Ep. 241: Dave Kellogg is a leading technology executive, independent board member, advisor and angel investor. In his most recent role, Dave was the CEO @ Host Analytics where he quintupled ARR, halved customer acquisition costs and increased net retention rates before selling the company to a private equity sponsor. Before that Dave was SVP/GM of Service Cloud @ Salesforce where he led the $500m line of business for customer service applications. Finally pre-Salesforce, Dave was CEO @ MarkLogic where he grew the team from 40 to 240 and revenues from $0 to an $80m revenue run rate. If that was not enough, Dave currently or has previously sat on the boards of Nuxeo, Alation, Aster Data and Granular.
In Today’s Episode We Discuss:
* How did Dave make his way into the world of SaaS over 20 years ago? How did seeing the boom and bust of the dot com and 2008 affect Dave’s operating mentality?
* What were his biggest lessons from being in the Sequoia boardroom when they presented “RIP Good Times”? How does Dave think about when is the right time to raise? How does Dave advise founders on how much is the right amount to raise? Does Dave agree that if the money is on the table founding teams should take it? Why does Dave believe 99% of companies die?
* The first step in being acquired by a PE house is “making the book”, what goes into “making the book”? Who is involved? How long does it take? What are the clear differences between a good book and a bad book? How should execs think about making exciting enough go-forward plans for it to be attractive to buyers but also realistic enough that they can hit it in the acquisition process?
* How does the selection for who receives the book look? Who decides this? What is the fundamental aim in the distribution of the book to many parties at the same time? What does Dave know now about the world of PE that he wishes he had known at the beginning? IOIs are the next step. What are they? How do they set up the process from there?
* How do management meetings with potential PE acquiring firms compare to founders meeting VCs in the early days? How many meetings is normal to have in this process? How long do they last? What does Dave believe is crucial to achieve in these in person meetings? How much of a role does price play in selecting the ultimate acquirer? How much of a role does their brand and reputation play?
Ep. 242: It’s the employees’ market. There are more jobs than there are qualified people to do them. SaaS companies face sustained headwinds in the attracting, cultivating, driving productivity, and retaining talent. Your market competitors are your adversaries, but so is the entrepreneur sitting right next to you whose business is in a completely different sector. Namely CEO Elisa Steele shares practical advice on how to win three key Talentshare battles, which are essential to winning the Marketshare war.
SaaStr’s Founder’s Favorites Series features one of SaaStr Annual’s best of the best sessions that you might have missed.
This podcast is an excerpt of Elisa’s session at SaaStr Annual 2019.
Missed the session? Here’s what Elisa talks about:
- How to win Talentshare when the system is stacked against you.
- How to drive synchronization, productivity when your needs are constantly evolving and the talent mix is incredibly fluid and diverse.
- How to use Culture as the lever to maximize the ROI that you get out of the biggest investment your business will ever make.
If you would like to find out more about the show and the guests presented, you can follow us on Twitter here:
Jason Lemkin
SaaStr
Dave Kellogg
Elisa Steele
Below, we’ve shared the full transcript of Harry’s interview with Dave Kellogg.
Harry Stebbings: This is the official SaaStr podcast with me, Harry Stebbings, and we are in Paris for SaaStr Europa this week, and if you’d like to see behind the scenes, you can on Instagram at HStebbings1996, with two Bs. But to our episode today and an individual that I’ve learned so much from in the past, both personally and through his writing, and so I could not be more thrilled to welcome back Dave Kellogg to the hot seat today.
Harry Stebbings: Now Dave and a little background on him. He’s the leading technology executive, independent board member, advisor and Angel investor. In his most recent role, Dave was the CEO at Host Analytics where he quintupled ARR, halved customer acquisition costs and increased net retention rates before selling the company to a private equity sponsor. Before that Dave was SVP and GM of Service Cloud at Salesforce where he led the 500 million dollar line of business for customer service applications. And finally pre-Salesforce, Dave was CEO at MarkLogic, where he grew the team from 40 to 240 and revenues from nothing to an 80 million revenue run rate. And if that wasn’t enough, Dave is currently, or has previously been, on the boards of Nuxeo, Alation, Aster Data and Granular.
Harry Stebbings: However, you’ve heard quite enough of me droning on and so now I’m very, very excited to hand over to the wonderful Mr. Dave Kellogg.
