20VC: Tom Tunguz on Why Now Is The Best Time To Be Investing and The Effect of Late Stage Valuations on Startups

Tom Tunguz is a Partner @ Redpoint Ventures, where he has invested in Axial, Dremio, Expensify, Electric Imp, Looker, and ThredUP. Before joining Redpoint, Tomasz was the product manager for Google’s AdSense social-media products and AdSense internationalization. Tom is also the author of the world famous blog and newsletter which can be found at http://tomtunguz.com We would like to say a special thank you to Mattermark for providing all the data used in the show today and you can check out Mattermark Search here! In Today's Episode You Will Learn: 1.) How Tom made his way into startups and the investing industry? 2.) What does the huge drop in late stage saas valuations mean for the early guys? Does Tom expect them to hunker down? Take more time? Spend less cash? 3.) In recent years with the likes of Zenefits, we have seen the rise of Free Saas Enabled Marketplaces, why have we seen this rise, what are the benefits of adopting this strategy? Does the lack of predictability and lower (30%) gross margin not generate concern towards the model? 4.) Where does Tom see room for real innovation in SaaS? Is Tom excited about mobile enterprise? 5.) Question from Javier Soltero @ Microsoft: How have you approached developing your 'personal' brand and how that has made an impact in your development as an investor? 6.) Question from Eric ver Ploeg (episode 70) and Tak Lo (Episode 37): Where does Tom generate the ideas for articles and what does the idea creation process look like?’ What does the scheduling look like to churn our such high quality content on a daily occurrence? Items Mentioned In Today's Episode: Tom's Fave Book: Narcissus and Goldmund Tom's Fave Blog: Saastr, David Skok Tom's Most Recent Investment: Dremio As always you can follow The Twenty Minute VC, Harry and Tom on Twitter here! If you would like to see a more colourful side to Harry with many a mojito session, you can follow him on Instagram here!

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:00Harry Stebbings?

  Hello and welcome to the 20 Minute VC with your host Harry Stebbings and my word do we have exciting news for all fans of SaaS today. Firstly, I'm delighted to say that Jason Lemkin at Sasta and I have teamed up to create the official Sasta podcast, bringing you the latest and greatest from the world's best SaaS operators and investors. And you can now download the podcast on iTunes and we'd love to hear what you think. And the second fantastic piece of news for all SaaS lovers is related to our guest today. He is a king in the world of SaaS with his newsletter and blog being read by hundreds of thousands of people, myself very much included.

• 0:40Harry Stebbings?

  It is of course the fantastic Tom Tunguz, partner at Redpoint Ventures, where he's invested in the likes of Axial, Jermio, Expensify, Looker and Threadup. And before joining Redpoint, Thomas was the product manager for Google's AdSense social media products and AdSense internationalisation. Now, before we dive into the interview with Thomas, I have to say a huge thanks to Mattermark for providing all the analysis and data for the show today. Absolutely awesome and you can now use Mattermark's search tool, which is absolutely free and it's incredible and really opens up the platform to everyone. However, it's now time to get stuck into the interview and talk some SaaS.

• 1:21Harry Stebbings?

  Therefore, I'm delighted to welcome Tom Tunguz, partner at Redpoint Ventures.

• 1:32Speaker 01

  You have now arrived at your destination.

• 1:35Harry Stebbings?

  Well, Tom, it's fantastic to have you on the show. I've really wanted to have you on for a long, long time now, so thank you so much for joining us today.

• 1:42Speaker 02

  Oh, thanks, Harry, for inviting me. It's a pleasure.

• 1:44Harry Stebbings?

  Now, I'd love to kick off today by hearing about your background and how you made your move into the VC industry.

