thomasz tunguz redpoint

The Golden Age of the SaaS Market

Tomasz Tunguz has become one of the most prominent figures in the world of SaaS valuation, business development and of course, venture capital. As a partner at Redpoint Ventures, Tomasz sits on the board of successful companies such as Looker (recently acquired by Google for $2.6 billion), ERPLY, Chorus.ai, Quantifind, and many others. Before joining Redpoint, he was a product manager for Google’s social media monetization team and managed the expansion of AdSense enter into six European and Asian markets. As a founder himself and former developer for the Department of Homeland Security, Tomasz lends his wisdom weekly on the popular blog tomasztunguz.com where he frequently benchmarks the metrics of major SaaS companies against each other, shares how SaaS operators can improve their understanding of key KPIs and provides useful insights into trends in the SaaS market.

seed finance trends
Chart source: https://tomtunguz.com/which-categories-of-seed-startups-are-thriving-which-aren-t/

In the Market Review article in this issue, we noted that CB Insights reported in May that 2019 will prove to be a record year in terms of Tech IPO valuations, and SaaS M&A activity surpassed the first half of 2018, according to SEG. With the Nasdaq frequently outperforming the S&P as the top of the market consistently brings in strong gains, we also see that these strong valuations are reflections of the profitable investment opportunities being found in the middle market SaaS businesses. We wanted to know Tomasz’s take on the higher-than-ever valuations routinely found in the cloud sectors in 2019.

The data whiz is well known for his ability to analyze and correctly identify market winners, and SaaS valuations, as he notes, are at an all-time high and in no danger of going anywhere. “There has never been a better time” to be a SaaS founder, as he mentions later in the interview, due to the efficiency of the SaaS sales model, the high demand for both business and consumer software products and the wide future of possibilities brought about in the space not only by data-driven growth but also advancements in AI and cloud security. As the author of Winning with Data: Transform Your Culture, Empower Your People and Shape the Future, Tomasz argues for the importance of transforming your company into one that uses data in daily decisions, as well as offering guidance on how to become a company that embraces the strategic use of business intelligence.

We had a chance to sit down with Tomasz to find out everything from where the next big opportunities are, how SaaS multiples are trending, why early-stage startups should scrap LTV for months to repay, and how to think about your marketing team as an investment portfolio.

We’re seeing valuations at record highs, but we kind of have these warnings of, they’re calling it not an economic downturn, but a mid-cycle adjustment. Can SaaS companies maintain these high valuations? Are they going to go down? Are they going to ride an economic wave? What do you see?

Well, the last time I ran the analysis, about the end of July, I looked at valuations in the public markets. In the public markets, investors value companies on a forward revenue multiple, which is the enterprise value divided by the sum of the next 12 months’ revenue. Over the last 15 years, the median has been about 5.7x. In the 2016 era, it was about 7.2x to 7.7x. Then, about six months ago, it was at 9.5x, and then at the end of July, it was 10.5x. What that means is we’re roughly 2x historical means — and the other thing that’s happened is that the variance is four times historical highs. The chart has basically just skyrocketed.

What does that all mean? It means that SaaS companies have never been valued as highly as they are today, and there has never been as broad of a range of different valuation multiples. That is ultimately because we are seeing some companies trading at three times and some companies trading at 45 times.

To summarize: the average valuation is as high as it’s ever been. That’s because the highest fliers are valued much more highly than they’ve ever been in the past.

When you have a company that’s valued at 20 times or 30 times or 40 times forward, what does that mean? It means that you’re betting that the company executes perfectly for two or three years, which might be the case. The bull case is that the company grows at the same rate as recent SaaS companies, which are growing faster than we’ve ever seen. Twilio just announced earnings. They crossed $1 billion in recurring revenue growing at, I think it’s like 80% a year and it’s just astronomical growth rates.

Zoom is obviously a huge grower, and profitable. I mean they’re just amazing businesses and the markets are way larger than anybody ever thought. That’s the bull case.