Harry Stebbings: Dave, I have to say it is such a joy to have you back on the show today. As you know, I loved our first episode so I’m so thrilled we can make this happen. Thank you so much for joining me again today, Dave.
Dave Kellogg: Thanks, Harry. It’s a pleasure to be here. I had a great time on our first show, too.
Harry Stebbings: Well I would love to start though, with a little bit about you. So for the people that made the cardinal sin for missing our round one, tell me Dave, how did you make your way into the world of SaaS and what was that starting point for you?
Dave Kellogg: Well, Harry, I’ve been doing enterprise software for over 25 years. Of note, I was a CMO at Business Objects over a nine-year period as we grew from 30 million in revenue to a billion in revenue. I was CEO of MarkLogic, a NoSQL database that we grew from zero to 80 million over a six-year period. I did a year at Salesforce, I ran the Service Cloud, and most recently I was CEO of Host Analytics, an EPM company focused on financial planning and analysis where we grew the company more than 5x during a six-year period. I also sit on several boards, and I sit on boards for various enterprise software companies.
Harry Stebbings: I mean, some incredible tenures at some fantastic companies there, Dave. But the thing that really really interests me especially, is the macro environments that you saw whilst being at those companies. So I do have to ask, having seen the market volatility of the boom and the bust, how do you think that really impacted your operating mentality, and how you think today, Dave?
Dave Kellogg: Yeah, I’ve got two stories for you here, Harry. One, in 2008 I had the good fortune to be in the front row of the famous Sequoia Rest In Peace Good Times meeting. I was CEO of MarkLogic and that was a Sequoia company, and we were all convened to Sand Hill Road on short notice, put into a room, and basically 56 slides of doom and gloom were thrown at us. And the basic message… one of the quotes was, “Cut as deep as you can possibly imagine, then cut deeper.” Literal quote. And I remember thinking in a room that, “This is weird, because every company’s in a different situation here. There’s hundred million dollar profitable businesses, there’s two of those guys who just raised their A round, who got 24 months of runway. Why are we all getting the same advice?”
Dave Kellogg: So one of my things about boom and bust is you have to figure out if it’s going to affect you. If you were very focused on financial services in 2008, you were in a lot of trouble. If you were focused on other markets, maybe it had only a modest impact. So my first thing is, be situational. The second rule I’ve taken from boom and bust is don’t get greedy, you know? In 2001, you could raise money pretty easily at pretty high valuations, and in 2002 there were two types of companies: those who had raised large amounts of money at crazy valuations in 2001, and dead, right? And there was nothing in between.
Dave Kellogg: So I think companies need to not get greedy. I know a story of a company that was offered 40 million dollars at more than 12x revenue, and they actually cut the round down and took only 20. And while that may prove brilliant, you never know in that case what’s going to work out. If it doesn’t prove brilliant, if there is a bust, they sure would love to have that other 20 million in the bank and the incremental dilution of 12x is so small. And you really need to think hard about are you being reasonable when it comes to fundraising evaluation?
Harry Stebbings: I totally love that rationale, but I do have to ask you… and this is off-schedule, so very unfair of me, but Reid Hoffman always says, “When the money’s on the table, take it. You don’t know what’s going to happen.” I’m never sure about that. Honestly I flip between the two sides. Which side do you stand on whether, “When the money’s there, take it.” Is that right, or not right, do you think?
Dave Kellogg: Yeah. So, my quick answer is I have my own two rules of fundraising, and the first rule is when is the right time to raise money? Answer: now. How much money should you raise? As much as possible. I think I’m more on Reid’s side of this. Look, as an operator, if you’re able to raise money it means you’ve probably had four solid quarters, and what you’re actually thinking is, “Can I stack on four more good ones and limit dilution, or should I just take the money now?” That’s the actual bet you’re making as an operator. If you’re certain you’re going to have one or two good quarters, okay, but most companies, most startups can’t see out four quarters. So to me, you’re actually taking quite a bit of risk, because if you miss one of those quarters, and you miss it badly, that round may no longer be available. It’s a little bit more binary than you think. So I think I’m more a Reid’s camp .
Harry Stebbings: You know, I totally agree. Can I ask, how do you handle valuation limits? Obviously, if you raise as much as possible, you can get quite lofty valuations, especially in frothy environments. How do you think about out-pricing yourself for next round and making that next round even more challenging? Is that a concern?
