Investor appetite for cloud subscription businesses is so high that even middling, late-stage companies can attract lucrative exit offers from private equity firms if they’re generating cash flow and are at or near break-even, Bessemer Ventures Partner Byron Deeter says. 

Moderately successful software-as-a-service (SaaS) companies are choosing to stay private longer to build more value before going public, becoming attractive targets to PE firms prepared to make late-stage offers at high multiples, Deeter said in a SaaStr webcast. 

“Before, getting to $1 billion was the win,” he said. “That was the IPO or the exit. Today, it’s the Series B or C financing offer.”

Because of the success of cloud SaaS, companies are waiting to reach a valuation of $10 to $15 billion before going public.

“It’s possible to see businesses in the $60-600 billion range,” he said. “Shopify, when we invested, the top end of our outcomes table was a $400 million IPO, because that used to be a success. They’re $200 billion or so now [as a public company since 2015]. Similarly with Twilio. They’re $60 billion or $70 billion today and climbing.”

Brain-breaking multiples

Bessemer tracks the largest cloud SaaS businesses. Among this group are companies reaching $1 billion in annual recurring revenue (ARR) and growing at an average 40% a year.

SaaStr CEO Jason Lemkin, in the webcast, pointed to HubSpot, one of the $1 billion ARR companies growing at more than 40% a year and accelerating. “It breaks your brain, doesn’t it?” he said. “What does that mean for [investment] outcomes?”

Bessemer’s business model concentrates on companies that promise 10x gains, but in the larger world of SaaS, there are thousands of companies that are posting reasonable but unexciting growth, seeing some cash flow and at or near break-even that can attract something up to 10x ARR returns. 

Depending on their business model, PE firms are even interested in companies at, say, 3x returns, on the strength of the additional value they can extract by cutting costs and folding them into complementary businesses. 

“PE firms are very good at consolidation strategies, and unlocking business efficiencies,” Deeter said. “So, one of the things you have to have a discussion about is, are you comfortable taking costs out of the business? And sometimes that will be part of their playbook. But the reality is, that is a valuable business, just not the big venture home-run swing type of business. But those businesses clearly have value and you can get a 10x for those companies often and both sides can win, meaning the PE firm will be able to extract value and get their 3x on that with some work and with some other assets bringing it together.”

Because PE firms see the high growth potential of cloud-based SaaS and also recognize these companies' strategy to stay private longer, more venture firms are buying late-stage companies outright, rather than just investing equity. In some cases they’re even adding a late round of leverage. The idea is to grow additional value before eventually having the company go public as a much larger and more valuable enterprise.

“It’s going to be open season for PE firms,” said Deeter, whose firm evaluates companies based on their relationship between cash flow and growth rate. “They’re going to pay decent multiples on these things because they know they can unlock more value. And if they can bring things together, unlock more free cash flow, they can get to scale. Then they’re going to grow that asset and then ultimately take it public for 10 or 20 times multiple at much larger scale and everyone wins.” 

Post-COVID position

Many cloud SaaS companies, especially those that provide a collaboration platform, benefited from the pandemic, but even as the need for remote work goes away, cloud is the future of software, Deeter said. That means some of today’s big platforms stand to grow into the next Apple, Microsoft, Amazon or other sector-defining company. 

“When you look now at a business like Canva, they’ve got a real shot to be the next Adobe, at $300 billion-plus,” Deeter said. “You can look at it even today [now that they’re a late-stage company] and say there’s still a venture return possible, where a 10x return could be had.”