The bear case is that if any one of these companies ends up missing earnings, then you’re going to have a pretty meaningful contraction in multiples, and consequently evaluations. One perspective is that these companies are going to continue to grow because we are still pretty early in the big waves that are pushing them, like the cloud wave. There’s about $1.5 trillion in software spending, only about $250 million of it is SaaS or like next generation. So even if you assume only 60% of that $1.5 trillion actually moves to cloud, we can triple or more from here.

If there is a correction in the market, it could be that those companies continue to grow unscathed, but much more likely, I think there will be some kind of moderation or attenuation in the valuations of those businesses.

What would be the driver of that moderation?

It would be if several companies miss earnings. If you go back to February 2016, the forward multiple was about 7.7x, and then in one day it fell 57% to 3.3x. Just because two or three companies missed earnings. Therefore, public market investors started fearing that everybody else was going to, and everybody sold all their positions in tech. That’s why I think if you start to see a couple of companies missing earnings, then the evaluations begin to correct pretty meaningfully because you lose that confidence in having perfect execution from a company for two years or three years.

Do you have any indication of where you’re expecting companies to miss or to hit?

There’s no sign. There is no sign that they’re going to miss. Most of these companies are doing really well and a lot of companies, right after the IPO, I mean they’re basically planning to run pretty consistently for a while. I expect them to continue to outperform. The fundamentals of these businesses are strong: the sizes of the markets they’re addressing, the strength of the products and the efficiencies of the sales models.

I mean, look at Shopify. It’s the only company that has a smile curve in sales efficiency. What I mean by that is, as it has grown, it has actually become more efficient to acquire a dollar of gross profit, which you never see. Most companies sort of asymptote or hit diminishing returns where a dollar of sales and marketing spend produces fewer and fewer dollars of gross profit. But in Shopify’s case, it just produces more and more profit.

A business model like that compounds twice. It has this beautiful account expansion dynamic and as accounts are expanding, it gets easier and easier just to buy another dollar of gross profit. It’s just an amazing business.

It would take some kind of exogenous macroeconomic event that really changes the way that large enterprises buy software if you’re betting on a correction in the market and in these valuations.

Well that’s very good to hear. What metrics are we paying attention to when we’re benchmarking growth against sustainability? Because I feel like there are these two camps kind of arising in the SaaS market: bootstrappers who are intent solely product-driven growth, and the VC approach.

I think Atlassian was one of the first companies — and definitely the biggest company — to go public as a bootstrapped software company (at least in the modern era). They did the secondary but they never really raised any primary. Then there was this wave of companies, probably epitomized best by Box, who built SaaS models that paid less attention to net income or profitability but who still built amazing businesses. Now, the pendulum is swinging back to founders who really want to see product-led growth and get to a meaningful scale without a whole lot of venture dollars. Zoom is a really good example of that. Notion’s raise at 800 is also a great example of a super capital-efficient businesses.

You’ve got lots of other private businesses that are trying to pursue this model. I think that’s really an extension of the consumerization of IT from, say, 10 years ago. We are really starting to see it much more broadly, where a lot of these products are adopted by individual people or teams within organizations, and they’re not being acquired through procurement. It’s basically: the customer signed up on a credit card for a $5K ACV, probably at the most, and then that brings with it just incredible account expansion for a really long time.

That’s a really good and healthy thing, right? I think it means that the buyer base is more sophisticated. I think it means that SaaS companies can get further along before they ever need to raise capital, whether it’s through their secondary or IPO capital, and that’s really positive.

However, I do think that there’s also another category of software. You know, you’re never going to sell a Workday implementation to a Fortune 500 through bottoms-up product-driven sales. The buyer wants the comfort of somebody coming in to customize it, leading the change management, or doing the change management and educating everybody in the company as they move over.

This does point to a bifurcation in sales models, in that lower ACV products are moving increasingly towards product-driven growth because the cost of customer acquisition is increasing monotonically. As a result that’s the most effective form of customer acquisition, whereas in the enterprise, the Procurement business model still makes sense. Therefore they’re likely going to continue raising large amounts of capital in order to feed very large go-to-market teams.

Do you think that despite all the conversation around this next-gen sales model, there’s still plenty of room for that enterprise model?