Dave Kellogg: Yeah, it is definitely a concern. To me, it’s a secondary one. My driving principle on all this is Don Valentine’s famous quote, “All companies go out of business for the same reason: they run out of cash.” Right? So, as a startup operator I’m very sensitive to running out of cash. My basic belief is, raise all the money you can when you’re raising, but don’t spend it according to the plan blindly, spend it according to milestones. So if the plan said hire 20 sales reps next year, but the existing 15 you have are struggling. Don’t go hire 20 more. Go back to the investors and say, “We’re waiting for a milestone, we’re waiting for a signal from the business to trigger that spend.” And if you do that, that money’s going to last a long time, and it will help offset that issue, because you won’t be out in the market in 12 to 18 months raising money, because you raised more earlier and spent it wisely. Buys you more time.
Harry Stebbings: No, I do agree that elongated runway and the benefits of doing so. I do want to discuss, though, in the state of play, as were talking about the fundraising, more on the exit side. I want to focus on that state, because we’re seeing increasing problems from the world of PE. In 2017, there were 513 exits, 499 were M&A, with many being PE. So it’s becoming a real fixture in our space. So, to provide some context though, when we chatted before, you said to me there were two types of sale. Can I ask, Dave, what are those two types of sale for you in your mind?
Dave Kellogg: Yeah, the two types of sale to me, and for most people, I’d say, is the strategic exit to a strategic acquire, i.e. another software company, or you have an exit to a private equity firm. Now I would say those lines are blurring in two ways. One, PE firms… fifteen years ago, PE firms were really just what I call, “Squeeze Players.” They’d show up and try and squeeze up EBITDA and try and sell you for an EBITDA multiple. But today, you have much more growth-oriented PE firms. You have PE platform roll-ups. If a software company owned by a PE firm buys you, the economics of that look much more like a strategic acquisition than the classical EBITDA squeeze. So, that’s why people are pitting more money these days, that’s why they’re offering competitive bids to strategics, because in many cases they’re rolling together software companies and the economics look more like strategic economics than classical private equity economics.
Harry Stebbings: Speaking of the buying and selling of companies, Dave, I do have to ask. Josh Felser of Freestyle said on the show once, “Companies are sold and not bought.” And it’s always stuck with me. Do you think that’s right to you, and how do you think that kind of bought versus sold or sold versus bought debate?
Dave Kellogg: Yeah, I think… it’s quite funny, because I was actually raised on the exact opposite adage, which is, “Great companies are bought, not sold.” And the intent of that was, that if you hang a For Sale sign on your company, you may not get the best price. That’s the underlying philosophy there. In the real world, these things are blurry. They’re not black and white. For example, you may have strategic outreach to your company that may trigger you to hire a banker to run a PE process. So you tell me which that is.
Dave Kellogg: I think the other way to look at these two types of exits, Harry, are… a lot of people focus on how it ends, that you get sold to a strategic or sold to a PE. To me it’s interesting to look at how it starts. Did you just out of the blue decide to run a PE process, or did you get strategic interest that either led to outreach to other strategics, right, because the end of the day, you’re trying to create a multiple bidder situation, and that’s what’s going to maximize value. So I always look at how it ended, but I also look at how it started. Look, an intelligently run PE process will generate a multi-bidder situation. That’s the whole point of it. Just as an intelligently run strategic process will.
Harry Stebbings: You said about looking at how it started, I do want to start at the beginning. It’s a pretty opaque world for us, and it’s actually not one that we shine much light on. And so I do want to shine some light on it and provide some transparency today. When we chatted before in terms of the start, you said it starts with “making the book.” Can I ask, what does “making the book” really mean, David? What goes into the book?
Dave Kellogg: Sure, for example, if you decide to hire bankers and run a PE sale process, and you may decide that for a number of reasons including strategic outreach, which says, “Hey, maybe it’s a good time to sell.” You will hire bankers, and they are going to want to make a “book,” quote-unquote, formerly known as a CIM, a Confidential Information Memorandum. That’s a typical name for it. And that’s going to be a hundred-page or so PowerPoint presentation of mind-numbing detail, lots and lots of numbers, and the story behind the company and where it’s going.
Harry Stebbings: In terms of the story behind the company, I am super interested. What’s the differentiator between, say, a good book versus a bad book? If it’s very numbers-orientated, and really very date-orientated, what makes a good book versus a bad book?
