- So how long have you worked for Scale? - A little over four
years, now. So I'm entering my fifth year. - Yeah. And now you're VP, right? - Yes, mm-hm. - And so you're doing this
thing of looking at all the companies that are coming in and helping us figure out what to invest in and what not to invest in. - Uh-Huh, yep, mm-hmm. - So, on an average year,
what does that look like? - Yeah, yeah. - You know, for a VC like
Scale, it's like a hundred selling companies that
you look at in some way, shape, or form. - That's right. - Then, yeah. - Mm-hmm, that's right.
We typically look at hundreds of companies, and then we do deep dives into maybe tens, depending on the year. - Right. And so, at that
stage, this is a place where maybe they're on the second
meeting, and you're asking to see financials. You're like, "What does that look like internally?" And so, I've always wondered,
I'm from the outside. What do you have to do during that phase? Because all I get is
the partners telling me, "You're great, we'd love to
invest in you. Let's just look at what's happening inside." - Send us all your data! That's right. So, typically
what we're looking for in terms of financials is we
want to make sure you have product market fit.
And there are typically a couple of metrics we look for. The first I would say is we like to make sure
that there is AR growth, meaning if you're looking
at AR for the last, maybe, eight quarters, we want to
make sure that net new AR is growing over time. So you want to see a curve like this. Right? Yeah. That's
usually a very good sign. There's a lot of demand for
your product, a lot of interest, so your company is growing very quickly. - [TIM] So that's kind of
people's annual recurring revenue that you want to see? And what's a rough benchmark, like what's really bad territory, and what's really amazing territory as far as you're concerned? - Yeah, that's a good question. I would say you want to make sure your net new AR increases over time. So let's say you add 10,000
net new AR last quarter. The next quarter after that, you want to make sure you add 20, and then the quarter
after that maybe 40 or 50. You just want to show that
there's a trajectory of growth. - Right. And so that makes
a lot of sense, and again, this idea that it's kind of
the first thing to look at, because if you have sales
momentum that buys you so much freedom in terms of
a bad quarter, a bad hire, or any number of things that might happen. If you have that sales momentum, you can afford to do a lot of mistakes. So what are some of the
other things you look at? - So the other thing I
think is very important for SAS businesses is making sure
there's good sales efficiency. So for us, our metric is
looking at the magic number. And what the magic number
does is it looks at, based off of your sales
and marketing slant for the last quarter, what
new revenue are you adding for the next quarter? - Okay. - So there's kind of
this fine balance between what you spend in terms
of sales and marketing, and what new revenue you're generating. So that also ties into AR, of course, too, because that's the bookings portion of it. - Right. - Typically we like to
see magic numbers of one. - So what would that mean intuitively? - Sure. One is like if you spent a dollar in sales and marketing,
you want to generate almost a dollar in revenue. If the company is ramping very quickly, as in they're investing more
in sales and marketing spend, this will often come
down, but it's something that we expect as you grow. But typically we like to
see one when we invest, and that's the metric that we look for. - So again, it's this sense
of growth and trajectory. So we know we're just about-- - Well, not spending too much money. So that's where the sales
efficiency number comes in, is you have this growth, but
you're not overspending for it. It comes a little bit more naturally. - Right. So let's dive
into sales efficiency. How do you measure that, and what's a good benchmark
for that, usually? - Sure. So, like I mentioned,
the magic number is one way that we track it. Generally, we want it to be one, and just keep it around there if you can. - Okay, that makes sense. So what are some of the
other things you look at? - Sure. I think our top
two really is the AR growth and the magic number,
the sales efficiency. We also look at gross margins,
so you want to make sure you're in line with other SAS companies, so typically around 60, 70%. You want to make sure that your
cogs are not out of control, because it is very important to make sure you have enough cash, because if you don't have enough cash, you're
basically going to go out of business, and nobody
wants that to happen. - Right. So this idea that
if you're really not able to capture a margin on
your current pricing now, it's unlikely to change
in the future, right? And you've got to stay within a certain benchmark to
have a good business. And so, in long term, I
think there's also something that maybe isn't telling
so much about the house or the company, but is important to VC, which is your potential
return, as well, right? So is that something you also look at when you look at companies? - We definitely look at potential return. But the return part is a
little bit tricky, right? Because we look at a whole bunch of different factors for this. So, financial is only one aspect of it. We also look at market size and all that. So, essentially, what we're looking for is how big can your company
become, and, based off of that, what can we potentially
make on the company? So generally, the higher