No question. No question. I mean, what are some more recent examples? Let’s look at the three biggest SaaS companies on the planet. One is Salesforce, one is ServiceNow, which sells entirely enterprise. One is Workday, which sells entirely to enterprise. 40% of Slack’s revenue at IPO was accounts $100,000 and over. They made a very deliberate decision to focus on enterprise accounts in year two or three of the company.

If you’re going to be deploying Slack, what Slack is selling you is change. They’re telling you how to be an innovative organization. I think investors are probably more drawn to companies that run with product-led growth because your return on equity, in other words, the number of times you can increase the value of your money, is far better there; you don’t necessarily have to spend as much money to hit the same revenue milestones, but you’re probably getting in at a much higher valuation.

Whereas on the other hand, I think the classic model will always be there because if you’re IBM, or if you’re, I don’t know, JP Morgan Chase, you might experiment with startups, but when they deploy, you’re going to want to pay them like $100,000 or $300,000. You will want people there installing and onboarding it, and it’s going to have to pass security audits and penetration testing and all those kinds of things and go through procurement and legal. The product-led growth motion doesn’t lend itself to that kind of purchasing process.

Does that create risk for incumbents to not really have to innovate as fast as they product-led companies?

Yes. You have Salesforce, Workday and ServiceNow and, I mean, Salesforce went public in 2004, so they have spent 15 years as a public company. One of our investment theses is that a 1% of Salesforce is a unicorn. What we mean by that is, if you were to find a dissatisfied segment of the Salesforce population and build a better product for that segment whose size of the customer population was 1%, and you were able to capture them, you would have a $1 billion business. I think we’re going to start to see, and are already seeing, some companies going after those bigger businesses and picking off customer segments or product lines that haven’t received the love and attention they deserve. People are just going to start ripping out those revenue streams from big businesses.
Is it safe to say that now is a good time to be a SaaS startup?

There has never been a better time. It is unbelievable. It is such a great time. I mean the amount of capital that’s available at every stage: you can get pre-seed, seed, post-seed, second seed, all kinds of series. The other amazing thing now is that companies are starting to be more widely distributed. You can get all kinds of talent as people are comfortable working remotely.
Then in terms of exit paths, you have all these strategic acquirers who are looking to acquire SaaS businesses. You have the IPO market that’s wide open. The last trend that’s been really crucial is private equity activity. Of all the SaaS companies sold in 2018 in terms of dollars sold, private equity bought half of them. They have become this huge third source of potential buyers.
In terms of all the capital going into the market, the interest and the wave of customers who are interested in buying SaaS is strong. And if you ultimately want to exit your business, the exit opportunities are endless.

There’s this great word SYZYGY, the only word in the English language with three ‘Ys’. It means the “alignment of three different planetary bodies.” That’s exactly what we have. We’ve got a syzygy in the capital markets for SaaS.

Let’s talk about metrics a little bit. Everyone talks about churn. Why is that? Do you consider it to be the most important metric versus say LTV, for which I think there could perhaps be an argument made?

I think churn is a really important metric. LTV is a really good metric for later stage businesses. I say that because most SaaS companies won’t know their true LTVs until they’re seven to ten years old. They’ll speculate what their LTVs are, they’ll project, but they won’t observe them.

It sounds like the conversation changes depending on the stage of the business.

Absolutely. If you’re Salesforce, you know exactly what the LTVs are across all your different segments. When you’re figuring out what your marketing mix is and how much you can spend to acquire a customer, you know exactly what the LTV is. So instead of focusing on payback period as a metric, you should just be focused on contribution margin or incremental dollars above your sales and marketing spend over the life of that account.

On the other hand, if you’re an early stage company, you’re just guessing. You could guess that you have a five-year LTV or seven-year LTV or a 15-year LTV. Your models are going to be really sensitive to LTV in terms of how much you’re willing to pay to acquire a customer, so if you don’t have a lot of confidence in that LTV figure and you are too aggressive, you could make a lot of poor decisions. This is exactly why we advise a lot of startups at their early days to focus on months to repay, which is the revenue times the gross margin divided by the sales and marketing cost to acquire a customer. In the private markets if you’re in the SMB to lower mid-market range, you’re going to typically be around 14 to 16 months. If you’re a $100,000 company, you’re probably going to be somewhere in the region of 16 to 22 months to repay.