Dave Kellogg: Sure. So first, a bad book… the number one sign of a bad book is the numbers don’t foot, and that would be best, because the PE people are super quantitative, and if you have errors in your numbers, that will undermine the credibility of the company. So, while it’s a rather basic item, it is absolutely essential that all the numbers foot, and a huge amount of energy is put in by the bankers on cleaning up your data, cleaning up your numbers, finding problems you didn’t have to make sure that all the numbers foot.
Dave Kellogg: I think a bad book, the numbers don’t foot, and in a bad book, the words don’t go with the music, do you know what I mean? Which is, the words are telling a story that when you look at the numbers, it’s not supported. And conversely in a good book, the numbers are all correct, they all foot out very well, the book tells a story about the company where it’s going, and the words match the music. When you look at the numbers, they support that story. And that, to me, is what creates a good book.
Harry Stebbings: What you said about the numbers and where it’s going, in terms of going forward operating plans, I am interested because you’ve got to create an aggressive enough one to make it attractive to the buyer, but also, not unrealistic. How do you think about doing this, and creating that dynamic of excitement but also realism within the buyer?
Dave Kellogg: Yeah, that’s a great question, Harry. By the way, one thing you mentioned earlier about the books. You said that this is not a world where most people live in day to day, and I think that’s true. So the very first thing I’d advise a CEO if you’re entering this process is to get somebody to show you ten books. That was the first thing I did. I said, “I’m not going to build one of these without having seen ten good ones,” and that also helped me when we built our book in kind of triangulating knowing what I thought a good book was versus a bad book.
Dave Kellogg: Now, back to your point, a key outlet of the book itself is the go forward operating plan. And, just as in a fundraising, there’s temptation to want to juice that up a little bit and make it a little more aggressive. The problem is that this process can take 6 to 9 months, maybe longer, and you need to be making quarters. God help you if you’re out marketing the book and you’re missing the operating plan in it. Bear in mind, you mail a book out at the start of the process, so there can be a full 6 to 9 months between when you first mail out the book and when you’re closing the transaction.
Dave Kellogg: So, I think one of the more difficult questions is to actually find that medium, and the answer to me is you need to be very comfortable that you’re going to hit the numbers in that book, because if you miss them, very bad things will happen. There can be a lot of pressure on you to drive them up, but I think you need to basically hold the course and say no, no, no, no, this has to be a must-make plan.
Harry Stebbings: Now I do agree with you on the must-make plan. It does make me think, Dave, to a lot of questions that I get in terms of from early stage founders who have their first few sales reps and they always say to me, “Harry I’m going through quota setting, quota construction. How do I create an ambitious quota that they feel they can really reach but also is a stretch, but also not too easy?” When you sit down with a founder and advise them on that question, what do you advise them?
Dave Kellogg: That’s a very tough question, particularly early on, Harry, because, as you know, you don’t have a lot of company-specific data to work with. So the best thing you can do in my mind is benchmark, look at other companies with a similar sales cycle and similar average sales price, and try and set the quotas as they would be set at those companies in their earlier state because they may be a hundred million dollar business today. You want to go back when you were a 5 million dollar business, what were your quotas? In my belief, for what it’s worth, on that issue, is that being a sales rep at a very early-stage startup like what you’re talking about is a pretty hard job anyway, so I would tend to set quotas on the lower side. Far better to slightly overpay your sales force in the early days than to have everybody quit because they’re not making money.
Dave Kellogg: Juicing up quotas is something you do later. I’m sure everybody gets that you start squeezing the sales force once you debug the sales model and you’re scaling it, and you care about the cost of scaling intact. In the early days… I always tell startups, “Don’t set your prices too high, and don’t set your quotas too high, because you don’t want people not buying because of price, because you’re trying to prove product/market fit, trying to optimize price, and don’t set your quotas so high your sales people don’t make money because they’re going to leave and then you have to rebuild your sales force.”
Harry Stebbings: I think people also actually forget about the confidence element and the confidence that’s derived from hitting your numbers consistently, and how you can then slightly leverage up and up with the increasing confidence of the sales force as well.
Dave Kellogg: Yeah, that’s true for the sales people, it’s true for the company as well. I remember when I started at MarkLogic, Mike Moritz of Sequoia came up to me, and he was one of these kind of “in a few words” guys, and he said, “I have seven words of advice: Make a plan that you can beat.” I think it was great advice, and I’ve always stuck with that. So many startups don’t. But, making a plan that you can beat, whether it be for a sales rep or the whole company, it gives you confidence because you can say you made your numbers, it gives you predictability on cash, because cash is oxygen to a startup. So, there’s pure goodness in my mind in setting plans that you can beat and setting quotas that you can meet.
