Since everyone is interested in SaaS funding and valuations I thought it would be helpful to tell you about an interesting Cloud Computing investor panel I attended at the recent All About the Cloud conference in SF. The session was moderated by Jason Green from Emergence Capital Partners and was joined by Gary Hromadko from Crosslink Capital, Mark McNay from William Blair and Evangelos Simoudis from Trident Capital.

So what did they have to say?

The market has finally changed for the better

2009 was all about survival and the venture community did less than half the investments than in a typical year.

This year is now about growing again and current investments are more focused on companies that have weathered the economic downturn. Their investments are focused on changing the slope of these types of company’s growth curves, by concentrating more on sales and marketing.

SaaS and Cloud companies are leading the way

Consumers have been driving the adoption of easier to use Cloud-based solutions like eBay, iTunes, Facebook, Twitter and LinkedIn. They are viral and can reach critical mass very quickly because there are low barriers to adoption.

With SaaS, the recession has really pushed the advantages of a subscription business model and moving from CapEx to OpEx software investments. It’s like leasing your car rather than buying it.

Lean start-ups are definitely in. Almost all early stage software investments in 2009-10 are Cloud-based because it takes a fair amount of capital to fund SaaS firms and it takes a long time for them to reach profitability. One interesting comment was that later stage on-premise companies are now being asked about what their SaaS/Cloud strategy is for the future, because without it, they may find funding might be difficult.

What the VC’s are looking for

SaaS 1.0 focused on a company’s income statement, expenses and cash flows than GAAP reported financials. One important measurement is a company’s incremental contribution margins (gross margins), which is critical for SaaS. Companies needed to balance capital efficiency with building a business that can scale.

Investors are looking for unique business processes that can only be built or automated through SaaS or the Cloud. Emergence latest investments are pure Cloud-based companies that have viral qualities like YouSendit, the files sharing company and Yammer and the enterprise micro-blogging firm, both of these companies are viral enterprise solutions. Yammer has more than 70,000 customers with at least 1 user and is signing up between 7-10,000 users a month and 10% are turning into paying customers. Crosslink invested in Carbonite, a backup and recovery company, has high margins and is the only other independent player in the category with Mozy, who is owned by EMC. They felt that scarcity of competitors and their ability to manage Customer Acquisition Costs were important in establishing the company’s value.

The panelists also said they are looking for companies that have a rigorous focus on metrics like Customer Lifetime Value and Customer Acquisition Costs. In fact CAC appears to drive business value because it has a lot to do with capital efficiency and the company’s ability to grow their business.

Exits, IPO’s and Valuations

Economy has recovered and CEO’s are ready to start taking on more risk, and it’s a real change in psychology because we are at the beginning of a macro trend that will last more than 10 years.

This is evident by more than 100 M&A transactions last quarter including high profile deals like IBM buying CastIron, Salesforce buying Jigsaw for $142M, Successfactors buying CubeTree for $50M. The current environment is right for deals, especially as SaaS is gaining enterprise momentum with recent deals like SuccessFactors’ mega deal with Walmart for 1.6M users. Transactions like Jigsaw, CubeTree, and CA’s purchase of 3Tera and Nimsoft for $350M all indicate a return to a healthy M&A atmosphere, that will probably last for the next 12-18 months.

Oracle and SAP won’t be aggressive on the M&A front until they come to the realization that they can’t build Cloud solutions internally. Because many SaaS companies have now crossed the $25-30M in recurring revenues threshold, these firms may become quite attractive to these larger ISV’s looking to make the move to the SaaS business model.

But these acquirers don’t want to take on the burn associated with many start-ups so it will be important to stay close to breakeven and you may have to sacrifice growth for profitability. Since the access to capital is still tight, start-ups will have to try and collect cash upfront and continue to tune their business models to improve cash flows.

Companies that seem to own a category have perceived scarcity value which will result in a premium on any transaction, especially if they are perceived to own a segment franchise. VC’s and acquirers are looking for a minimum of 40% CAGR to get a premium valuation.

On the other side of the liquidity front, the IPO window for SaaS companies is beginning to open up and firms like SolarWinds and LogMeIn have now been joined by SPS Commerce and Convio. At least before the recent stock market downturn, these companies had traded up by 15% since their IPOs.

The panel seemed to believe that the market is definitely getting better and that is good news for SaaS and Cloud Computing companies looking for funding or an exit!

While walking through the exhibit area of Salesforce.com’s recent Dreamforce event in San Francisco, I was struck by large number of enterprise customers present and the low number of enterprise applications being marketed. I started to think about my experience earlier in the year helping my prior company successfully secure their Series B funding and why the word “enterprise” generates an immediate negative reaction with many venture capital firms when it comes to investing in SaaS providers offering enterprise solutions? When making the venture capital rounds earlier in the year to secure this additional funding, I was surprised by the polarity of views on enterprise applications for SaaS. One group of VC’s defined SaaS applications from a commercial market perspective … high transaction volume, low sales touch and low cost per transaction. To this group, SaaS and enterprise software were mutually exclusive. The other group of VC’s understood the higher costs associated with selling SaaS for complex enterprise requirements and saw the potential rewards. We successfully completed the funding with a group of VC firms in the later group. Their message to us was clear, we believe in the value of your business model but you must lower the cost of acquiring new customers.

