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Scott Orn

Scott Orn, CFA

Mark MacLeod of SurePath Capital Partners breaks down the SMB SaaS M&A market

Posted on: 05/07/2019

Mark MacLeod

Mark MacLeod

Founder - SurePath Capital Partners

Mark MacLeod of SurePath Capital Partners - Podcast Summary

Mark MacLeod, an investment banker to fast-growing SMB software startups, dives into how SaaS companies prepare for an exit. Learn what a SaaS startup has to do to be acquired, what the M&A process is like, and how to maximize the probability of an exit.

Mark MacLeod of SurePath Capital Partners - Podcast Transcript

Scott: Hey, it’s Scott Orn at Founders and Friends Podcast by Kruze Consulting. And a quick shout out to our sponsor Brex. They are the credit card for startups. Easy to use, virtual credit cards, physical credit cards, integrated with QuickBooks easily, no personal guarantee by the founder. That is huge. Check out Brex, B-R-E-X dot com and put in Kruze when you go through the signup flow and you should get a discount. Thanks. Now onto a great podcast with Mark Macleod. Welcome to Founders and Friends Podcast with Scott Orn at Kruze Consulting. And my very special guest today is Mark MacLeod of what, SurePath Capital?
Mark: SurePath Capital Partners.
Scott: We go way back to FreshBooks and all these other things. But SurePath. And SurePath is on fire. So, thank you for carving time out of your busy schedule.
Mark: It’s a real pleasure to be here.
Scott: Yeah. Mark is amazing. And you started your company four years ago?
Mark: It’ll be five years in May.
Scott: And you were just, off the record telling us some of the deals that you closed and it’s insane. I follow you on Twitter, I know exactly what’s going on.
Mark: Thank you.
Scott: How does it feel to someone who builds something amazing and is right in the middle of the hurricane?
Mark: Is funny, it’s mostly, obviously awesome. But for a SaaS guy, being in the deal business is the literal opposite of SaaS. We did 53% of our revenue in 2018 in December.
Scott: Wow.
Mark: We closed two deals on the same day in December, three overalls. That break between Christmas and New Years I was literally comatose-
Scott: Oh my god, yeah.
Mark: … Just because I couldn’t think. So, you have to have a strong stomach and a strong balance sheet. One thing I will say though … So, I’m coming up May 31 this year will be two decades in the startup world. And I’m always at the right hand of CEOs, either as their CFO or as their investor, and now as their advisor. They would always talk to me about how they felt paranoid and could never sort of just-
Scott: Talk to somebody.
Mark: … Appreciate where they were. And now I get that. Because if you think about our business, it’s obviously very lucrative. But we don’t have recurring relationships. And in fact it’s strategic to close a deal sooner rather than later because you never know what’s going to happen. Is going to Trump nuke North Korea? Is Brexit … You close a deal as soon as you possibly can. And then your revenue is done.
Scott: You sell your best clients, too.
Mark: Absolutely, yeah.
Scott: That’s kind of our problem too, our best clients get huge and then they bring it all in-house. We still haven’t figured that out yet.
Mark: You need a recruiting division to deal with that.
Scott: So you did 50% of the revenue in the last month. I mean that kind of makes sense because MNA is a year-end thing. Did you age five years?
Mark: I think I did. No, it was honestly … Now if you think about it, again, these-
Scott: There’s a lead up, right?
Mark: Yeah. There’re different phases. There’s the upfront prep phase, there’s the marketing phase in the middle, then there’s the legal closing in the end. I am personally involved more upfront in making sure we have the right strategy and we’re telling it to the right audience. Then in the heavy, the negotiating the deals-
Scott: The last two weeks, yeah.
Mark: … And the closing, the middle is more the team. We each, I guess, felt different pressure points. But no question, was super happy to have those done an not work.
Scott: But weren’t you feeling … Because I remember this when I did MNA at Hambrecht and Quist, we had this guy David Gold and Paul Cleveland. And they were the Obi-Wan Kenobis of our … And that’s how you are now. And you have to be on the phone for those critical two days.
Mark: Correct.
Scott: Maybe there’s two or three dinners and you’re going back and forth. And you’re talking to your client every hour. That’s really intense. That’s probably what December was like for you. Right? Because that’s right up until the-
Mark: Yeah, that. Yeah, absolutely. Then a lot of the heavy lifting is … Particularly some of our clients that are maybe bootstrapped and don’t have a board and all these things, maybe don’t have a great back office. Which is something where we have brought you guys in.
Scott: Thank you for that, by the way.
Mark: But if they don’t have that, then sometimes we end up filling in the blanks there on disclosure schedules and all this stuff that the company would do. So, there’s some serious heavy lifting in the disclosure schedules. And all this stuff that the company would do. So, it’s some serious heavy lifting in the final mile.
Scott: And just no judgment on your clients, all the clients who are coming to us who are a little disorganized or haven’t been through it before, they don’t know what they don’t know. A lot of stuff they’re being asked that question for the first time, they’ve never been asked that.
Mark: That’s right.
Scott: So you have to … They may give you an answer that’s actually not true. Not that they’re lying, they just don’t know the answer.
Mark: They just don’t know, yeah. They’re well intentioned I’d assume, almost universally.
Scott: Yeah. Especially an MNA thing, they want to do it right. And you’ve also explained how disclosures are binding and all this other kind of stuff.
Mark: Right. Yeah. But it’s tricky. If you think about the decision to buy a company, you can’t unwind it. It’s not like if you buy a sock, “Oh, you know what? I made a mistake. I’m just going to sell it.” You’re done. What you’re really selling is trust. Therefore, actually having super solid data, having every I dotted, every T crossed helps you sell trust. It’s actually strategic to have the most kick-ass back office you can.
Scott: And the person who’s buying you probably is putting their career on the line.
Mark: Absolutely.