Harry Stebbings: Getting back to the PE process though, and as we said that we’ve assembled the book now. The book looks great, and we need to actually engage in the process. What is the next step look like, and how does the selection process for who to send the book to look like?
Dave Kellogg: So this is a key role of the bankers, which is… I was, and I think most people would be shocked by just how many different types of private equity firms are out there that buy software companies, and I think if you wanted to mail a book to everyone, you would probably literally be mailing hundreds of books. If you say, “Let’s only mail a book to people who buy mid-market SaaS companies between 30 and 70 million in revenue that are or are not profitable, because that’s a constraint, where the check size is x.” Right?
Dave Kellogg: When you put those basic filters of market, check size, profitability, I think you can easily mail out 50 to 75 books, and the bankers are going to know all that. They know who likes to write what size checks, they know who already owns potentially adjacent companies for roll up opportunities, they know who not to call on because your check size is too small or too big. So there’s a big part of value there brought by the bankers knowing who to mail the book to.
Dave Kellogg: I think the other part of this is in a good process, you’re not just mailing the book to private equity sponsors, as they’re often called, you’re mailing them to strategics, because strategics can take a lot of time to get going. In fact, there’s an argument you mail it to strategics first, because corporate processes being corporate processes can take a long time, and one of the goals of your PE sales process is to try and force the strategic to move, because they know a sale is imminent.
Dave Kellogg: A lot of times–look, I’ve been on the buy side of this years, at Business Objects we looked to buying companies two, three times over four-year periods. There has to be some compelling event to make you want to move, and if a banker calls up and says, “Company XYZ is in play,” that might be enough. So that’s the other dance the bankers are trying to do, trying to run this kind linear funnel PE process against PE people who don’t want to be in it, because they know the goal is to set up a multi-bidder situation, and they’re also smart people and trying to avoid that happening. So there’s a lot of complexity there. And then you’re also overlay on that, trying to get strategics involved in a timeline that works with corporate timelines, and then trying to force people who’ve been kind of watching from the seats to jump down on the playing field.
Harry Stebbings: I am fascinated. You said there about the depth of the PE world. What other thing was most surprising to you that you maybe didn’t know before entering the process as to the structure, the depth, and the PE world itself that most surprised you?
Dave Kellogg: The thing probably that most surprised me was that in many cases, certainly not all, when a PE acquirer buys a software company, they will typically ask management to roll in a portion of their proceeds, if the management team is staying off. And I’d not heard of that before. Maybe other people knew about it, but I remember in one of the meetings, they asked us, “What percent of your proceeds do you want to roll over?” And we were like, “What? What’s rollover?” To be fair, we should’ve been prepped on the issue, but I don’t see it’s the majority of them, and I’ve seen some PE surveys that talk about the percent that do rollover.
Dave Kellogg: But in some situations the PE firm, and I’d say this is really more in a family-owned business situation perhaps, but they like when the existing investors–When they keep a team they want some existing investors to roll money into the new entity. That was an entirely new concept to me, because I thought when strategic buys a company, it’s bought. And I figured with a PE firm it’s the same thing, that when they bought the company they literally squeezed out every investor, and it was a hundred percent theirs.
Harry Stebbings: I have to say I’ve never heard of a rollover, so have no fear, Dave, you’re not alone in that one. In terms of the next steps though, when we chatted before you said to me, “This is when you get the IOIs back in.” I have to admit, I don’t know what an IOI is, so what is an IOI, and how does it play into the process as the next step?
Dave Kellogg: So once you mail out your CIMs, or your book, the PE firms are going to study it. There’s certainly no lack of data in there to study. You’re also going to set up a data room, there’s actually more data, where they can look at the CIM, they can look at additional data, obviously all under NDA, they can build their models. And at some point you set a deadline that says, “Look, if you’re interested in acquiring the company you need to submit an indication of interest, an IOI, which is a two-page letter. We’re going to outline the things that need to be in there.”
