.
As soon as we raised our Series B of $15m, a few things changed. The expectations for growth became bigger (as it should). But that wasn’t the problem. The problem was that within months of announcing our Series B led by a16z, similar VC firms announced investments into our category funding competitors that went after the same cheese we were after.
This caused a chain reaction of external changes that lead to a domino effect internal to our business. Externally, the market became flooded with product. Internally, it caused every player in the space to race to outspend each other in the pursuit of growth.
With the availability of free flowing cash at all the companies in the space, we all set out to outspend each other and grow. Bigger Dreamforce booths. More marketing spends. And more Salespeople and SDRs to spray the market and pray that they buy.
And, buy they did. While our overall business grew by 80% the segment of the business we focused our business resources on grew by 160%. But of course, as we see in Silicon Valley as a whole, that growth comes at a cost: fundamentals. Even with good fundamentals, you always want great — because that yields an even longer term sustainable business.
This story is not specific to the sales space. The same has played out in food delivery, the “do it for me space” from house cleaning to park my car for me spaces, and it even permeated in perhaps the unicorn that started it all: the ride sharing spaces. A lot of times, over investment in a space results in hyper competition and a race to the bottom.
At ToutApp, we decided that the outspending the competition and continuing to raise unlimited amounts of VC while our employees and my stock ownership dips lower and lower is not only a fools bet, but also something that is probably not going to work any longer.
Fred Wilson aptly pointed out my sentiment around this when in his post he said:
Getting a huge lead on your competitors, raising a ton of money to operate a scorched earth strategy and force your competitors out of the market, will work for some. But not nearly as many as the capital markets seem to think.
Founders will have to get to profitability through creativity, ingenuity and scaling through technologies instead of just hiring.
Earlier this year, we announced that ToutApp would not take part in paid sponsorships in any further Sales industry events. This is just a small part of our strategy for us embracing operational ruthlessness to achieve true success for our company.
In this new environment for Silicon Valley, founders will have to drive their companies to embrace frugality, focus on operational ruthlessness, and play the competition game not by outspending but by outsmarting. (Again, all obvious things every startup should do, but perhaps didn’t in the recent environment)
As we continue to define our strategy here at ToutApp, there are a few guiding principles I’ve established in the company:
- Out-teach the customer instead of out-spending the competition
- Provide objectives in every department for driving efficiency and automation and establish negative incentives for driving headcount and “building mini-empires in the company.”
- Relentlessly track down friction points across the business and streamline for a buttery smooth customer experience through the product
- Out-innovate the space instead of playing catch up and creating “me-too” products
- Drive for cash flow positive and drive surplus proceeds right back to the customer and employees
Over the past 10 years, VC-backed companies have solved scaling problems through humans (by hiring more people and ballooning in size), whereas in the next 10 years, we’ll be solving problems (ironically enough) through better technology. I believe tech companies will start to have engineers dedicated to internal systems and processes so that they can do more with their people instead of hiring more.
This new environment requires a bigger emphasis on core financials and BizOps earlier in a company’s life
I’ve always been enamored about how PE firms run operationally efficient companies. I believe the same type of operational ruthlessness will find their way into VC-backed businesses as well.
Nick Mehta, Fred Shilmover and Byron Deeter recently hosted a webinar on how to run operationally lean companies during a downturn. If you’re a founder of a company, I highly recommend watching the recording here.
The webinar highlighted things we already started to prioritize more than ever in our business. For companies to succeed, beyond creating a great product and having a fantastic go to market strategy, they have to start building disciplines around operational ruthlessness.
Some key things that particularly resonated with us and we’ve embraced since the beginning of this year already include:
- Rule of 40% – Good SaaS companies should aim to run at > 40% of Revenue Growth (Y/Y MRR growth) plus Profit Margin.
- Apply hyper focus on successful segments & De-emphasize segments that are costly to retain & acquire
- Focus on increasing ASPs
- Track distribution of ASP, and apply marketing efforts on MRR buckets where customer concentration is low
- Focus on lowering Payback Periods
What this means for Venture Capitalists
We may be entering a time where Founders will actually turn away from doing monster rounds. This will mean that VC firms, beyond the cash they promise to provide, will have to differentiate in uniquely new ways. This also means VC firms with the billion dollar funds they’ve just finished raising will have to find effective ways of deploying it.
Jackson Square Ventures follows a model where it is a firm comprised of extremely experienced general partners with both deep operating experience and nearly a decade each of VC experience. I’m on a texting basis with our partner Greg Gretsch, and at any time I’m stuck on something whether it is operational or strategic, he’s available to dig in and help or loop in one of the other partners. “Greg, I’ve got a really stupid question and I’m not sure who to ask,” I would say in the early days when he invested in our eight-person outfit and this first time CEO. “There’s no such thing as a stupid question,” Greg would assure me.
A16Z is on the other end of the spectrum. They follow an agency model. When I have an issue and take it to our partner Scott Weiss, he puts in his thoughts but more often routes me to an expert in the firm that can help. I’ve worked closely with a16z’s recruiting teams, Executive Briefing centers and even HR practitioners over the past year and it has proven to be very helpful.
I’ve had the luxury of enjoying both models and have found each to be phenomenal in their own ways.
In this new period of company building, Venture Capital firms will have to beef up skill sets (either through general partners or through teams) that help their portfolio companies embrace operational ruthlessness.
In my mind, this is a step different from recruiting, introductions and strategy that VC firms bring to the table. This will be a discipline in itself that sets the tone for how companies are instrumented and run efficiently.
What this means for ToutApp
For our customers, this strategy will ensure they are partnering with a company that is here for the long run with a fundamentally sound business model.
In terms of our day to day operations, nothing changes. In terms of how we compete, our plan is continue to build a team of great people that think deeply about the business and executes aggressively and smartly.
In environments like this, it’s no longer going to be about out-raising and outspending the competition, it’s going to be about outsmarting the market and delivering a uniquely different offering for our customers that is a no brainer for them.
It is astonishing to me that even though human beings have been building companies since the beginning of time — we still suck at it. But in this period, I believe we are headed into a golden age in how efficient high growth money making corporations that also do good are built.