• 1:52Speaker 02

  Yeah, absolutely. I moved around a ton as a kid and then when I was seventeen, my love affair with technology started when I was about seventeen and my dad sent me to South America to stay with a friend of his and I got a job at a law firm and I was, my first day there was doing translation from English to Spanish. That's the reason he sent me was to practice my Spanish and I'll never forget, the manager director of the firm there said, "Hey, you're some kid from the US. You must know something about technology. We're four months behind on our bills. Can you build some Excel macro or something to help us figure out, you know, how to bill our clients and all that kind of stuff?" One thing led to another and I ended up actually starting a small company

• 2:32Speaker 02

  with my dad that built software for law firms and we were doing like documents, management, so managing all the documents pertaining to a particular client and then generating bills. I loved that that experience because he was doing a lot of the coding and then I was doing all the sales and the marketing. So it's going, you know, we built this software for one law firm and then we started to try to sell it to other law firms in different countries and so it was kind of running around South America. You know, that was awesome. I really had a blast and then I went to college and grad school and I studied machine learning, applied to physical systems, so things like autopilot for aircraft and satellite stabilization. And then when I left school, I really wanted to know, like I had this wonderful experience

• 3:13Speaker 02

  with my father, building this technology company that was relatively, I mean, quite small and I wanted to know how it was done for real. Like I wanted to know how you built like production scale systems that really could handle huge amounts of data and how companies really sold. So then I went to work for a startup that was founded by a bunch of graduates from Dartmouth, which is where I went and I stayed there for about a year and then I learned what I needed to know and then I went to Google about, yeah, a year later and I started as basically like a customer success manager with a quota. Yeah, and so what we were doing is websites were running Google Ads and our job was to make sure they ran more and more Google Ads and make sure, or help them figure out how to make as much money as possible using Google Ads. This is like, you know, let's

• 3:56Speaker 02

  see, oh five and I was the newest guy on the team and so I started working With these brand new kinds of websites called social networks. For Google, they were interesting because they generated huge numbers, huge amounts of traffic, but they didn't actually generate that much revenue. And that's because the intent model that Google was so predicated upon didn't really apply in social networks. It was more a time-driven thing. So anyway, so I worked with them for about a year and then I switched into product management. I started working with engineers and marketers and all kinds of designers to build products to meet the needs of these social networks. And I stayed there for about two years and then I came to Redpoint and that's eight years ago.

• 4:35Harry Stebbings?

  And you've become a huge authority in the SaaS landscape in that time. And so I really wanna start, I wanna break the episode into two halves and talk about SaaS landscape firstly and today where we're at and how it's developing. And then talk about the incredible process that is your blog and your writing. So let's start by taking a macro view then of the SaaS landscape. And I'd love to hear your thoughts on what the huge drop in late-stage SaaS valuations really means for the early-stage guys. What do you think of this?

• 5:07Speaker 02

  It means relatively little at the Series A. You know, I think you'll probably see, you know, see, well, first, let's go stage by stage. See, valuations from what I've seen are falling. I remember maybe like a year ago, you know, the high-water mark for Y-combinator companies was something like a 20 million cap or an unlimited cap. And I think you'll see maybe one or two of those, but I think on the average you'll probably see five to seven million caps for a lot of the companies. And that's a pretty meaningful drop. At the Series A for SaaS companies, I suspect you might see like a 10 or 15% reduction. I mean, I ran this analysis for SaaS there in 2015, early 2016. The average Series A for like a premium SaaS company was about $10 million.

• 5:50Speaker 02

  And I suspect it will probably fall to seven or eight on average. And valuations will kind of fall with it. At the Series A, it's a meaningful drop, but it's not a huge drop. It's nothing like we've seen in the public markets. Where we are seeing a lot of contraction or compression is in the B rounds and later. I think the major difference or the reason you're seeing a greater There is B, C's and D rounds, they're all priced the way that public companies are priced. They're priced as a function of a forward revenue multiple, right? Uh, which is, let me take the sum of the revenue over the next 12 months, multiply that by a number and that's the valuation. And that number's fallen by fifty seven percent in the public markets when I ran it two weeks ago. So from seven point seven times multiple to three point three.

• 6:35Speaker 02

  So let's compare and contrast. So it used to be like premium companies in the SaaS market would command a fifteen times forward multiple. That was in the privates and then the publics were seven point seven. And now the, the publics are three point three. So if you're still paying fifteen times forward, that means you're paying almost four times what the public markets are. That gap is, is unsustainable. I mean, it's, it's hard for a venture investor to continue to accept that delta just because you're just taking a lot of risk and you're paying really far into the future.

• 7:03Harry Stebbings?

  And I, I, I'm intrigued then, why for so long did venture investors accept paying for tomorrow's growth today? Uh, and why are they only realizing now that that maybe isn't sustainable and acceptable?