If you’re somewhere within those thresholds, then you should feel confident continuing to spend. It’s a good metric to use because as soon as you acquire a customer, you can validate whether or not your marketing mix is within that range.

Now, going back to the first part of your question, churn is really important because one way of looking at a SaaS company is that in essence, each customer is an annuity stream. I’m looking at it in a financial lens here, but if I have a customer who is worth a dollar today and I have a total dollar churn of 5%, they are going to be worth $0.95 cents in the next year and then dropping to $0.89 the following year. So the value of that account is going to decrease, and it’s going to decrease at a compound rate.

Alternatively, if I’ve got a negative churn of 40% a year, then if I do nothing to my business, it still grows 40% a year by itself. It’s like a super high interest rate bank account. That’s really compelling, right? Because if you’re trying to go public, you want to be at $150 to $200 million in revenue growing at 70% and if your net dollar retention (NDR) is 40%, well then you only have to grow 30% because the 40% basically takes care of itself. I’m oversimplifying here, but it’s way more attractive than a company at 0% NDR, or negative NDR.

What advice do you have for founders with net dollar retention below 100%? Is it always a problem right away?

It is a problem right now. It probably means you don’t have product market fit because if people aren’t willing to stay with the product or they want to spend less for the product, that means that there’s not enough value in the product or it doesn’t quite meet the needs of the customer.

For perspective, the range of NDR that we see at the Series A, tends to be 110% to 140%, and in the top deciles, 200% plus. Nothing will make a SaaS investor jump out of their chair more than 140% or greater net dollar retention with, say, a tripling in ARR. If you are going to invest in a business based on two metrics and the benchmarks, that’s what they would be.

What are you looking for when someone is pitching to you?

The first place you start is the team, the passion the team has for the space and then the authenticity the team has for the space. It’s wonderful to hear and see people who are solving problems that they faced because they’re building tools that they have an intrinsic knowledge of. [Editor’s note: this maps to DocuSign founder Tom Gonser’s answer of looking for the “unfair advantage” in the teams he invests in at Seven Peaks Ventures, in our January 2019 issue.]

I think the second thing that you want to see is a large addressable market. To create a very big business, you need a very big market and a lot of demand.

The third consideration is those metrics we touched on earlier, as they are really important: revenue growth, net dollar retention, sales efficiency and sales cycle. Those are the big four.

Then the last thing that you need is this sense that the team can walk through walls. Most of us at RedPoint have been founders, so we have a lot of empathy for the founder journey; the most exciting roller coaster in the world — and also the most terrifying — is founding a company. There are going to be lots of moments in the journey of the business that are going to be very difficult. You just want to have confidence that the team will be able to endure and persevere through those moments.

That’s a really good way of putting it, “walking through walls”, because that is what it is sometimes. It’s doing the impossible.

Oh, no question.

Tom Gonser called it “the unfair advantage”, because a lot of people that they were investing in were people who had worked in a space and had identified a weakness and then basically built a business based on that weakness. Dropbox and many others it seems were built that way, and I thought that that was kind of an interesting way of putting it.

I totally agree. Peter Thiel in his book ‘Zero To One’ has this notion of a secret, being: What is something that you believe you know about the space in which you’re operating that no one else believes? I think all great businesses are started that way.

Oh that’s interesting. Can you talk a little bit more about that? What might that look like?

Well, say Dropbox, right? So Dropbox is an incredible product. It’s based on a technology called Rsync, which has been in the Linux and Unix file systems for a long time. So if you’re a programmer and you have two different computers and they were in two different locations, you could just literally type ‘rsync.star’, and just hit enter and then it would synchronize the two computers.