Scott: Or maybe they get one other … One Mulligan and if they make another bad buy they’re fired.
Mark: That is exactly right.
Scott: The companies you’re selling startups to are really, really big, big companies that can’t mess this up. It’s a big deal.
Mark: That’s exactly right. That might be a theme worth drilling into. Which is from an acquirers’ standpoint, it is as difficult, as fraught with risk, as political in some cases to buy a quote-unquote small thing as it is to buy a quote-unquote large thing. And therefore, all things being equal, I’d just assume buy the large thing. So, there’s a floor from a revenue standpoint, I would say, below which you are very unlikely to find a buyer.
Scott: Yup. Because it’s got to move the needle for that person. And usually that person is running a big division or something like that. Right?
Mark: That’s right, that’s right.
Scott: I know. Also, you said something, you were like, “We don’t have recurring relations.” But you actually do have recurring relationships with the buyers. You’re Mark MacLeod, you’re SurePath, they have to always, they need to take your phone call at all times. But you can’t sell them the lemon because you need them to be there for the next company.
Mark: Yeah, that’s for sure. And again, we’re super specialized. Our goal is to be the leading boutique investment bank in SMB software globally. We’re still in the early innings of that. But we already have two mandates in Europe that we’re live with now. We’re not in Asia yet. I understand there’s lots going on in Asia, so all in due course. We want to own that market and be the one call that CEOs in that market make when they want to do something. So, you’re absolutely right. Our goal is certainly every buyer is going to take our call. Actually, we do act for buyers now. We have a buy-side practice, that’s kind of a new development in the firm since last year. But most of our work is sell side. So ultimately why we do obviously represent the sell side client, it is a balancing act. Something we will never do is outright lie to a buyer and tell them there’s competitive bids at X dollars when there aren’t. Because to the extent that that gets found out … First of all, that deal is dead. They’re not buying our client. Then our credibility with them is shot. So there’s-
Scott: That happens by the way.
Mark: I know it happens.
Scott: We have clients asking us all the time at H&Q to do that. And we didn’t do it either. It’s like maybe some of our competitors did, I don’t know. But too stressful.
Mark: I’ve been asked more than once and I can’t.
Scott: It is a recurring thing. When you go to the Shopify conference and you see all the other big ecosystem players there, you need to be able to … They want to shake you. You want to have a good relationship with those people. You can’t just-
Mark: If we are not trusted by the buy side, we can not serve our sell side.
Scott: Exactly.
Mark: That’s right. So you have to walk a fine line.
Scott: What is the buy side service you’re providing now? Is it research or is it-
Mark: No, no. It’s actually some things … Again, from the very early days, like two quarters into SurePath, I made the decision to focus on SMB.
Scott: Maybe say why, because you-
Mark: Yeah, sure. First of all, if you think of SMB, that’s a very wide-ranging. It’s not a one thing. It’s everything from the freelancers working out of their basement that FreshBooks serves all the way up to multi-hundred person sophisticated mid-market enterprise. So it’s basically, it’s B to B and it’s not consumer. And it’s not like the big steak dinner Oracle Enterprise things. So all of our companies, they’re in that middle of B to B. And as a result, probably have high velocity marketing funnels, lots of small or mid-size customers. But they tend to be data-driven. Versus if you’re Fortune 500, well guess what? You have 500 prospects you can go after, you know in your mind how your business works, where are your-
Scott: And their super expensive salespeople is how you go after that.
Mark: Yeah.
Scott: And a lot of sponsorships and thing like that.
Mark: That’s right. Our companies are more data-driven, and that kind of lends itself well to our expertise. And I have personally been in the SMB space with Shopify and Freshbooks, etc. Kind of since 2009. That’s our sweet spot that we’re going after.
Scott: First of all, those are two amazing companies, so you’re always very modest. But you’ve worked at two awesome companies. We were actually talking about how I bought Shopify because of you, because my friend the Sports Basement deployed it. And they’ll hopefully pay for my daughter’s college some day. It’s an amazing company. FreshBooks is doing great. But also, you said about the data stuff, maybe connect that. Why it makes it easier to raise money for an SMB company that has a lot of data. Or do an MNA deal when a company has a lot of data. Because you have something to show the buyers, right?
Mark: Yeah, again, going back to selling trust. I’ve operated these kinds of companies at scale. When I was a VC, I was investing almost exclusively in SMB software. And if you’re business is one that has lots of small customers and you’ve been doing it for a while, then what you’re going to have over time is all this cohort data where you can slice and dice your business every possible way by source of customer, by vertical, size of customer, geography, whatever attribute. And we like to do that. When we get involved with a client, we like to rip it apart, put it back together. Any SaaS business is going to have some magic. So some stuff that’s working super well, and it’s going to have warts. We try and find the magic so we can exploit it in two fronts. One, A, if you’re not aware of this magic already, let’s figure it out and do more of that.
Scott: Invest more on that.
Mark: And second, let’s make sure that’s part of the story. On the flip side, if there are warts, which there will be, can we make them go away in some fashion? Or if not, how do we have mitigating stories. And so-
Scott: Or maybe the buyer can mitigate those warts themselves because they’re complementary in some way.
Mark: Right. The quintessential example of a wart in the context of SMB is churn. Everyone knows you sell the small business, they churn at a high rate. The problem with any metric when you are putting it across tons and tons of customers is there’s no such thing as an average customer. While you may have a high headline churn number … I benchmark it on a logo basis. If you’re north of 3% a month, it’s considered high. And if you’re north of one and a half on revenue, it’s probably a little-
Scott: You’re making me feel good. We’re below that, that’s awesome.
Mark: Good.
Scott: We’re not pure SaaS, but we’re a reoccurring business.
Mark: Right. When you dig underneath the hood and you slice and dice by your different segments, you may have this overall number that is north of three on a logo basis, but have meaningful pockets of your business that are less. When you go past the averages to find the true insights, that’s when you can do good work.