• 7:16Speaker 02

  It's not that we're, you know, venture investors are no longer paying for forward growth. It's just that if you're at two X the public multiple, you're probably paying something like twelve to sixteen months in the future.

• 7:26Harry Stebbings?

  Yeah.

• 7:26Speaker 02

  But if you're at four X the public multiple, you're probably paying two to three years into the future. And what that means is you're basically betting on perfect execution for that amount of time. Uh, which means you are, you know, you're taking all the risk and, and not being compensated for it. So that, the change isn't that venture investors are willing to pay less into the future or more. It's just the, the benchmark has changed, the public market benchmark has changed. And so that implies something about paying further into the future in the private markets. Does that make sense?

• 7:55Harry Stebbings?

  Absolutely. No, it does, it does. And, and you also mentioned the devaluation of the very early stage being the seed and the series A. How are you planning, I mean, how are you reacting to that? Are you aggressively investing as a result of this devaluation? Are you remaining the same? Are you pulling back because it may signal bubble-like tendencies? What's your thoughts on this?

• 8:16Speaker 02

  I think it's, I think it's a great time to be investing. No one can time the market, right? If you can time the market, you'd be retired because you've made so much money already.

• 8:25Harry Stebbings?

  Yeah.

• 8:25Speaker 02

  You know, our philosophy is really, hey, let's just continue to invest in really great companies, no matter what's happening in the markets. And let's make sure that, you know, irrespective of where the, where the private markets are, we always come to a fair deal with the companies that we make. So that both of us, when we enter the boardroom for the first time, we're both really excited about working together and we've positioned the company for success. So it's not really a question of like, hey, the markets are down. Now it's time to squeeze founders. It's not really the mentality, right?

• 8:54Harry Stebbings?

  Let's go.

• 8:57Speaker 02

  It's not really the mentality, right? Because that's not the constraint. Like, we're not trying to buy as much of the company for as little as possible. The, the real goal when we invest in a business is to capitalize the business. In other words, give it enough money to get to the next milestone, to be able to reach, to, to raise the next round and then attain the next milestone and build a really big company.

• 9:15Harry Stebbings?

  Absolutely. And, and you mentioned there about investing in the truly great companies, and you do that at all times, um, obviously as a great venture investor that you are. So I have to ask, what are the characteristics then to you that, that make a great company? Is there a business model in particular? Or a sector of SaaS that, that really attracts you?

• 9:35Speaker 02

  It's really hard to generalize.

• 9:38Harry Stebbings?

  That is a tough question.

• 9:39Speaker 02

  You know, what you're looking for is a couple of different things. I mean, and I kind of struggle to articulate them clearly. But the first is a technology innovation that translates to go-to-market advantage. One example of that is you figure out the mobile app store better than anybody else in a particular category. All of a sudden, your cost of customer acquisition relative to your competition is substantially lower, which means your payback period is better, which means you have better efficiency and you can grow faster. That's, that's a pretty interesting one. Another example of that would be, like, Relate IQ, use machine learning in order to ingest data. And so that changes the way that sales conversations happen when you're pitching customer relationship management. That would be another example of that. A second kind of company that we look for are founders who have a unique perspective or insight on a particular market.

• 10:23Speaker 02

  So typically that's in the SaaS world, it's typically people who have worked in a particular market sector and know the space and the customers really well. We invested in this one company called Dremio, which is in a kind of data movement space. And it's two founders from MAPR, which is a in the Hadoop world. They've been working in big data and open source infrastructure for about 10 or 15 years. So when they want to build and hire a team, they can recruit lots of people to come join them. When they need to talk to customers, they already have that rolodex. And then because they've been working in this space so long, they understand, you know, they've seen the problems at several companies over a couple of generations of software. And so they they can anticipate what might happen next. So that's, you know, that's another example of what we look for. Yeah, those are probably two big buckets.

• 11:06Harry Stebbings?

  Fantastic. And we mentioned their slightly kind of business models and evolving markets and times. And I have to ask now, a very current company, obviously Zenefix.

• 11:16Speaker 02

  Yeah.

• 11:17Harry Stebbings?

  That brings about kind of, I'm intrigued to hear your thoughts first. So let's start with that, actually. Your thoughts on Zenefix. What's gone wrong? Why has it gone wrong seemingly so quickly? And how do you react to that?