I met Drew right when he was coming out of YC and I asked him like, “Hey, is this an Rsync client?” And he’s like, “Yeah, that’s exactly what it is.” I don’t know if the technology’s the same, but he had this brilliant insight that this technology that engineers were using in order to synchronize files across computers could be used by consumers. The problem was that no consumer was going to type that into the command line — but if you packaged it in a beautiful way and made it scalable, the idea was that it would grow like crazy. Look at the business he’s been able to build.Redpoint

Like Looker, a business intelligence company that we are investors in. The founder there, Lloyd, started two or three different companies. He sold his first app Server to Netscape. Then he was at Microsoft for a while. He was an architect of Borland.

He kept on seeing the same problem within businesses, and because he’d been in so many different ones, he had a unique perspective. He noticed that everyone had a different definition for the same metrics, and as a result, the customer success team or the sales team or the marketing team might all have slightly different definitions of revenue. They might get into fights because none of the numbers matched up, until eventually they would debate.

So, with Looker, the secret there was that you could create a language that defined all the metrics of a business that everybody else could use and so everybody was on the same page all the time.

Do you have a way of indicating how founders know when it’s time to add paid acquisition on top of content marketing? Is it when new leads plateau or should they add growth channels while it’s still growing? I guess I should also ask, do you even advise all SaaS businesses to start a blog?

I think you should always experiment when things are working. You never want to need a new customer acquisition channel to come online before you know that you can make it work. Basically what’s been happening is that a lot of SaaS companies find a single channel of customer acquisition. They saturate it, then hit some turbulence and are forced to figure out another channel.
What you want to do, if you can, is to hedge and experiment with other customer acquisition channels when things are working, which is what we advise a lot of our companies to do. I think of Head of Marketing as a person who is managing a portfolio of different customer acquisition channels, and you, like an investment manager, want the performance to keep increasing every month. Some stocks, some customer acquisition channels are going to go up that month and other ones are going to go down, but overall you want the basket to perform.

In terms of starting a blog, I’m a huge believer in content marketing. I think it is a force that has compounding effects; if you are writing evergreen content, each marginal post is just going to keep generating traffic for you over and over again. The hard part about it is that its payback period (or that the time to value) is pretty long and you need to be consistent for a long time.
However, if you look at a lot of different developer tools or many of the product-driven growth companies, most of them start off with content marketing. The reason for this, I believe, is that the basis of all marketing is trust. In order to have trust, you first need to establish credibility. To establish credibility, you need to give something to the community so that they begin to trust you. Then, and only then can you sell your product.

Whereas if you’re kind of up-market and you’ve got an inside sales team or an enterprise sales team, they can build trust through relationships. Somebody who’s doing a product-led growth strategy by definition isn’t building trust through relationships.

How is the rise of audio-visual going to change that? Everyone is saying marketing is completely moving to video and essentially, if you’re not creating video content, you’re dead. I wanted to get your take on that.

I think video is important, but ... I don’t know. I think each channel is important. We just invested in a company called Qualified that allows you to spin up a video conference with an account executive immediately. I think that kind of video can be really powerful.

But I don’t know if marketing is going to obviate audio and text. I think it depends on your audience.

How do you know when your payback period is too long and what the best way to fix it is?

That’s a good question. I think too long of a payback period can be driven from a few things. It can be because your pricing is too low. It can be because your gross margin is too low, and it can be because your sales cycles are too long. Those are probably the three most common drivers. So let’s tackle each issue, one by one.

In the first scenario, your price is too low so it takes you, say, two years or three years in order to pay back your cost of customer acquisition. If your price is too low, most of the time it’s because you just don’t have the gall to ask for a higher price — but you should. It’s just a matter of courage (unless you don’t have product market fit, but let’s assume you have product market fit).

Sometimes payback periods are longer because your gross margins are low, particularly with a lot of AI-driven startups. The median publicly traded SaaS company has a gross margin of about 71%. You have some companies that have 80% gross margin and then you have others, ones like Twilio, that are at 50% gross margin. 70% to 75% is ideally where you want to be.

The next generation of AI companies, particularly the ones doing deep neural nets, often have depressed gross margins relative to other companies that process large amounts of data. We might see them in the 30% to 50% gross margin range.

Let’s take a 35% gross margin: if you have exactly the same go-to-market motion as a company with a 70% gross margin, your payback periods will be twice as long. By increasing gross margin and reducing your cloud spend, which is typically the biggest driver of decreases in gross margin for SaaS companies, you can shorten your payback periods.