return the better, but it depends on stage. So if you're investing in
a more early-stage company, then the return, we expect
it to be a lot higher. If the company is more
leader stage, then we expect the return to be a bit lower. And we like to have a
balance in terms of having a certain number of early-stage companies, and then a certain number
of late-stage companies. - Right. So that could be
a financial consideration that's really not saying much at all about your company's health, but might lead a VC from passing on a deal,
just because they're not going to get a big
enough outcome out of it. - If you feel like you're not going to get a big enough outcome and you
have this model that you have for your fund and it doesn't
fit, then, most likely, the VC won't invest. - Right. But it could be
that another VC or another financial institution of some
sort would take that deal because you're performing
well, and they don't have as high of expectations in terms of the return they're going to
make on the overall investment. - Yeah. - Are there any other things,
any other considerations, that come in? Any other
metrics you look at? - Yeah. I would also look at
cash, because when we invest in a company, you want to make sure you don't spend too much, because, again, you don't want the company
to go out of business. And if you run out of cash,
then you're out of business. For SAS companies, you have
to invest money to make money. So we want to make sure,
when we invest in companies, that the cash will last
them at least two years. Yeah, so generally that's
why we spend so much time looking at your sales efficiency metrics, and your gross margins,
too, is to make sure that you won't run out of cash. - So what's the idea of
two years versus a year? I know companies have different
kinds of mental models about that. - Yeah. You know, I think
that's a very good question. Generally, we like to
think of it in two years, because if you can make
the money last two years, the company will hopefully
be big enough where they can raise at a bigger valuation, and that's what we're looking for. A lot of companies, especially
in the last couple of years, they've raised a little bit sooner. So they'll raise after a year. How often you can raise, it
depends on a mixture of things. Like the capital market,
so I would say funding came a little bit easier in
the last couple of years, now it's getting a little
bit more challenging, so the cash has to last
a little bit longer. But if you're thinking about
how much you're going to spend for the next year because
you're doing annual planning, this definitely should come into play. So if you think you're not
going to be able to raise for another year, then
you should probably spend a little bit less. But if you think you can
raise money in the next year, then you can probably
spend a little bit more and get higher growth. - But otherwise the prototypical
gross curve would be, you're able to take this
influx of funds, right, and really grow your company,
and get to the next benchmark, the next order of magnitude,
in that two-year period. - Right, yes, that is the goal. - And do another round, right? And some companies grow a
lot faster, and they're able to raise faster, and some of
them are never able to raise. - That's right. If you're
more capital efficient, then the cash will last you even longer. And we love finding companies
that look like that. - Yeah. Which is actually a
little bit atypical, right? I think a lot of people
just would rather have you on that kind of curve
and growing explosively, and just keep getting
new funding all the time. - That's right. I feel
like the market has changed a little bit, where at lot of
VCs now value profitability, a path to profitability, versus
the insanely high growth. Ideally, you can find
companies that have both, but it is really rare. Generally, the companies that do have this have some sort of virality. So there's some portion of
it that can make it go viral. Most traditional SAS businesses
are just not like that. You have to invest money
into sales, and marketing, and sales people in order
to drive the growth forward. - [TIM] Right, like they
grow fast, but not like-- - Yeah, not like
exponentially. That's right. They're not consumer companies,
they're different models, after all. - [TIM] Makes sense.
Anything else you feel like we should cover? Anything else go through your mind when you review companies? - Yeah. I would say financial
is just one aspect of it. We also take a lot of other
things into consideration. At our stage, it is good
to use financial metrics as a filter, because we'll
get many companies, right? And if you have more than a million AR, then the financial metrics
are a good way to gauge the health of the business,
but at the same time, we also take things like
market size, team, et cetera, into consideration. So I would say financial
metrics are important, but it's only one factor that we look at. - Okay. Is there one gigantic
red flag or pet peeve when you get data from
companies that makes you go, no, no, no, no, no? - That's a good question.
You know, I like to get the underlying data. So oftentimes we'll have
people calculate metrics for us and present it to us that way. Sometimes I find that it might
not be calculated correctly, and I just want to get
the raw data and then figure it out myself. So if people were to send
us data, I would prefer it if they just sent us all
the raw data and have us figure it out, versus
calculate the magic number. I appreciate the effort, though, it shows you did your homework. - Yeah, but now they
know. Thank you so much! - Yeah, thanks!