Scott: That makes total sense. We actually had three or four companies go out of business last month. So on our churn, it looks like we lost three or four customers. But really, we kind of knew what was happening. That’s also just part of our business. We know that going in. There’s nothing you can really do to manage that. For some of your SaaS clients, it may be that they’re super strong in one region of the United States but aren’t investing correctly in another region. Or maybe a customer acquisition channel, maybe they’re awesome on Google and Facebook, but aren’t doing enough content marketing, or something like that. And find the magic for them. Then you have something to show the buyers. Like, “Oh my gosh, look at this X multiple on customer acquisition spend. If they just had more capital or attached to you guys, this could be a humongous business.” And that’s where you come in. Right?
Mark: Yeah. That’s why, again, it all comes back to trust at the end of the day. If we have ripped this business apart and put it back together in the form of an authoritative data room, we are de-risking this thing for whether it’s a buyer are an investor, we have done the analysis.
Scott: That’s so cool.
Mark: They just need to audit the analysis and then write a big check.
Scott: I’ve never actually hear an investment banker, quote-unquote, I’m doing air quotes here, actually say that. That’s not how they normally think. They normally think in terms of how many payers they could get in a bidding situation. Or how many have they shown the private placement or the MNA documents too. And how many are in the next step? It’s more of a funnel analysis.
Mark: Yeah, it is.
Scott: Not like a strategic or financial analysis. I will say I don’t think I’ve ever heard anyone say that before.
Mark: All right, so I’m going to go on my soapbox for a moment.
Scott: This a compliments here bud, you hear it?
Mark: I appreciate that. Let me say this. I don’t think investment banking is an easy business. But it is not hard to be better than most bankers. I think most bakers who … By the way they’re smart overachieving people as individuals. But I guess it’s just the history of how they do things. But I am unencumbered from ever having been a banker.
Scott: That’s an awesome point.
Mark: Right. So I’m coming at this from what makes sense, what I would want to see as an operator or as a VC. And if you’re thinking about-
Scott: And as a buyer.
Mark: Yeah, of course.
Scott: You’ve been at these big SMB companies.
Mark: That’s right. Yeah, ran Corp Dev and FreshBooks. Yeah, totally have that view. We see processes, especially now doing buy side work from more traditional banks. First of all they have these confidential info memorandums that are like War and Peace. Like as if there’s going to be an evaluation per page.
Scott: I used to have to write those, yeah. They were terrible.
Mark: It’s like if we give them 300 pages it’ll be worth more or something. So that’s a thing. Then it’s just like this brute force auction.
Scott: Yeah, that’s what I’m talking about.
Mark: And I think auctions suck for every side. I think as a buyer, you feel like, “Okay, I’m just in this impersonal things with 100 other people.” As an investor, many of them actually just refuse to even participate.
Scott: That’s the thing, because people don’t want to be in an auction because it drives up … It’s like the winner’s curse because then you end up overpaying for something.
Mark: Right.
Scott: The only way you can win is if you overpay.
Mark: And even for our clients, if you have a business that’s valuable enough that you’re considering selling it, well, first you have to continue running your business while you go through this process. And if you’re talking to every buyer with a pulse, then you’re going to take your eye off the ball or something. I fundamentally think … And it’s a balancing act. You can’t have these one-off discussions. You do have to talk to multiple parties. There does need to be process tension. But we think that the magic happens when two sides have the opportunity to fall in love with each other. And get past the Excel spreadsheets and see the values alignment, the vision alignment. See the strategic impact. Again, that goes back to why we are specialized. Because if we’re dealing with a finite set of buyers, then hopefully over time we not only know what they’re thinking, but we can influence what they’re thinking. And here’s what we’re seeing in the market. It doesn’t have to be a SurePath client. We just know what’s going on. And we’re just trying to be a value-added thought partner. And we regularly-
Scott: It’s a big enough market, too, where it’s huge. You guys are on fire. And your firm can grow 10X and you’ll still not be serving all SMB-
Mark: Sure. That’d be just so many companies serving. In our state of SMB thing, I know you’ll talk about that, there was like 600-something deals in that space in North America last year. So we served 9 of those 600 deals. So we’re nowhere.
Scott: Then just connecting it, that magic. Because I think, people, maybe on the outside, they look at an MNA thing as the day the deal is announced or the day the documents are signed or the money is wired, that’s the deals done. But really everyone involved has to work together well after to achieve whatever the purpose was.
Mark: That’s right.
Scott: The founder doesn’t want their company just to get mothballed. That’s actually the worst situation for the founder.
Mark: Correct.
Scott: And the buyer needs it to perform and needs to do well. And probably needs it to 5X or 10X, whatever the multiple is, to be worth whatever they paid for it. You’re kind of setting them up for a good marriage instead of the shotgun wedding that-
Mark: Yeah, I often say, there’s two sides to a deal. There’s terms, and they matter a lot. But then there’s who you’re in bed with. Do you see the world the same way? Yeah, as a fonder and team that have built a product, will it continue to live on? Do you have a good home?
Scott: That’s super because a lot of people care about their legacy. I don’t think companies get bought as early as the did maybe when I was investment banking back in the day. Maybe some, there’s some small ones. But most companies probably are getting bought after 8 to 10 years, right?
Mark: Yup.
Scott: Of the founder building it. That’s a core part of their life. They’ll want to sell it at that.
Mark: That’s right. We sold a company last year where kind of multiple bidders. We actually ultimately didn’t go with the highest bidder.
Scott: Wow.
Mark: And I thought the board was really classy about this. This was a classic situation where the company had raised a lot of capital, and had raised too much relative to the revenue it had achieved. There was real revenue, there was real enterprise value, but they had gotten ahead of their skis or whatever in terms of how much capital they raised. So it was to a win situation for the VCs. But one of the buyers at the table was one that the team was particularly excited to join. And to the credit of the VCs, they left value on the table.
