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!

There were a number of keynotes at last week’s All About the Cloud conference that focused on Public and Private Clouds and the market. What was interesting is that the typical hype associated with Cloud Computing appears to be calming down. It seems like it is no longer necessary to justify or explain the Cloud, or at least for the audience at that conference. According to Gartner the Cloud Computing market will be $150B in IT spend by 2013 as compared to $56B in 2009 and is the #1 Strategic Technology for CIO’s in 2010

The new Cloud attitude appears to be more about ‘when’ and ‘how’ enterprises will be utilizing Cloud solutions rather than ‘if’.

Coexistence is ‘In’

The other interesting change, which I first noticed at the end of last year at both OracleWorld and Dreamforce, was that everyone seemed to be talking about co-existence or hybrid uses of the Cloud with on-premise assets. This more reasoned approach is going to make more sense to CIO’s and business executives to who have spend millions building out their infrastructure over the past 10 years. Cloud can be complimentary. Starting with fringe or edge applications and then over time becoming more useful for mission critical functions.

The Consumer Cloud

Tuesday’s press panel with [insert names] focused mostly on the use of the Cloud for consumer applications like Facebook, Google, Amazon, eBay and future offerings like iTunes LIVE and Microsoft Office 2010 (launched on May 12^th). Cloud is everywhere but the average consumer doesn’t even know they are in the Cloud. With the advent of ubiquitous broadband access, smart devices and massive data centers, there are all sorts of Cloud based consumer services emerging. But the market is still evolving because the Generation X’ers are plugged into the Cloud but as Kevin O’Brien from Oracle said in his session, ‘My mom still doesn’t know what the Cloud is’, and she is probably isn’t alone.

Private Clouds

There were many sessions that discussed how there is money to be made in the Private Cloud market. You can have many of the advantages of the Public Cloud without the security and control issues. IDC projects that by 2014, $11.8B will be spend on servers to create Private Clouds, considering overall IT spend in the US is approximately $1T, that’s not big percentage today, but it will be in the future.

Scared of the Cloud

Are CIO’s scared of the Cloud because of their potential for loss of control, security issues and resource impacts? Several sessions touched on this aspect of the Cloud Computing market including CIO’s creating hurdles to adoption.

Given the cost and scalability advantages why wouldn’t organizations like the State of California quickly adopt Cloud based solutions? What about the switching costs like decommissioning your own data centers, software and restructuring personnel. If you already own PeopleSoft and it is working, will you really be open to a Workday ‘rip and replace’ scenario? Enterprise organizations are warming up to the idea, just ask Flextronics.

One panelist cited a recent Google Docs deal that went sideways at UC Davis where they scrapped their trial for several thousand users. Maybe there were other considerations than the Cloud but most of the sessions agreed that the benefits of the Cloud outweigh the risks and CIO’s are starting to think in terms of intelligent trade-offs instead of just being against the Cloud. This is probably smart, given the recent economic conditions and every CEO is looking to optimize their IT spend.

Cloud 2010 and Beyond

Cloud is just the new thing. According to Bill McNee at Saugatuck Technologies, their most recent Cloud Computing survey indicated that 86% of the respondents thought that the Cloud would be part of mainstream IT by 2014.

There appears to be reasonable optimism that Cloud Computing is not a fad and its going to happen, it’s just going to be the way people are operating today in the future. The Google Docs business is adding 3,000 new companies a day, that doesn’t seem like a fad. According to Gartner, their Hype Curve for Cloud Computing showed that July 2009 was the peak and it really appears that the market is maturing about the Cloud.

Venture Capital firms are only funding Cloud-based start-ups and large technology companies like Cisco, CA and IBM are buying SaaS and Cloud based companies (like CastIron Systems) because they realize they need to overcome the ‘Innovators Dilemma’ around the Cloud. There will be an increase in successful SaaS and Cloud companies as the market continues to mature, as well as a lot more M&A activity.

As one speaker so aptly described the current market situation for many companies when evaluating Cloud Computing, ‘When a piano falling from the sky, you should be worried more about will it hit you not where it is while it is falling.’

Happy New Year!

In February Montclair Advisors launched our SaaS Business Profile Series and have been focused on covering as many SaaS companies as possible during 2009. As it turns out we were able to profile more than 30 SaaS companies of all types including pure SaaS firms, Cross-Overs and Hybrids!