The commoditization of SaaS is clearly happening in the small to medium size business market and for some enterprise market companies with relatively simple solution requirements. SaaS solution examples like Intuit’s Quicken Online and their new website building service are examples of the high volume, low sales touch, low customer acquisition cost business model. Some SaaS services offer free trials like Salesforce.com or open source downloads of their applications like Adaptive Planning to help move the prospective buyer cost effectively through the sales cycle. The sales “touch” of this style of selling is typically sending additional information via email, using web seminars and using telesales representatives to close the deal and complete the transaction. For prospective customers who need a straight-forward application that requires little or no professional services assistance for implementation, the cost of customer acquisition can be lowered significantly. It’s very understandable why some VCs only want to invest in the commoditization of SaaS with its high-volume and low-cost of sales. Can the lessons learned in this process of commoditization be applied to SaaS based enterprise solutions targeting companies with complex application needs or implementation requirements?

The answer is yes… and no. Certainly, the days of high touch enterprise style selling in the SaaS marketplace are not over yet but change needs to happen. Enterprise companies with sophisticated business requirements want to evaluate SaaS solutions but need a “high touch” approach to working with the software vendor. This typically involves lengthy requests for proposals, face-to-face meetings with executives, users and IT, customized demos, pilot programs and site visits to the vendor’s data center or reference accounts. I am sure that selling Salesforce.com to Dell or Successfactors to Siemens was not accomplished with just a free trial, web seminar and telesales rep. The challenge is in how to effectively start moving these more complex sales towards a lower customer acquisition cost business model. Here are ten ideas to reduce customer acquisition cost for a SaaS vendor to consider when selling into the enterprise market …

1) Develop, document and articulate a high impact solution methodology that can provide a prospective enterprise market customer with a clear roadmap on how the SaaS application integrates into their business requirements. A solution methodology typically involves documenting how real world business processes map to the SaaS solution and how the SaaS solution can be successfully implemented without the need for extensive consulting.

2) Use web marketing effectively to improve the quality, quantity and impact of information for the enterprise company buyer. Answer the prospect’s questions before they ask them using Flash based graphical displays, testimonials, videos, structured demos, FAQs and case studies. Web based training materials can be very instrumental in helping a company though the evaluation process.

3) Leverage social networking techniques and processes to allow prospective customers to tap into the collective knowledge of your customer base to help them through the purchase process. Of course, this implies that you are maintaining very high levels of customer satisfaction and you can filter information as needed. Suffice to say, there’s an inverse relationship between customer acquisition costs and customer satisfaction.

4) Use web conferencing technology as an alternative to on-site visits. The quality of web conferencing for both audio and video has improved dramatically over the past few years while dropping in cost. Using web conferencing to stage demos for more than one prospect also helps to reduce selling costs.

5) Organize group visits to data centers or training facilities. A large enterprise company that I worked for a few years ago would stage CIO conferences that included a visit to their data center so they could reduce the number of one-off site visits. This also allowed prospective buyers to meet and network with key vendor staff and existing customers.

6) Focus on cutting the cost of lead and opportunity generation. It’s all about conversion rates…. lead to qualified sales opportunity, sales opportunity-to-close. For SaaS-based applications designed for defined markets, target marketing to specific market segments can be much more effective than broad-based marketing to diverse market segments. The velocity of conversions from responses to leads or leads to opportunities has definitely slowed through the course of this recession. Improving the conversion rate from leads to opportunities by using lead scoring and lead nurturing techniques can significantly improve the ROI of marketing programs.

7) If you can’t measure it, you can’t manage it. Taking a disciplined approach to using CRM, analytics and marketing automation to measure, monitor and manage sales and marketing results is key to cutting customer acquisition costs. If you don’t know what your pipeline metrics or your customer acquisition costs are, I doubt if you will be able to manage them effectively.

8) Know a duck when you see one, particularly when it comes to enterprise sales. Actively manage the sales cycle and accurately access the reality of each sales situation. Chasing enterprise deals that are not properly qualified will most likely not close and will dramatically increase your customer acquisition cost.

9) Drive your order processing costs down. Make your pricing and contractual models easy to access and understand. Complex pricing and contracts beg for long and costly negotiation cycles. Utilize SaaS focused billing solutions from companies like Dreamforce exhibitor Zuora to help simplify the process and reduce costs. One company that I spoke to at Dreamforce told me that their internal cost to process an individual order exceeded a thousand dollars.

10) Automate as much of the implementation and data integration process as possible, articulate an implementation methodology and make configuration an end user process. This is a significant challenge for SaaS based enterprise solutions because implementations are typically complex and there is a large quantity of data that most be extracted from an in-house system, transformed and loaded into the SaaS solution. Without an efficient process or tool set to simplify implementations, the cost of sales goes up because the sales cycle is extended to explain and build confidence that the prospect’s requirements can be successfully met.

Implementing any number of these ideas will help to lower customer acquisition cost. Years ago, Salesforce.com successfully competed against Siebel Systems in large enterprise accounts by following a number of the ideas mentioned above. They showed that a complex enterprise application could be sold and delivered more cost effectively using SaaS than its licensed based counterpart. Companies like Salesforce.com and Successfactors did not turn their back on enterprise sales with its implicit high customer acquisition costs but instead adapted their sales model to lower customer acquisition costs by leveraging a balanced approach to telesales and field sales, web marketing, social networking and their most important asset… satisfied and successful customers. I doubt that selling a SaaS based application to an enterprise company with complex requirements will ever become a true commodity sale but customer acquisition costs must continue to managed and reduced. As customer acquisition costs are reduced, I am confident that VC community interest in SaaS-based enterprise solutions will soon increase.

This week’s Smart SaaS blogger is Gary Damiano.
He can be reached on LinkedIn or at gedamiano@gmail.com.