Scott: That’s awesome.
Mark: And allowed management to go to their preferred home. So that was really good.
Scott: You don’t get that very often.
Mark: No.
Scott: Just to pry into that a little bit, was there self interest because the founders will come out in a couple years and work with those same VCs again?
Mark: Maybe.
Scott: Or is it just doing the right thing? Is it that’s a-
Mark: I think it’s doing the right thing. The founding CEO was quite articulate about why it made sense to go there. And he felt that they could have the biggest impact there.
Scott: That’s awesome.
Mark: So it was really cool.
Scott: Yeah. Changing gears a little bit, let’s talk about one of the deals you just did. Probably those two the almost killed you on the same day.
Mark: Yeah, that’s right.
Scott: Tax Jar.
Mark: Tax Jar.
Scott: We love Tax jar here.
Mark: Yes.
Scott: We refer Tax Jar. Do you want to set it up? Or do you want me to tell people why Tax Jar is important.
Mark: Mo, you go for it, then I’ll-
Scott: The Supreme Court recently, or last summer, you can find the blog post on Kruze Consulting’s blog, said that basically company that don’t even have nexus in a state are going to be subject to sales tax pretty soon. You used to always have that nexus which is basically employees or assets in a state. Then there’s some threshold. So all of a sudden, literally overnight, Tax Jar and Avalara became probably two of the most probably important SaaS companies out there because every kind of SaaS or eCommerce company that’s selling nationwide or in more than just one state, which is pretty much all of them, has this kind of tax obligation hanging over their heads. The tax obligation still isn’t really defined that well. We’re starting to do a lot of sales and use taxes studies. But everyone needs to get this in place so that they can do the calculations so they know what to submit. And there’ll be some threshold. It’s going to be $50,000 or $100,000 or whatever it is, in a given state before you start charging sales tax. But basically, everyone needs to start thinking about this. So A, I didn’t know you were representing Tax Jar until I saw it on Twitter. But those two companies really like the Wayne Gretzky … You’re a Canadian, skated to where the puck was going, not where it is. So I was amazed by that. But now they’re in a position where there’s only two viable pieces of software to do this. And we’re like hand over fist handing these clients to them. I told you off mic I was buying Avalara stock whenever I could. Only because I couldn’t really by Tax Jar stock, it’s private. But how did you get involved with Tax Jar? Did you see this opportunity? Give us the play by play real fast.
Mark: Sure.
Scott: I know there’s probably some stuff you can’t share. But share the juicy stuff.
Mark: It’s an interesting case study. I often tell the team, we have a very short sales cycle. When someone has a decision they need to do something, they’re going to figure out who their advisor is pretty quickly. And we are very privileged in that most of our leads are inbound, so it’s sort of not even a classic sales cycle per se. But we often build relationships, we have a long relationship cycle. But done right, paves the way to a short sales.
Scott: And they call you right when they need you.
Mark: That’s it. And again, the mantra that I share internally all the time is I want SurePath to be the one call that the CEO makes when the time is right. And that is what happened here. But I first reached out to Mark, the CEO of Tax Jar two years ago. And just started to get to know him. Met him once. Tax Jar is a fascinating company actually. So completely crushing it, no physical office-
Scott: Oh, nice.
Mark: The team is distributed. I reached out, I thought-
Scott: That’s inspiration for us. That’s awesome.
Mark: Yeah. I thought he was in San Diego, I was at an event in San Diego. I had a call with him from the airport. Turns out he had moved to Boston. So next time I was in Boston we met at a Whole Foods Cafeteria.
Scott: The glamorous life.
Mark: Yeah, exactly. But just kept in touch periodically. Then yeah, kind of around the time of this ruling, he called up. And he’s like, “Dude, our phone is blowing up. We need to figure this out.” So I would argue that that ruling disproportionately affected smaller businesses rather than larger businesses. Because larger businesses probably already had Nexus and the infrastructure already. And while both Avalara and Tax Jar cater to both segments, I would say Avalara has more larger clients whereas Tax Jar’s historical strength was with smaller. Without talking of school too much, what I would say is there was a lot of strategic interest in Tax Jar as we turned into offers. But we also felt like they were in the early innings of their business.
Scott: I would agree with that by the way. Because most of the companies … Just to give a data point most of the companies we talked to about this don’t even know what sales and use tax are. And they’re like, “What, huh?” So we almost are like the bearer of bad news a little bit. And they don’t always like it. But then we can follow up with, “We have a great software solution in Tax Jar, you should try them out, da, da, da, da, da.” And that mitigates it a little bit. But startups don’t know about this stuff yet.
Mark: Yeah, that’s right.
Scott: Still not penetrated. So they have a huge market opportunity ahead of them.
Mark: Yeah, they have a huge opportunity in their core SMB. But actually they’ve gone through a similar evolution to Shopify. Shopify for years, kind of like long tail of merchants, and then a few years back launched Shopify Plus. And Tax Jar has done the same thing. They have a pretty new product called Tax Jar Plus, directly competitive with Avalara. And we felt like just between … To your point, across any segment, this category is only going to grow.
Scott: Yeah.
Mark: It doesn’t make sense to sell today. So instead we help them find a private equity sponsor in Insight partners who could not only fund them, but could bring … and I contrast VC to private equity and we could talk about that.
Scott: Yeah, you called it private equity. I always think of them as a late stage VC. But those lines have blurred a little bit.
Mark: They have blurred. And we could definitely talk about that. But they look to have meaningful stakes in companies so that then they can be involved and have the incentive to be involved. Now, they are not benign. They wrote a 60 million dollar check out of a 6 and a half billion dollar fund. If you have a 6 and a half billion dollar fund, you’re trying to turn it into 18 billion to achieve your IOR target, that is a non-trivial challenge. And therefore you’re not just going to invest and show up at a board meeting once a quarter like, “Hey guys, how’s it going? Are we doing all right or not?”