The last of the top three reasons that your payback period might be long is that your sales cycles are really long. If it takes a lot of customer lifecycle marketing, or if it takes a lot of sales effort to sell somebody a 12 to 18 month through 24 month sales cycle, that’s a really hard place to be.

I invested in a company that had two-year long sales cycles. I’ve learned that it probably means that it’s an unaddressable market for a startup, and it’s much better served to a big company that can bear that long of a sales cycle. Because if you’re a startup, you’re probably needing to raise every 12 to 18 months. If one side sales cycle takes you 12 to 18 months, then you’re kind of banking the company on a handful of different deals. If they don’t go through, then your fundraising is challenged and if they do go through you’re in a good place.

Do you believe that you either need to be completely downmarket or completely upmarket, or do you think there’s a middle ground?

No, I think it is a really smooth transition. If you take a look at New Relic and AppDynamics, both of those SaaS companies are in the application performance management space, so they help engineers understand when software performs slowly and why.

New Relic is a bottoms-up business. When they went public, their average contract value was about $5,000. What they did was to just keep moving up. They kept moving up and up and they got into the mid-market and they had a whole bunch of different enterprise accounts.

AppDynamics had an opposite strategy, where they went after the enterprise and then they moved down. Both of those businesses ultimately ended up meeting in the middle, which is kind of an unusual phenomenon, but I think actually happens more often. These things are fluid. There are some companies like NetSuite that will never move beyond a certain price point, but I do think companies move around quite a bit in terms of price points.

How can founders think about churn in line with their annual contract value?

The way that I think about churn is, depending on the price point, you’re going to observe different levels of logo churn. So if your price points are somewhere like $10K or less, it’s going to be pretty likely that you’re going to see around a 7% to a 25% annual churn depending on the kind of customer.

If you’re selling to restaurants, you’re probably going to see 20% to 30% annual churn. That’s because it’s a customer base that doesn’t have a whole lot of margin, doesn’t make a whole lot of profits to buy software and a lot of them go out of business.

In the mid-market, you typically see something like 5% to 15% logo churn. In the enterprise, you typically see 1% to 5% churn.

It’s really important, if you are a more mature business, that you look at churn on a customer segment basis. Because what you don’t want to do is blend in, say enterprise churn with SMB churn and to get to some middle number that doesn’t really tell you anything about what’s going on at the different segments of your customer base. You have to break it out and look at all the metrics separately, such as the payback periods, sales efficiencies and sales cycles.

On the topic of when your customer is too big, you should never have a “bet the company” customer. If you’re in a position where you’re saying, “Wow, this contract is going to make our business or break our business,” that is a terrible deal to do. That’s typically because a startup has no leverage in those conversations. The big company is going to ask you for more and more. Pretty soon you’re going to be building a custom product with a bunch of different people all focused on serving whatever Fortune 500 is starting to pull you around. The only time to get in business with a big company is when you have enough of a counterweight to be able to walk away from the deal and be okay.

I know that’s a heuristic and not a rule, but truth be told it’s more of a feeling. You don’t want to be a seven-person company competing for a $5 million deal. It’s just not going to work.

Right, I think it’s important for startups to hear that because there’s so much pressure to say, sign Uber, even though signing Uber might ruin your company.

Absolutely.

Looker

Moving into more of a forecasting topic, I want to talk about where you see the next big niches and opportunities coming up. We’re entering a next frontier within AI and machine learning and you’ve pointed to speech recognition taking off. Is that a big thing we should be on the lookout for or is there anything else that you are excited about?

Yeah, I’m excited about four different themes. The first one we talked about before, which is “1% of Salesforce is a unicorn.”

The second theme is this idea of an AI agency, artificial intelligence agency. There are large swaths of the US economy that are almost entirely served by agency. You’ve got debt collection agencies, marketing agencies, accountancies, law firms, recruitment agencies, translations agencies, and there are like 50 or 60 of these categories.