We would like to thank all of the executives and companies that participated during 2009 and we look forward to continuing to follow their progress during 2010.

What we learned from these thirty-four profiles:

• SaaS is an evolving business model - It is still a new concept and few firms are running a pure subscription software models. Beware that there is still a lot of “Fake SaaS” out in the market overall.
• There are many variations of SaaS - these variations are based on the company’s starting point, the market they serve and the types of products they sell. Interestingly, Salesforce.com is actually not a very representative SaaS business model for the broader market.
• It takes time to build a real SaaS company - For many SaaS firms it takes up to 7 years to reach breakeven and nearly 10 years to ultimately gain scale with their business model.
• Cross-over providers will still need to hold onto their on-premise legacy for the foreseeable future, because it is hard to switch customers to SaaS all at once.  It is also difficult to upset your maintenance revenue streams, especially during tough economic times.
• The Great Recession has permanently changed the Software buyer’s behavior towards SaaS due to the lack of available capital. When you see SAP and Oracle and many of these profiled ISV’s moving their businesses to SaaS, you know it isn’t a fad.
• Penetrate and Radiate. The successful SaaS firms have started small, with easy to sell, easy to consume solutions.  They then develop additional software, services and content solutions to sell back into their installed base.

Here is an overview of the thirty-four companies Montclair Advisors covered in 2009:

Profiles by SaaS Category

Pure SaaS:        15     Started out and only offer SaaS subscription services

Cross-Overs:    11      Started out as on-premise, but have fully transitioned to SaaS

Hybrids:             8      Continue to offer SaaS services AND on-premise software

Public vs. Private

Public:               6

Private:             28

Profiles by Age of Company

0-5 Years:         9

5-8 Years:        10

8+ Years:         15

M&A by Companies

Sell-side:            2    Mint.com by Intuit for $170M and QuickArrow by NetSuite for $20M

Buy-side:           4    Lithium Technologies (Keibi Technologies), RightNow (HiveLive), Taleo

(Worldwide Comp), Xactly (Centive)

Fundraising Public & Private

What was also interesting to see is that even in the toughest economic climate since the Dot Com meltdown, that many firms that were profiled were able to raise capital in both the private and public market places.   The big winners were SuccessFactors who raised more than $200M in a public offering and Workday, raised an impressive $75M private round that was led by New Enterprise Associates.  As the economy begins to turn in 2010, expect to see more SaaS firms going back out to raise growth capital.

We hope these profiles have been helpful to our readers and we will continue to profile interesting SaaS firms in 2010, because we learn a lot about our emerging industry and we will continue to build back into the Montclair Advisors advisory services that help our clients become successful SaaS companies.

Please let us know what you think, because we would welcome any ideas on how to improve the Saas Business Profile Series for 2010.  Just drop me an email at kevin@montclairadvisors.com.

Company:         Cast Iron Systems

Started:             2001

Located:            Mountain View, California

Geography:       Global

Market:              SaaS and Cloud Integration

Products:           Cast Iron Integration Solutions

Key Customers: Allianz, British American Tobacco (BAT), Amerisource Bergen, Emerson, IBA Molecular, Krueger International, Peet’s Coffee & Tea, PGP Corporation, and salesforce.com.

Website:            Cast Iron Systems

Twitter:             @Castironsystems

Recent News:

Cast Iron Systems Reports 12th Consecutive Quarter of Growth

Cast Iron Systems and SuccessFactors to Help Customers Improve Business Execution

Taleo and Cast Iron Partner to Bring the Benefits of Cloud Computing to Companies Investing in Talent Management

Cast Iron Accelerates Data Migration and Application Integration to Amazon Web Services

Cast Iron Systems Wins Most Innovative Business Model Award

I asked Simon Peel, Cast Iron Systems’ SVP of Strategy and Marketing a few questions about his business and his view of the SaaS market in 2009.

Did you start out as a Software-as-a-Service company?

We started out in 2001, and our first commercial product was launched in the market in 2003. This first product was intended to be a mission critical integration for on-premise systems like Oracle and SAP.

One thing we knew all along was that application integration is different than data integration. Originally there was business process integration and then new applications started to show up such as Salesforce.com that needed a standardized approach to application integration. Our Salesforce partnership began in 2004 and then our business really started to pick up. We found that customers were very interested in connecting on-premise systems to Cloud-based systems, using a hybrid model, so we then provided connectivity between Salesforce CRM to on-premise ERP systems.