Scott: Even just the sheer 60 million is a huge check. Someone’s butt is on the line for that. You can’t just lose 60 million dollars.
Mark: That’s right. We had conversations with our client about that. But there was specific value add beyond the capital they were looking for that we felt Insight could provide.
Scott: Well, Insight does a lot of SaaS deals. And they probably could pay for themselves, in the dilution in a way, just by introducing you to their portfolio. You know what I mean?
Mark: Yeah, that’s true. It’s kind of that simple sometimes.
Mark: That’s true.
Scott: So that’s an amazing … So you basically took them all the way through and Insight-
Mark: Kind of dual-tracked them, pretty short order, delivered strategic offers, delivered financial offers. We picked up half and closed.
Scott: Wow, then good for you. That’s awesome.
Mark: Thank you.
Scott: Another topic we wanted to cover which is … Because you kind of segued and there with private equity. And private equity to me was always like KKR, and I don’t know all those super all school-
Mark: Sure. Thomas Bravo, all those.
Scott: LBO groups and things like that. And probably 10 years ago it started changing in that smart private equity people figured out that you could actually invest in SaaS companies because they had a reoccurring model, predictable. And it turned out they were kind of capital intensive in the early days. And they became massively cash flow positive in the later days. Kind of fit the profile. So you were starting to see companies that have done like C or one round of VC and then don’t do any late-stage VC and go right to private equity. What’s-
Mark: We’re seeing them a lot.
Scott: Yeah, what’s happening there?
Mark: First of all, just to pile onto your observation about private equity. The origin of private equity was in this LBO thing. You would buy cashflow-
Scott: Philip Morris.
Mark: Exactly. Barbarian at the gates. You would buy a cashflow generating business, lever the shit out of it, put as much with that as you could on. Try and drive for operational efficiencies and we run it for cash flow. Which you can to do in SaaS or should not do. So what happened a few years ago is PE investors got religion around unit economics being more important than bottom line profitability and you’ve got folks like Vista Equity Partners as an example, who’ve really gone to town on that. So now in aggregate, the tech focus, like the private equity funds, are managing 1.2 trillion of capital. Not assets under management, currently active funds-
Scott: Really? Holy cow. Cash.
Mark: … That they will deploy in the next 24 to 36 months. So they are a huge force in the market. I don’t have a crystal ball or I’d be dialing into this form, I don’t know, British Virgin Islands or something today. But I’m here hustling. So I don’t have a crystal ball, so take it for what it’s worth. We’re obviously way overdue for a recession at some point. I don’t think it’s going to be like 2008 where institutional checks dried up. And therefore I think PE will continue to be a force in the market whether we have a downturn or not.
Scott: And their stomach is pretty strong. I think another way to say that is there might be … I wouldn’t say a put, but if things did go down 20 or 30%, they’re going to be opportunistic and buy those companies.
Mark: Absolutely.
Scott: Like Hub Spot has already gone public again after getting bought. Did they have-
Mark: They had venture, like general catalyst and scale venture partners, they just went public.
Scott: Okay. For some reason I thought they got bought. I know Thomas Bravo has bought a couple of SaaS companies. They actually bought one of my old lighthouse deals, Centrify recently which is awesome, it was awesome for everybody, it was great.
Mark: Yup. And Marchetto-
Scott: Yeah Marchetto is the one I was thinking of, I’m sorry, not Hub Spot.
Mark: Yeah. And it was bought by Vista. And then Adobe just bought it.
Scott: Yeah. Exactly. And the private equity guys made like 3X, right or something.
Mark: Yeah.
Scott: Which makes them like a billion.
Mark: In a short period of time.
Scott: Yeah. That’s what I was, it wasn’t Hub Spot, it was Marchetto. Do those guys start dipping down? Or how do they … Because they’ve been kind of buying companies that maybe went public or super late stage. Are they getting more confident?
Mark: They are. I would say again, you have the grant funds, the Vistas of the world. They can’t slum it too much. But you’ve got lots of fund managers who you’ve never heard of who are managing 200, 300 million dollar funds that play in this thing called lower middle market.
Scott: Yeah.
Mark: So 10 million or slightly above businesses.
Scott: And those used to be small family businesses hey would go after. Like in my … 10, 15 years we first started.
Mark: Yeah. But now they have huge appetite for these kind of quote-unquote small SaaS businesses that they can either apply operational excellence to or acquire companies to add onto. They’re looking to do things with them. But there’s lots of them. So coming back to this bootstrap, or some bootstrap and kind of skipping VC, if you read Tech Crunch all the time, you think your only path to funding a business is venture. Venture gets I think a disproportionate amount of the press, but is actually inappropriate for most businesses.
Scott: I would agree with that. We’ve seen of our competitors take venture and it’s very difficult. And we’re like more of a service business. But it’s like it really messes you up if you’re not the right profile.
Mark: That’s right. And again, if you think about the SMB market we play in, one of its attributes, and we talked about this last time I was here, is the fact that it’s evergreen. These markets have been around forever, they’re going to be around forever. And the point of that is that you don’t have to burn your way to greatness and try and get it all done in five years. FreshBooks was 10 years old when it raised its first institutional funding round, over 100 employees, it was a real business. Shopify was six years old when we did the series A. You can take your time. So what you see, probably a full half of our clients at SurePath are companies that have maybe in case of Tax Jar raised the seed round. And then been profitable for the last three years. Or just never raised a penny and just-
Scott: You referred a client like that over to us that we work with. I don’t want to say their name. Actually I told you this off mic, I had to call them and be like, “Hey guys, guess what? You have to pay taxes this year.” And they’re like, “What?” And like, “Yeah. It’s crazy. You’re making money.” And it happens, we see it a lot.