Dave Kellogg: First and foremost, some sort of price range, how much you’re thinking of paying for the company. Second, perhaps a strategic rationale. What are you thinking of doing with it? You going to roll it into another company? Are you going to try and grow it, you going to try and juice up EBITDA? What is the high-level plan? What are your intentions for management? Are you going to fire them all, are you going to keep them? And it might be, what’s your source of funds? So it’s coming from PE firm main fund 7, which has 1.2 billion dollars in capital. You know, I want to say 6 to 12 questions they can answer in a two-page letter. That’s what the IOI is, and that’s the milestone that you cross. The books get mailed out, you set a deadline, and the IOIs come back in.
Harry Stebbings: Okay, so the IOIs come back in. In terms of the selection of the IOIs, do you go to management meetings with all of those who send back IOIs? Do you select them very rigorously? What is that process look like as to ones sent back in with you?
Dave Kellogg: Yeah, that was funny, Harry, because my assumption was, “Yes, hey, anybody who’s interested, I want to go meet with them!” It’s the salesman in me. But the bankers were kind of resolute that no, you don’t do that. If you get a good number of IOIs as we did, that you’re going to pick who you meet with, because these meetings take time, and they take a lot of time, not just from the CEO, but the whole exec team. Typically, a management meeting, which is what happens after an IOI, might be four to six hours of either most or all of the executive staff, and there might be more than one of those meetings. So there might be two to three four- to six-hour meetings per IOI. You know, if you get 10 IOIs, you can’t keep running your business and do all those meetings. So the bankers will work with you and the board to filter which ones.
Dave Kellogg: Some of it’s based on price. I think probably at the phase a lot of it is based on price. Some of it is based on certainty. We’ll talk about that more later. Certainty comes into the equation at the end, but you can develop a feeling pretty quickly from talking to people how much homework they’ve done. And this was something else I learned, in the process, Harry, that you’re actually trying very hard to figure out how much homework the other parties are doing, because at the end of the process, that’s going to give you an indication of certainty. Because if someone pulls up with a nice offer but they haven’t done their homework, or, “Oh, we’ve got to do customer references, we haven’t built a financial model, we didn’t due diligence the contract,” it’s like, “Wait a minute, you’ve not done your homework.” Whereas if somebody else shows up who’s completely fluent in every number you’ve posted and done all those other things. You’re like, “Wow, party B here is much more serious than party A.”
Harry Stebbings: Absolutely, in terms of that prep. It’s relatively similar to the VC in that perspective. From what I’ve unpacked, there’s two elements there. You mentioned the time commitment for the team, and this is a tough one. How on Earth do you manage to hit the ambitious targets that you set in the go forward operating plan, whilst you are committing such a large amount of your time to fundraising? Often startups don’t hit their numbers when fundraising, and it’s to be accepted given the time they’ve given to the fundraise itself. Is that the same in PE, and how does that look because you can’t hit the numbers when you’re selling the company like that, can you?
Dave Kellogg: Yeah, a friend of mine has a kind of somewhat tongue-in-cheek VC fundraising process that’s like a 13-step VC fundraising process, and step 13 is, “Blame the quarterly miss on the fundraise.”
Harry Stebbings: That’s good!
Dave Kellogg: That’s how much it happens in VC land. In PE land you can’t miss these quarters and so, like I said Harry, earlier, this is why you need to put real thought into what plan you’re signing up for, and it’s a really good point. You need to be aware of the fact that you and the team are going to be out a lot. I think in my experience, we had a very strong sales management team, so they can keep running the company and hitting the quarters. If you didn’t, that’s going to be a real factor, and it’s probably going to make you limit the number of IOIs you pursue, or the number of management meetings you have, because you simply can’t risk missing the quarter.
Harry Stebbings: Got it. Yeah, absolutely, I get it on the need to continuously hit quarter. The second element that we said that, was in terms of the selection, and my question is, to what extent does brand play a role in PE selection of IOIs? In venture, the brands are hailed, and often tier ones are selected over others. Does brand play the same role in PE?
Dave Kellogg: I agree with you on venture. In PE I don’t think it does. Because in VC there’s a lot of halo effects associated with who raised your money. If you raise money from a top tier firm, in your A round, your B round will be easier. A lot of the top tier firms have marketing departments that help market your company and talk them up in the market. So there’s both tangible and intangible benefits of raising from an A tier firm, which in many cases in VC land will allow them to offer a lower valuation than the B tier firm. In this particular case, you’re selling a whole company. So, you’re not going to be worried about those add-on effects. Your existing investors are primarily worried about their return on investment. So if you’re a VC-backed company, selling to a PE sponsor, price is going to be a huge part of the equation, and the other part of the equation will certainly not be brand, it will be certainty.