• 11:29Speaker 02

  You know, Zenefix is a media darling, right? It was one of the fast, one of the companies with the fastest growth and valuations probably in the SaaS world, you know, the iconic unicorn. It was really pursuing a markets. The other great part about it is that it's pursuing a market segment that really hasn't been touched by software, right? Which is healthcare insurance for companies. And so it was really exciting, right? And all of a sudden, when you have this media tension, there's a huge amount of focus on you, right? And so no company's execution is perfect. But if you have the media's microscope on you, your imperfections or your errors in judgment, they get magnified. And so I think that's what happened in this case.

• 12:11Speaker 02

  The compounding factor is that Zenefix operates in a regulated industry. There are lots of laws that have to do with consumer protections. And so it's better to operate with respecting those laws. And I'm not sure about the internals, but it seems like they might have run afoul of those, or at least their investigations. And so that little speed bump is magnified for them.

• 12:34Harry Stebbings?

  And talking of Zenefits, it brings about the question of their kind of model being the free SaaS-enabled marketplace.

• 12:41Speaker 02

  Yeah.

• 12:41Harry Stebbings?

  We've seen a massive rise of this in the last probably five to 10 years. So why do you think we've seen this rise and what do you think the benefits are of adopting this strategy and model?

• 12:52Speaker 02

  Yeah, so free SaaS-enabled marketplace is when you have, there's a supplier of something who has a piece of software, there's a buyer of something who has a piece of software, and then there's a marketplace in the middle. You can have some of those SaaS-enabled marketplaces that are free. In other words, the software on each side is free and the marketplace is taxed, or you can have everything being paid for. The attraction of a free SaaS-enabled marketplace is your distribution mechanism is really disruptive, right? So like, there's a company in Canada that's called Joyce that provides a free SaaS-enabled marketplace for home remodeling. And there's an application for contractors, there's an application for consumers, help them figure out what remodel they want to do. And then there's a marketplace in the middle so that you can instantly find the best contractor to solve your needs in your area.

• 13:36Speaker 02

  You know, historically SMB acquisitions are really expensive and the payback period's not, it's not, it's not work, not work. They get around this by having three-year contracts with their SMBs, just to make sure that the unit economics work. But you can't do three-year contracts everywhere. So the free model displaces the cost of the inside sales teams. And then, and so you can get massive amounts of distribution really quickly. You know, as software continues to kind of pervade and, and challenge really like older industries that really haven't been touched, it's, it's a phenomenal distribution mechanism. The other thing about SaaS-enabled marketplaces is typically the vertical SaaS. So it, you know, it looks on one segment, it could be healthcare, it could be general contractors. And so as a venture investor, when we look at vertical SaaS, we really want to find companies that have winner-take-all dynamics there.

• 14:21Speaker 02

  Because if you choose a vertical approach, the trade-off that you're making is you say, I'm going to take a smaller slice of the market, but I'm going to focus my software to totally meet that segment's needs. And so for us, we get really, because you constrain the market size, we get more excited about a vertical SaaS company when there are winner-take-all dynamics.

• 14:40Harry Stebbings?

  And, and I'd love to now move to the second side of the interview now and discuss your personal persona and brand. And the phenomenon that is your writing and blog newsletter, and it is, I mean, you, you laugh, but it is a huge phenomenon and you've.

• 14:54Speaker 02

  Totally ridiculous.

• 14:55Harry Stebbings?

  You are a star of the SaaS world. So I wanna, I've got a question. So I crowdsourced questions and one question from Javier Soltero.

• 15:04Speaker 02

  Oh, yeah.

• 15:05Harry Stebbings?

  Yes. So I asked him what he'd like to ask you and he asked, how have you approached developing your personal brand? And how has that made an impact in terms of the development of you as an investor?

• 15:17Speaker 02

  It was nothing ever really deliberate. You know, when I first started attending board meetings, I was really lucky. I, when I joined Red Point, I shadowed Jeff Yang for about twelve months and he took me to all kinds of meetings. Private company and public company, board meetings, hirings, pitch meetings, all kinds of stuff. The block kind of started because I was sitting in board meetings and people were asking me questions about things and I didn't know the answer.

• 15:42Harry Stebbings?

  That's not the, that's not the answer I expected.