Mark: That’s right.
Scott: Any advice … And we talked about this in the MNA part of this, VCs do provide value add. Not always, but a lot of times they do. Where should those folks … And maybe the question is they should be calling you or the answer is they should be calling you. But where do they go for advice to help them chart the right path? Is that where you come in and they should be reaching out to you? Or how do you think about that?
Mark: Yeah, I don’t know, it depends. I think first of all with VCs, I love VCs, I used to be one, I work with them a lot. But one of the reasons I’m not a VC anymore is there’s actually an inherent conflict between a VC’s objectives and a founder’s objectives. Venture is so dependent it on outliers, finding the next home run, that you are actually out of alignment with most of the founders that you back. So I actually think turning to your VC for advice is problematic because of that basis. Because they are incented for you to grow as fast as humanly possible. And if you die trying, well then screw it.
Scott: I just had one of my … On that note, it’s not a SurePath plan. But a SaaS company serial founder sold for 60 million dollars, 6-0. But he had only taken one round and he was totally out of line with his VCs. Kudos to his VCs because they actually let … Because a lot of times they can block it. They actually let him do it. But it was like a crazy amount of life-changing amount of money for him and his co-founder. But his VCs weren’t very happy. It wasn’t a win, even though they got probably 3X in money.
Mark: Which is perverse.
Scott: It’s weird, yeah.
Mark: It’s totally wrong.
Scott: But he’s a second time founder so he’s been through it. So he kind of knew that this was the right time to sell the business and could stand up to them if they pushed. I don’t know if they did push him that hard. But in the end they were supportive.
Mark: Most of the time, the right time to sell the business is earlier than VCs would want, the vast majority of the time. That is particularly true … I think that’s true across the board. But as we crunched the data on SMB exits, most of them are sub-50 million. And I think in this environment where there’s so much capital and things are so frothy, you can keep raising bigger and bigger rounds and feeling really great about yourself, and totally screw yourself on the exit.
Scott: When the music stops. It’s kind of like that one time you were talking about that had overcapitalized. And they’re lucky they got someone to buy them. Because a lot of acquirers don’t want to buy something that’s been overcapitalized for two reasons. One, they had bad habits and the burdens too high, and B, it’s a fight with the investors to sell because they’re not getting what they want anyway. So it’s just not a good outcome.
Mark: Yeah. And also I would say buyers and VCs have a funny relationship with each other. So many VCs, some of the best ones, will have good relationships with the buyers. But I think as a rule, a buyer is not looking to make a VC rich. A buyer only cares about the team that they’re going to inherit.
Scott: Totally. It’s like the cost of doing business is dealing with the VC.
Mark: That’s right. And so I-
Scott: You hear that now. I’m sure you see this a lot where people are trying … Especially in the smaller exits, they’re trying to realign the distribution of proceeds to the management team.
Mark: Yup, how they’re redo the waterfalls.
Scott: Do you see that? How often do you see that? 10% of the time? 20%?
Mark: Yeah. Across the board on these kind of overcapitalized ones, they’ll either be a complete redoing, or if the board has just taken the pain already and come up with a carve-out, maybe they’ll be okay with that.
Scott: I’ve never seen a board do a carve-out without having it gone to their head. Do you see that coming in or …
Mark: We’ve seen it twice.
Scott: Wow. I’ve seen the promise there’s going to be a carve-out for many months, but no carve out. Then the managing gets it there and it’s a huge fight, and sometimes that blows the ideal up because the management team is, “You promised you’d do a carve out and you’re not doing one now. And da, da, da, da, da.”
Mark: Yup. To be honest, in that case, certainly if I was a buyer, I’d just impose it. Nothing is happening without this carve out.
Scott: Yeah, that’s what needs to happen. Okay, I think I might have taken us on a digression there. Do you want the talk the state of SaaS or SMB SaaS?
Mark: State of SMB software? Yeah, sure.
Scott: Okay, my first question is did the … This is a little digression, but did the downturn in November, December scare, affect your numbers? What happened? Because I know around here in San Francisco, it was like pretty much everyone is over-invested in SaaS and tech. So everyone’s portfolio look like a 20% hit. And we were looking at buying a house, it was affecting the housing market. What was your read on that, the time?
Mark: Yeah. It was about 20% correction in December. We hadn’t had one like that since 2008. You know what that was like. It went the other direction in January-
Scott: Yeah, I know.
Mark: So it kind of sorted itself out. So our index, we have thing, the SurePath SMB Index. So 35 publicly traded companies that’s serve the SMB market. The index, as a result of December was flat for the year. But on the whole … So we’ve been tracking that thing for three and a bit years now. On the whole it’s way above most major indices. And-
Scott: Didn’t it bounce 11% in January? I think that’s what I read.
Mark: Yeah, it was huge, I wish it was an ETF. Anyway, and note to self, turn it into a ETF.
Scott: That’s a good idea.
Mark: And I would say, I noticed this in 2008, again, that was just a blip in December versus a sustained downturn. But what I saw in 2008, 2009 was that recession was a net positive for Shopify and FreshBooks. I was involved with both companies at the time. And it was a case of forced entrepreneurship. People were downsized and so opened up consulting shops. Or, “I always had this passion to be a baker, so screw it, I’m going to be a baker.” So it was bad-
Scott: Your two companies can’t raise money anymore.
Mark: Yeah. So it was bad for the economy overall, but it actually increased the proportion of people who become entrepreneurs. And therefore was actually good for small business and companies serving small businesses.
Scott: Oh, interesting, I didn’t put that together. Yeah, because that’s who they’re selling to.
Mark: Yeah. They had more people on the top of their fund.
Scott: Oh, interesting.