Cast Iron had kicked off the Salesforce relationship with some transactional projects but later the partnership became mission critical for Salesforce and other SaaS-based application systems. After the Salesforce.com partnership was launched, it took a couple of years to get rolling but then a lot of other SaaS companies began coming out of the wood work because many of our competitors viewed this connector market as an after thought.

Other phases and partnerships during our history include when Netsuite, Taleo, RightNow and they all came to the realization they needed integration. That’s when we launched the Powered by Cast Iron program. This was validated by companies like Taleo, who decided it was smarter to just OEM Cast Iron, because they want to take the integration off their development team’s plate. As part of the Powered by Cast Iron program, we also needed to show our partner’s sales teams on how to sell our integration technology and then advise them on how best to build their own application programmable interface (API).

Then the latest phase of our growth has been in the Cloud with new relationships with Google, Amazon and HP and our most recent Dell new announcement. They all want a piece of this new rapidly growing Cloud market.

We view application the integration market like how Cisco looked at creating ‘packaged networking’ solutions. Remember all of the SPX, IPX drivers how they were a big nightmare for customers looking to put together networks, Cisco just took this complex problem and provided an easy solution. Our founders came out of companies like Webmethods, Vitria, Tibco and Informatica. They understood that most large customers didn’t use 80% of the delivered functionality, customers want suppliers to keep it simple, with a plug-and-play solutions that can handle transformation, that keeps data clean, and manages the logic, workflow and alerts. Cast Iron also adopted the appliance form factor, just like Cisco did with their router boxes, because we knew we had to provide integration-in-a-box. SaaS applications doesn’t want to provide a complicated solution, they need to just make it easy.

Why do your customers buy from Cast Iron?

Cast Iron is the best-known integration provider and we have been in the market the longest. We are the trusted integration provider for hundreds of clients, because can connect so many systems in just a matter of days.

We are flexible and have many case studies on how Cast Iron has deployed our solutions in just 10-15 days in a variety of form factors; Cloud-to-Cloud, hardware appliances or on a VMWare server.

Customers also see that mega partners like Amazon.com, Google, Salesforce.com, Netsuite, HP, and Oracle have selected Cast Iron and it shows how that they have done their due diligence and selected us as their trusted integration partner.

What do you see as the key trend emerging in the SaaS industry?

Integration is becoming a mandatory requirement for any real Cloud computing initiative. Simple uploads are no longer good enough. First generation SaaS firms are also starting to think about growing up. Enterprise architects are now looking at these systems because they all need to talk to each other.

The fact that Marc Benioff, the CEO at Salesforce.com, was a keynote speaker at Oracle World a few weeks ago, shows that SaaS and the Cloud have made now made it over the hype hump and won’t be pushed out by on-premise ERP, it is okay for on-premise solutions and SaaS to co-exist. In this new world, there needs to be more cooperation among ecosystem providers, so integration is now key to strategy, business processes, and every piece of the eco-system.

There are many layers of the Cloud – infrastructure, platforms, and application companies in each layer is figuring this out because they also need to bridge SaaS and on-premise systems and make it easy. This is a big shift because many Cloud and SaaS companies are asking ‘should I own integration or partner instead?’ For example, Dell integration services provides integration for both Cloud and on-premise systems in multiple form factors. The Dell team looking at this challenge is young agile and quick thinkers and their decision was to either own integration or outsource it and they ultimately decided to partner with Cast Iron. Vendors who are smaller than Dell can’t afford to deal with their integration solution and that is why they are looking work with firms like ours.

What is your outlook for 2009?

Before 2009 we had to push, push and push, but given our new partnerships with Google, Dell and HP, we are starting to get a lot of pull in the marketplace. Over the next couple of years, we believe a lot of application vendors will all be reselling our integration solutions. Many mega vendors have already figured this all out and realize that embedding integration technology makes financial sense and the per unit costs will continue to go down over time.

The dirty little of secret of SaaS is the 6-year total cost of ownership is actually more expensive than on-premise. Many SaaS firms are experiencing approximately 1% churn per month, or 12% per year. Customer acquisition costs are huge. But by embedding easy integration plumbing, this one step can actually dramatically lower churn rates from 12-15% to around .5% per year. So we believe this is what is driving a lot of our momentum in the marketplace.

Thank you to Simon Peel for contributing to this profile.