• 15:45Speaker 02

  No, and so I felt like, you know, I could be in a position to answer this and I was certain that the data existed. Cause I'd come from Google and that's clearly a very data-driven culture. And so what I started doing is basically analyzing these data that I could find to answer particular founders' questions. And then I started publishing those results, right? And so the mentality or the approach that I always had was, hey, I don't really know the answer, but let me go and try to see what the data says. And then you interpret it for your business. And I never wanted to, you know, and like one of the themes I continue to remind myself of is there are lots of different kinds of businesses and you can build a business in many different ways. And so it would be really arrogant of me to make a recommendation that to say this is the best way of building a business or this is the right way of doing it.

• 16:29Speaker 02

  And so that's why I really tried to either surface the raw, I mean, the data, you know, the conclusions of the data or the observations, data or frameworks to think about it. Give people that kind of flexibility and not make particular recommendations.

• 16:42Harry Stebbings?

  And I have to ask Tom, as a content producer myself, how on earth do you produce such high-quality content with such heavy data? Every single day. I mean, do you sleep?

• 16:56Speaker 02

  Well, I do sleep. I just wake up early. So it started when my first son was born and he was getting up at 4:30. He wanted a bottle at 4:30. So then I would wake up and I would write. And what's nice about writing at that time is there are no distractions. You know, the tools that really have helped me along the way, there's this one, there's this book that's called The Pyramid Principle, the Minto Pyramid Principle, that's taught to every consultant at McKinsey, and it's just a way of structuring arguments. It's this woman who wrote it named Barbara Minto, and she has this thing, it's a situation, complication, question and answer. So the situation is what's the status quo? The complication is something has changed. The question is, okay, you know, what is the question that results from that complication? And the answer is, hey, what do you think?

• 17:40Speaker 02

  And so I try to, you know, if you think about it that way, you can come up with 500 words on almost anything.

• 17:46Harry Stebbings?

  Absolutely. And that brings me to then another question from two other guests we've had, which is Eric Verplu, who actually cited your blog and newsletter as his favorite resource, and as did Taclo, who cites it again as his favorite. But they both wanted to know, where do you generate your ideas from and what does the idea creation process look like for you? Do you kind of randomly select topics?

• 18:11Speaker 02

  There's two parts to the idea creation. The first is, someone once told me, I can't remember who this was, so unfortunately I can't give the right credit, but someone once told me, he asked me, who are the best content marketers on the planet? And he said, it's the television studios. In the morning, there's news, kind of midday, there's talk shows, and there's soap operas in the early afternoon, then you go into cartoons, and then it's news again in the prime time, right? And so the lesson to take away from the TV networks is they understand each persona that they're going after, and then they target content for each of those personas. And so at the beginning of the week, I try to think about, hey, I'd really like to write something, you know, what have I learned in the last week that is material to sales or marketing or product or fundraising, right?

• 18:56Speaker 02

  And I have five or six of these different categories. And I just kind of think through that, and then sometimes I have no ideas. And then what you do...

• 19:07Speaker 02

  And then what I do is I just start listing stuff, right? I'm like, what was, you know, I go through my calendar, it's like, who said something interesting? You know, what did they say or what have I read recently that's really interesting? And I try to tie two things together.

• 19:19Harry Stebbings?

  Okay.

• 19:19Speaker 02

  And that's a different way of thinking. And then the last is, you know, what have I, what have I talked about or read that's really resonated with me? So today's post was about the New York Times Magazine work issue. And I read that and I was like, wow, this is actually a really nice compendium of research about what the office of the future would look like. You know, and that was interesting for me.

• 19:38Harry Stebbings?

  Well, fantastic. Well, finally now, after about a year and a half, I know what's behind the idea creation.

• 19:44Speaker 02

  Yeah, a little, a little bald man behind that.

• 19:48Harry Stebbings?

  And I'd love to dive into a quickfire round now with you. So I say a short statement and you give me your immediate thoughts.

• 19:54Speaker 02

  Okay.

• 19:55Harry Stebbings?

  So your favorite book and why?

• 19:57Speaker 02

  Uh, favorite book Narcissus and Goldman. My aunt gave it to me. It's about, it's a coming of age story. And it's written by Herman Hessebrah, a Buddhist philosopher to the West. It's amazing.

• 20:08Harry Stebbings?