Within those categories, you don’t have ‘winner take most’ dynamics because there are no economies of scale. Our set position is that machine learning actually changes those dynamics, so that you can get to economies of scale, which will lead to a next generation of agency that’s powered by machine learning but masquerades as another agency. That will take most share.

There are certain categories where machine learning helps more, and there are certain categories where machine learning helps less. We’re working to identify the categories where machine learning helps more, where they can give you more leverage.

The third theme is use-case specific RPA. RPA is an incredibly fast-growing category of software: it stands for Robotic Process Automation. There are three companies there that are probably the fastest growing companies in history in software. They allow business users to automate computers in a really novel way. We believe that the three kind of horizontal platforms have been built, but that you can deploy machine learning to find individual use cases or expensive internal processes that can be automated better with machine learning than it could be with IPA. An example of that is a company we’ve invested in called AppZen that automates expense report auditing and is growing really fast. That’s a process that used to be manual but is now largely automated.

The fourth theme that we’re pursuing involves our belief that software is going to be re-architected again. What I mean by that is, the first wave of software was client server where you had the application running on a PC and you had the database running in a central server inside of the company. Then Salesforce and others created this initially ASP, but then SaaS model where they took both the application and the database and they put it in the cloud and the SaaS vendor operated both. I think in certain categories the database and the application are going to be split again and the application is going to be managed by the SaaS vendor, but the database is going to be managed by the customer. It’s not going to go on-prem, but it’s going to go in the cloud, in something that’s called a VPC (or virtual private cloud).

Amazon or Google or Azure will still run a database, but it will be mostly under the control of the customer and the SaaS vendor is going to continue to operate the application. That means that the customer gets all the benefits of SaaS and that it’s paid for on a subscription basis, the product gets frequent updates, but they also get the benefit of controlling their own database so that they can comply with all the regulations that they care about, or limit the SaaS vendor’s access to certain things, or just generally be more in control and also secure it to minimize leaks and security breaches. Those are the four areas that we’re kind of chasing.

Do you think that the global conversation around data and security is what’s motivating that split that you’re anticipating?

Yes. Without a doubt.

What is your favorite SaaS company that is not in your portfolio and that isn’t Atlassian? (Everyone’s answer is Atlassian).

Oh, really? How interesting.

My favorite SaaS company outside the portfolio has to be Zoom. I think it’s such a great story. Eric had a vision from the very beginning. He comes from that space, and he wanted to reinvent the product that he had architected before.

Then the other thing I love about Eric is his warmth. The motto of the company, “Meet Happy,” the things that he said at the IPO, which is, “I just want our investors to all make money.” — he just has an incredible competitiveness and at the same time an incredible altruism and I think holding those kinds of opposites in him at the same time is a really beautiful thing. It’s rare.

Oh no, it’s fine. I think there’s this really cool new conversation going where some founders are taking the approach that competition can be community, and there’s like enough for everyone to go around.

I love that. I love that. That’s so great.

Do you have a book recommendation that you’re really excited about?

I just read the Elon Musk biography, which I couldn’t put down. The stories that come out of that book about Elon’s family explain his ability to take huge amounts of risk. Then there’s another one called “The Barbarians,” an excellent book about surfing that won the Pulitzer prize.

Do you think that humans are living in a simulation and why or why not?

No, I don’t think they’re living in a simulation. I think it’s real. I think the world is real, but I think we only experience a small part of that world.

There’s this book called Flatland and it’s a story of a point, a line and a triangle and maybe a rectangle, a bunch of shapes. It sounds like a children’s book, but it’s not. It’s the story of how they’re living their lives in this two-dimensional world on a piece of paper. Then at the end of the book, they meet a sphere and they just have no idea. I mean, their minds are blown. They just have no idea what to do and it’s a little bit like Plato shadows on the wall. You know Plato shadows on the wall? [Editor’s note: Plato’s Allegory of the Cave refers to two prisoners who have faced a wall their entire lives and have only ever seen shadow. One day one prisoner is set free, goes outside, and fails to explain to his counterpart what the real world is like because the other prisoner has no ability to conceptualize a world like ours without seeing it.] I think humans are like that. I think we’re looking at shadows on the wall.

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