Dave Kellogg: At the end of the process, the two things you’re thinking about is I have a number of parties offering different prices, is anybody going to try and re-trade that price? They’re going to be like, “Who do I trust?” Or maybe this is where brand comes into it, Harry. I’d say almost more reputation than brand, but some PE buyers have reputations for trying to niggle down the price at the end of the process. Say, “Hey we get a customer reference check, and it didn’t come out well, so we wanna take some money off,” or think of any excuse you want. “The stock market’s down a bunch, we wanna take some money off,” “Oh, the CFO wants to quit, we didn’t know that, we have to hire a new CFO. We thought we were buying a fully functioning management team.” They will kind of create excuses to try and quote-unquote, “Re-trade the price” at the end. Certainly boards are sensitive to that. So I think I’m going to say that reputation matters a lot. I wouldn’t go so far as to say it’s brand, because with reputations, there’s simply a round on these people who try to re-trade a deal, or is it more like it is in the VC world, my word is my bond.
Harry Stebbings: No, I totally get you in terms of “my word is my bond.” Can I ask, in the meetings themselves, I’m a big fan in terms of VC fundraising it’s for really great founder experiences and making that as high quality as possible and building that trust. Is that the same sort of softer intangible sort one focuses on in these meetings, or is it much more transactional and data-oriented with less trust building built into it?
Dave Kellogg: I think, Harry, I’m going to give you a slightly unusual answer to this question, but I think you’re hitting on what I would call the philosophical difference between PE and VC. The philosophy of VC is, “You are a founder, we want to be your partner in helping you build your company, and a lot of value is going to get created by that.” That’s kind of the VC philosophy in a nutshell, but PE philosophy is very different. We are a financial investor buying the company, hoping to either grow it, or make it more profitable, or roll it into another business. We are hoping to get a 3x return in four to six years, typical PE math.
Dave Kellogg: So it’s not really about “we’re your partner in building a business,” it’s about “we’re here to get a return.” I would say the dialogue is much more about the operating plan, the growth, the opportunity. Can we grow this thing? Because the other thing that’s different in PE, is there’s much less margin for error. In VC, you can have five or six companies in a portfolio fail because the math works to offset that. In PE, these guys are only looking for a 3x cash-on-cash multiple, so you can’t have four of them fail. They all better deliver that multiple. I think there’s a big philosophy difference.
Dave Kellogg: The other thing I’ll say, Harry, is the way you can most see it with a concrete example is stock options. From the VC side, the philosophy is you get shares in the company for making a contribution to the company. You can exercise your shares. You can leave the company and keep the shares you’ve exercised. On the PE side, it’s typically a five-year vest or a four-year vest. It’s typically performance-based vesting. You get your vesting if I get a 3x multiple. So the philosophy on the PE side is very much, “You make money only if and when I make money.” So it’s different, and I think for anybody, you’re looking at a job at a PE company or entertaining selling to and staying on with the PE company, the biggest, most tangible difference you’ll see is in how the equity works.
Harry Stebbings: Absolutely fascinating listening to this. And as I said, the first time I discussed this, so I’m learning a huge amount here, Dave. I do want to discuss… as we touched on price being such an important element. In terms of price math around PE, during our conversation earlier you said PE math is pretty simple. What is PE math then, for this process, and what can be expected whole periods for PE and how does that factor in?
Dave Kellogg: Sure. I think… and I’ve got to be careful here, because like I said earlier, there’s really two types of PE. There’s the more growth-oriented, strategic-oriented PE, and their math is going to look like a strategic acquirer, right? They’re going to be looking for cost synergies. They’re going to be looking for can they drop more product in their sales force’s bag and increase quotas? And that kind of math will tend to result in higher multiples than just classic profitability math. So, I think if it’s strategic PE firm, you can see anything from a normal PE multiple up to what I’d say is a good strategic multiple.
Dave Kellogg: Now, for the classical PE, if it’s a squeezer, and if you run this process you will definitely bump into some of them, their math is pretty simple. They want to hold the company four to six years, they want to get a 3x return, and they’re probably muddling around selling the company for 16x EBIDTA. And if you know those three facts, you can actually build their financial model. Then you can understand what they can afford to pay and what they can afford not to pay based on that math. So I’d say that’s the classical EBIDTA squeeze math, the EBIDTA play. The strategic math is usually much more variable.