  Okay, now your biggest productivity tips and tools. Now, that could be for, for being productive, but I'm also intrigued to hear if you have any writing tools.

• 20:18Speaker 02

  Dictation. So I do all my emails by speaking and I write most of my blog posts by speaking. You can speak three times faster than you can type.

• 20:26Harry Stebbings?

  So what tool do you use to just, uh, the built in dictation?

• 20:29Speaker 02

  No, I, there's this, uh, nuance of the product called Dragon. That's really good and it gets better with time. And then I use, um, a Sennheiser headset with noise, digital noise cancellation. That's really important.

• 20:41Harry Stebbings?

  Okay, fantastic. And then your most read blog or newsletter? I mean, what, what's your must reads? This is ironic considering we've had so many stating yours as theirs, but what's your?

• 20:54Speaker 02

  You know, I really like David Skok. Cause he's also really metrics driven. I really like his, obviously, uh, Saster is terrific. I read, uh, Fred Wilson a lot. Bill Gurley, when he posts is, is, you know, what I like about Bill is he doesn't post very frequently, but he's super incisive.

• 21:11Harry Stebbings?

  Oh, he's unbelievable. Yeah.

• 21:13Speaker 02

  Yeah, it's unbelievable. And then the first round of you, I, you know, they, their production value and they can, they consistently high quality and the depth of the articles they've taken up, you know, a long form. TAC and I think it's really uh it's really differentiated.

• 21:28Harry Stebbings?

  And what are you excited about in SaaS? Many people have told me mobile enterprise, mobile enterprise. Where are you excited for?

• 21:35Speaker 02

  The two areas I'm looking at right now, one is machine learning in soft in software as a service. So how can I use, you know, deep learning or even more basic like support vector models and that kind of stuff in order to in order to help people be more productive with software. And then the second is, I really believe that that we are going to shift to a user interface that's more conversational with software, chatbots and all that stuff. And so I think that's a big thing.

• 21:58Harry Stebbings?

  And do you think there will be a company that makes a million pounds on Slackbots?

• 22:03Speaker 02

  Uh, you know, I think there will be a couple of, I think there will be an ecosystem built on top of Slack. And then I think there will be a handful of companies that um that take that UI metaphor and become really successful outside of Slack. In other words, like, could you imagine a CRM that's basically a question and answer for the salespeople who are just inputting the data as opposed to looking at a form? Can you just imagine a computer asking and speaking to you and asking you a bunch of questions?

• 22:30Harry Stebbings?

  And then finally, your most recent investment and why you said yes, that's public?

• 22:36Speaker 02

  Yeah, the the most recent public investment is a is a Dremio business that I mentioned before. And that was a company uh I had I had been looking for for about a year. We had invested in a business intelligence company called Looker, uh which is growing incredibly quickly. More than employees and uh anyway, so one of the biggest problems Looker was facing when they sold their software was data fragmentation within their customer. Um and so and so I went, I talked to Frank and I asked him, hey, what is the biggest problem you guys face? Let me go invest in that business. And he said, this is the problem. Uh and so I spent a year researching. And uh and then we finally came across them in July of last year. And so we, you know, within the first five minutes, I knew.

• 23:17Harry Stebbings?

  Well, well, Tom, it's been such fun having you on the show. I'm so grateful to you for giving up the time today and thank you so much for joining us.

• 23:24Speaker 02

  Oh, Harry, it's been a pleasure. Thank you so much.

• 23:28Harry Stebbings?

  Wow, what can I say, what a legend. Tom, such a fantastic and fun interview and that was just incredible for me as a long time fan and reader of your newsletter and blog to have him on the show. Absolutely fantastic and I so hope you enjoyed it. And if you are loving the 20 Minute VC, then sign up to our newsletter on the20minutavec.com or you can follow us on Twitter at 20minutevc. And if you love all things SaaS, then do not forget the new and official Sastre Podcast brought to you by Jason Lemkin and I is here. And you can download it now on iTunes and it's from the latest and greatest in the world of SaaS, from the operators to the investors. And we'd so love to hear what you think.

• 24:09Harry Stebbings?

  And so you can find that on iTunes by typing in the official Sastre Podcast. Thank you so much as always for your continued support. It was such a pleasure bringing you today's episode and I look forward to seeing you on Wednesday.