Mark: And so I think what I’ve noticed, again, it’s a function of our economy is a small business economy even though the big companies get all the headlines. And as a result, if you’re serving to lots of small customers, who by the way are the bulk of the economy, your business is far more resilient to ups and downs. Whereas if you were to sell to Fortune 500, the swings are going to be bigger. So what I’ve just noticed is the highs are maybe not quite as high as in other sectors. And the lows are definitely not as low. So less volatility, and on the whole more up and to the right.
Scott: I always feel like these companies, the companies you service and the companies we service a lot, and even us as a company, are like these quiet powerhouses though, it’s like the ball gets rolling down the hill, and then … Because even we lot four clients that went out of business. That would have spooked us like three years ago, It would have been kind of scary for us. Because it probably would have been, I don’t know, 8% of our client base or something like that. Or maybe 5%, whatever the number is. Now, it’s not even a blip on our screen because the machine is working so well. Obviously if there’s a really bad recession it’s going to hurt. And the hurt on us is probably disproportionate to these service startups. But these companies, yeah, people are still going to be using FreshBooks to do their invoicing and collections. And people are still going to be selling online using Shopify. And they still need accounting, so they’re going to … You know?
Mark: Yeah.
Scott: It just feels like they’re just so ingrained. And the cost of switching is pretty high for these companies, too.
Mark: Yeah. A theme that we’ve seen when we crunched all the data in the state of SMB software like with went through 5,700 deals or something. Crunched them down to 600 and change that were SMB focused. So there’s many, many themes that came out of that. But one of them is this notion of ERP. In enterprise, you have this ERP, it’s like your system of record. You run your business on it. It’s probably-
Scott: SAP and Oracle are probably the two most famous for big businesses.
Mark: Right. There’s no small business ERP. But what we’re starting to see more and more is vertical specific platforms that you do in fact run your business on need to end. So there are old examples of that, like Mind Body, for yoga studios, gyms. But we’re seeing new examples of that like Cleo for law practices-
Scott: I just talked to someone with Cleo last week.
Mark: Cool.
Scott: Yeah.
Mark: We’re really seeing it in the restaurant industry. So you’ve got like Toast and Upserve in Boston. You’ve got Seven Shifts. You’ve got a whole bunch of companies, Touch Bistro. Basically almost every part of the experience of running a restaurant is turning into software.
Scott: Amazing. You know what’s funny about that? I told the Cleo lady, I was like, I wish what you’re doing exists for accounting firms.
Mark: I know.
Scott: Because we still can’t find … We’re actually do this big systems upgrade, where doing Salesforce-
Mark: You should check out Practice Ignition.
Scott: Did they change their name to something else?
Mark: Nope.
Scott: Okay. I’ll check them out.
Mark: Based in Sydney, Australia.
Scott: Practice Ignition.
Mark: And it’s kind of proposal, invoicing, contract manager for accounting firms.
Scott: I’ll check it out, yeah. It’s like it’s crazy. I was like, “Is our vertical not big enough? What’s the problem?” But for restaurants it makes total sense.
Mark: Right.
Scott: And Shopify is like the ERP for eCommerce companies.
Mark: It is, yeah. So the big … The thing that’s kind of why this is going to get the long-term secular trend is demographics. Previous generations of small business owners and their business on pen and paper and Word and Excel. But the new generation is running their business probably on their smartphone. Or at the very least and their computer. So any aspect of their business, they’re thinking technology.
Scott: Also I think the remote workforce is actually a big part of that because one of the reasons we need … Like we’re literally doing this evaluation right now, if we need better scheduling and utilization because now we know we can’t … There was never a perfect way to do this. But looking over and seeing who’s busy and who’s not. Now we can’t really do that. So now it’s scheduling and budgets and utilization is incredibly important to us because we’re so remote. And that, everyone’s more comfortable hiring that way now. And probably five years from now it’ll be insane. Then it’ll really-
Mark: I think it’s a huge trend. Again, Tax Jar is one of our clients, and they’re fully remote. Buffer used to be one of our clients, fully remote. I think a lot of investors question whether you can build a big business. And I would just point to InVision, which is a 100 million dollar business.
Scott: Are they?
Mark: 100% distributed.
Scott: I’ve been listening to their Podcast called Yonder. And they interview startups that are remote. And Zapier is totally remote, and that’s an amazing service, too.
Mark: Amazing business.
Scott: So you’re seeing the verticalization of ERP basically?
Mark: Yeah, that’s right, I think that’s the only way to do it.
Scott: Makes total sense.
Mark: Enterprise ERP is horizontal, it’s clunky, it’s built in every possible use case. And therefore the user experience is horrible. The only way to do something that you could run your business on that is say to use is to do it for a vertical Yup.
Scott: I agree. And you’re kind of doing that in your business, you picked a vertical, we picked a vertical. I always tell people picking … We used to do all kinds of startups or all kinds of businesses. Then Vanessa was like, “That’s it, we’re focusing completely on venture capital-backed startups.” And that’s when we just shot up and started growing like crazy. And you picked SMB software companies. Makes total sense.
Mark: Yeah, it totally makes sense. Because then you just build this body of work.
Scott: Yeah, you know exactly who you’re targeting. Was there any other interesting conclusions out of the software, or the TS19 report?
Mark: Yeah. One of them we’ve touched on already which is the growing force of private equity, we’ve lived this first hand our last two deals at SurePath ended up going to private equity even so they didn’t start out that way.
Scott: I feel like that’s still, people don’t realize how powerful that is. But if you’re in 1.2 trillion dollars in cash-
Mark: Current funds. That’s not even assets on demand.
Scott: That’s basically like Google, Microsoft, is that their market caps together or something like that.
Mark: So they’re huge for us, so that’s a thing. Payments is an interesting angle. Probably everyone who’s listening to this, certainly if you’re running a startup you probably collect payments over Stripe or whatever. They’re very used to that. So if you look at the payments industry, there’s lots of pretty meaningful companies. But fundamentally, their product is the same. Like Card Not Present collecting payments, one platform looks a hell of a lot like the other. They all charge 2.9 plus 35 cents or whatever, they’re the same. So the more enlightened payments players are recognizing that their core business is large, but undifferentiated. And are starting to buy vertical software-
Scott: Interesting.