Harry Stebbings: Dave, as I said at the beginning, I could continue these conversations for hours. So it makes me rue the time setting that I put on the podcast, but I do want to move into my favorite element, being the quickfire round. The 60 Second SaaStr. Are you ready to dive in, 60 seconds per one?
Dave Kellogg: Let’s go, Harry!
Harry Stebbings: Okay, so what do you know now about the process that you wish you’d known at the very beginning?
Dave Kellogg: The importance of timing strategics relative to the private equity sponsors.
Harry Stebbings: What’s the biggest misconception of the world of PE, Dave?
Dave Kellogg: That they won’t pay a high multiple.
Harry Stebbings: “Burn rate is a function of the personality of the CEO.” Jason tweeted it the other day. I’m intrigued. Do you agree, disagree, what are your thoughts?
Dave Kellogg: I agree. I’ve always thought the profitability was more of a decision than a built-in assumption. It goes all the way back to my days at Business Objects. We had decided to be profitable. Other competitors had not decided to be profitable. I agree. It’s not entirely, but boy it’s pretty correlated.
Harry Stebbings: And then, final one that I want to learn from you on, and it’s you’ve sat on boards both on the board member side and then on the operator side. What advice would you give me, having just joined my first board?
Dave Kellogg: I think the answer is ask questions. Don’t make statements. Because I think… I have a little rule, Harry, which is, “Whenever a board member gives a CEO directive feedback, it’s never good,” because if they thought it was a good idea they were going to do it anyway, so you didn’t have to direct them. So the only case in which they’re doing it is they thought it was a bad idea. To me, never give directions to a CEO. Challenge them, ask them questions, make them think, but try to avoid sentences like, “I think you guys should do blah,” because whether you realize it or not, you’ve just given directive feedback, and they’re thinking, “Oh gosh, is Harry going to be mad if we don’t do blah?”
Harry Stebbings: Yeah, I couldn’t agree more in terms of not giving that directive, but, Dave, as I said to you in the beginning, I always love having you on the show, and I’d love to do a second one, as we said, on the next element that we discussed earlier. So, thank you so much for joining me again today, Dave, it’s been such a pleasure.
Dave Kellogg: Always a pleasure, Harry, thanks for having me.
Harry Stebbings: What can I say? Such a huge pleasure to have Dave on the show for a very special round two there, and if you’d like to see more from Dave, you can, on Twitter at Kellblog. I do also want to say a huge thank you to Dave personally. He’s always been there to support and help me and I really do so appreciate that. It would also be awesome to welcome you behind the scenes here at SaaStr. You can do that on Instagram, at HStebbings1996, with two Bs.
Harry Stebbings: But before we leave you today, what makes people love the brands they love? In a word, connection, and social media is where they look for that connection. Well Sprout Social gives businesses a unified solution to find, engage with, and nurture their audiences through social. In one intuitive platform, see and respond to every message, join the conversations happening around your brand, and turn rich social data into actionable insights. More than 25,000 organizations around the globe use Sprout to create real connection. Join them and learn more about the true value of social, at SproutSocial.com.
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Harry Stebbings: And last but not least, every week we talk briefly to a WePay partner in a mini series to get their best advice on achieving success. This time we’ll hear from Justin Goodhew, founder and CEO at Trellis. Trellis is an event management platform for charities and non profits. Trellis enables event organizers to easily build beautiful event and fun raising pages to sell tickets, collect donations and automate their workflows.
Justin Goodhew: Hi Harry. When you build out your product, you should just know that it’s going to take twice as long as you think. And you might be shaking your head right now disagreeing with me, but I guarantee you, the first time you do it, it’s going to take you twice as long. That list of features? Just cut it in half. Cut it in half again. Find out exactly what it is your customer wants and just build that, the other stuff, they can wait. So make sure you give yourself the extra time, money, and runway to be successful.
Harry Stebbings: Thank you Justin. Taking the time needed is important to make sure you grow. You can also find growth with the combination of WePay and Chase, which means payments you can bank on. To find out how you can add benefits like Chase Pay and more to your payment solution, visit WePay.com/Harry. That’s WePay.com/Harry.
Harry Stebbings: As always, I cannot thank you enough for your support. It really means the world to me, and I can’t wait to bring you a fantastic episode next week.
