The Middle Market, the Private Markets and Making the Case for Services Revenue

Perspectives and Quick Takes From Bigfoot and Our Community of SaaS Operators and Investors

Thanks for joining me for another Bigfoot Bi-Weekly Roundup. With the newsletter, my goal is to provide an informative, conversation-provoking, and action-oriented read that enables our operator and capital provider peers to learn, grow and connect.

This week I cover:

• How we label businesses

• Takeaways from Carta’s Q1 2023 state of the private markets

• Making the case for services revenue

If you enjoy what you read, we'd appreciate you sharing our insights with your network!

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A Bit Less Business Labeling Could Go a Long Way

Lately, I’ve been thinking about how we label businesses and the connotations, confusion, and biases that come along with classifying a business a certain way. I think we all get too caught up in labeling, and I don’t think it’s serving any of us. I also think that if and when we apply a label to business, we should not think that it’s set in stone forever. Businesses evolve over time and may move across labels throughout their lifecycles.

For example, how do we think about a startup vs. a small business?

What’s a startup?

The definition that has won out is the one put forth by Paul Graham 10 years ago.

A startup is “a company designed to grow fast”

What’s a small business?

According to the Small Business Administration (SBA)

A small business is “a company with fewer than 500 employees”

I recently asked operators how they think of and operate their business. Interestingly, 1 in 3 said both a “startup” and a “small business”. I don’t know why, I’ll have to ask.

In my opinion, Paul Graham’s “startup” definition has caused peril for a generation of software companies that have over-indexed to growth and overcapitalization. In short, this definition made things go crazy. We’ve all seen it by now.

I find the SBA’s definition based on employee count to be quite lackluster, but they’re focused on job creation and employment statistics, so fair enough.

A definition I get a bit more value from is the “middle market”. According to the Federal Reserve, the middle market is made up of

“businesses with between $10 and $250 million in annual revenue”

I think that captures it well, focusing on revenue scale rather than growth or employee count. This article from Grata goes further into defining the middle market.

To me, middle-market companies are “established businesses”. Their level of revenue conveys that to me. They’re not necessarily designed to grow fast, even though they may be doing so. They don’t have an arbitrary employee count threshold. They’ve probably got some product market fit. They may have raised some capital.

They come in many shapes and sizes across many industries, and I happen to believe that more and more of them will be software businesses that can succeed over the long term without unnecessary pressure to conform to a less healthy format.

This is an exciting prospect. Let’s focus on fostering it.

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Takeaways from Carta's "State of Private Markets: Q1 2023"

1. Down Rounds Up - There's been a lot of narrative around down rounds over the past few quarters highlighting both Founders’ and VCs’ hesitancy to conduct them and the saving grace of extension rounds to help avoid them. Well, now we have some meaningful data that the market is playing its hand with down rounds increasing. "Just shy of 20% of all venture investments in Q1 were down rounds, the highest proportion since at least 2018. A year ago, barely 5% of venture deals resulted in a reduced valuation." I expect this % to keep ticking up.

2. Bridge Rounds Up - "At least 40% of all investments in Series A and Series B companies were bridge rounds in Q1, the highest figures of the 2020s."

See the below results re: anticipated bridge rounds from our capital market survey from Q2 2022. The majority of respondents (60%) said 10-25% of their existing investments would need a bridge round in the next 12 months. Turns out the figure 9 months later was actually quite a bit higher at 40%.

We will be sending out the same survey shortly and will share the results via this newsletter. Stay tuned for more details!

3. (Micro) M&A Up - "The number of venture-backed companies that were acquired or merged with another company increased by 20% in Q1 compared to Q4 2022, with 57% of those M&A deals valued at $10 million or less".

Wow, 57% of Q1 M&A deals were $10 million or less. I’m glad there’s a market of buyers for these companies, but let's be real, these are acquihires or hard resets with the company drastically leaned out. I'm not saying it's necessarily a bad outcome as some folks can remain employed and the businesses can potentially be re-engineered in a healthy format. However, it likely is a poor financial outcome (zero return or complete loss of invested capital) for preferred and common equity holders.

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Bigfoot Capital offers growth-oriented loans for B2B software companies with $2M- $20M in revenue. We pride ourselves on partnering with companies and their stakeholders to provide a capital partnership that comes with stability and support.

If you operate or support a B2B software business and want to learn more about alternative capital options that preserve equity, get in touch with our team today.

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🔊 Bigfoot Quick Takes 🔊

Professional Services <> SaaS P&L

I wanted to share a gem from Dave Kellogg regarding providing professional services and its potential impact on your SaaS P&L.

I'm generally neutral to pro having services in the revenue mix. If that service’s revenue is at a 2% gross margin as in Dave's example, I'm a hard pass.

But I frequently see services revenue at 35%+ gross margin. And I've long believed it can be a solid differentiator and retention hook for those who roll up their sleeves to do it in a profitable format.

Founders seem to get misled on the potential benefits of providing services and having them as part of the business model as VCs have generally been vocally anti-services revenue. Services revenue gets dinged on valuation multiple relative to recurring subscription revenue, which I think is fair, but it can still be profitable revenue and should not be wholesale neglected.

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