Mark: … That they can offer to their merchants to different the rails.
Scott: Well, Square is the best at that probably.
Mark: Absolutely.
Scott: They’re amazing, they’re doing an incredible job. You’ll love this, I had a great conversation with Stripe about six months ago, they called us out of the blue. Actually Ben from Growlabs introduced us. Because someone over there is working on SaaS revenue recognition out of Stripe. (SaaS accounting mattes!) We were going to build it ourselves. And I got on the phone with this guy. He’s a great guys, he’s a product manager. And he’s like, “We knows this is the pain point, how they go to pain point.” I was like, “Probably 40% of our client base and we’re doing this on Excel spreadsheets. And we have the template set up so we can do it very efficiently. But if you could do this, that would make our lives so much easier.” And he’s like, “Give me a year and I’ll have that ready for you guys.”
Mark: Amazing.
Scott: But that’s an example of a payments company making the entire ecosystem happier. That’s going to be really big.
Mark: That’s a big force in the market. We’re seeing lots of MNA, lots of interesting partnerships just to add more value to the merchants and stop them from switching to other rails. Because otherwise you’re competing and price.
Scott: We need Shopify to do something with … Maybe you can make a few phone calls. The Stripes Shopify reconciliation is not going too well-
Mark: Interesting.
Scott: For some of our clients.
Mark: Yeah, that’s funny. Yeah, if you think about the-
Scott: Why don’t they do their own payments? I don’t understand.
Mark: Well, they do, but through Stripe.
Scott: Oh, okay.
Mark: Two thirds of their revenue is what they call Merchant Solutions, most of which is payments. And they have lending and a few other things. But it’s through Stripe.
Scott: I know.
Mark: But if you think about the use case-
Scott: They’re not talking-
Mark: … Of the core Shopify customer, it’s not recurring SaaS, it’s just transactional and [crosstalk].
Scott: But they have a SaaS component. Don’t you pay a subscription and then you get-
Mark: No, but meaning the value to the … Meaning the end customer is not a SaaS business. It’s a merchant.
Scott: Yeah, okay. I think we covered everything. By the way, this went very long. I hope you’re okay.
Mark: Yeah, it’s totally cool.
Scott: Okay. Mark, thank you so much. Where can hey find SurePath? And one question I didn’t ask you was when should someone reach out to you, basically?
Mark: Yeah, great question. If you think about the things that we do … Set aside By site, we help companies raise growth capital, and we help them exit. Growth capital to me, we have two kinds of clients. One is a client that’s done the standard venture thing, they’ve done the C, they’ve done the A. A great time for us to get involved is after the A. Ideally right after. Like you have our closing party, recover your hangover, give us a call. And the reason is sort of twofold. One is it’s not easy to raise any round, but I think it’s relatively easier to raise C and A because the investment decision is fundamentally a leap of faith.
Scott: They’re still falling in love with you as a founder.
Mark: Right. But if you decide to raise that B, every I will be dotted, every T will be crossed. It will be a very data-driven decision. And therefore we can add a lot of value to make sure you’re set up for that. Then also going back to this notion of most exits being smaller than most people think. If you decide to raise that B, you’ve actually decided to forego where most of the exit activity takes place. So we actually want to be part of that discussion with you to help you make the right choices.
Scott: And you’re basically saying you’re not going to sell for anything less than two million dollars or something like that.
Mark: Yeah, which is super rare. Something we didn’t touch on is another theme in the state of SMB is if you think about kind of consumer markets, enterprise markets, they’re kind of natural consolidators. Historically, IBM, very inquisitive in the enterprise market. There is no dominant acquirer in SMB. It’s a very long tail. Andy look at massive company like Intuit that has a long history as an acquirer. Its largest acquisition ever is 340 million. And like-
Scott: TSheets, right?
Mark: Yeah, TSheets. It wouldn’t even move the needle for today’s venture fund.
Scott: Yeah. TSheets took one round.
Mark: That’s right. So we want to be part of that conversation. And help people figure that out. And then for exits, again, it just comes back … We want to have these long-standing relationships, build the trust, track the business so that when the time is right, we can move quickly. So we actually like to get involved, to get to know businesses early. But we wouldn’t formally engage until a company was … if they’re venture funded, they’re post series A. Or if they’ve kind of skipped all of that, like a Tax Jar, they’re just far enough along where we can surface all the options and therefore put them in the driver’s seat. I love that. And let the founders make an educated decision.
Scott: Yeah.
Mark: Because otherwise inertia will take you a certain way. It may not be the right way for you to go.
Scott: That right.
Mark: Yeah. SurePath. What,
Mark: And check in, get on the mailing list. Because I get the email every month, it’s awesome. I always think why didn’t I buy more SMB software companies for my stock portfolio. Mark, thank you so much, much appreciated.
Scott: Thank you. Appreciate it.
Mark: Cool. Hope you enjoyed that podcast with Mark. He is amazing. Awesome to have him on the podcast again. And before we hang up here, our last shout out to Brex, our sponsor for podcasts at Kruze Consulting. Brex is the credit card for startups, they make it easy. There’re no personal guarantees, they have great rewards. You can go through the Brex signup flow, type in Kruze, K-R-U-Z-E, and you’ll get a discount. Thanks to our friends at Brex for sponsoring the last five or six podcasts. Appreciate it

Kruze Consulting is regularly reviewed as one of the preeminent providers of finance, accounting, tax and HR services to high-growth companies. For our offices in San Francisco, San Jose, Santa Monica, New York and now Austin, TX, our experienced team serves venture and seed backed companies in diverse industries from SaaS to biotech to hardware to eCommerce.

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