BESSEMER CLOUD COMPUTING LAW #10: Cash is (still) king.
The cash flow characteristics of a cloud business are wonderful in the long term, but can be lousy in the short term. Cloud companies require you to fund research, development, sales and marketing upfront in return for a multi-year stream of revenue. This typically demands enough investment capital (over stages) to fund 4+ years of runway before a company can achieve positive cash flow (GAAP profit is even longer).
Imagine you are flying a private plane from Silicon Valley to Wall Street (which sometimes is the figurative or literal goal), and you need to stop a couple of times for fuel (investment capital) for the trip. It is critically important that you plan your equity and debt financing events in advance to maximize value and minimize dilution.
Understanding the cash flows of your business – including gross and net burn rate – is critical to survival in the early days and critical to your dominance in the long term. There have been many promising cloud startups that stepped on the gas too early and were wiped out as a result. Always model the business with a comfortable cash cushion and recognize that most cloud businesses paradoxically consume more short-term cash as growth accelerates. As a business, it is critical to weigh forward investments carefully. Cloud businesses typically require multiple rounds of investment and a good amount of capital. For example, it took $126M for NetSuite to go public, $61M for Salesforce.com, $41M for Eloqua, and $45M for Cornerstone OnDemand.
We are now seeing a second generation of cloud businesses that have the potential to be more efficient than many of their predecessors by leveraging Platform-as-a-Service (PaaS) and Infrastructure-as-a-Service (IaaS) to outsource more and shift many startup costs to variable models. However, even in most of these cases, significant capital will still be required to build a dominant cloud business. If you plan these stages thoughtfully, you will be able to minimize dilution by progressively decreasing your cost of capital, mixing seed capital with venture capital and possibly debt before attracting public market investors. With the increased sophistication of debt and equity providers in the cloud space, we are now seeing multiples of CMRR (and similar subscription measures) as the primary valuation metric.
It is worth noting that many businesses are not natural candidates for venture capital and should look to other sources of capital for early funding. Friends, family members, former co-workers, and strategic partners are all time-tested pools of friendly startup capital. Venture capital firms can be extremely valuable as partners in your business, but are really only a fit for opportunities where the team is “swinging big” and have the potential to be billion dollar businesses at some point.
Although we place a great emphasis on the risk of underestimating the cash cushion needed to build a large cloud business, another great risk is that of underinvestment in the business. Trust your metrics and your dashboard and invest behind success.
If your cloud metrics show strength and your unit economics are meaningfully positive, then it would actually be irresponsible to not invest aggressively in growth. The Cloud Computing market is no longer a secret, and the competitive dynamics continue to heat up quickly. If customers love your product and the financials make sense – it’s time to run after the opportunity aggressively to grab the full market potential, or someone else will!
If this sounds like your business, please reach out to us at Bessemer as we’d love to be your partner and join you for the path ahead.
For a PDF of Bessemer's Top 10 Laws of Cloud Computing and SaaS please click here.