Kent Collier
Founder & CEO at Reorg
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The Rule of 40 is dead.Its evolved state, the Rule of 50 (ARR Growth Rate + EBITDA Margins > 50), has taken hold across growth equity investing in 2023 as SAAS companies have rationalized costs and S&M spend and boosted EBITDA margins at the expense of eye popping higher growth rates.50% growth + a negative 10% EBITDA margin was great.Today, a 30% growth + a positive 20% EBITDA margin would result in nearly a doubling of the multiple and capital raising prospects of the company. IMO, the story will not stop there.A new more nuanced metric: Proprietary + Embeddedness will be next great way to value a SAAS business: 1) How proprietary is your data and content?2) How embedded is your technology, workflow into customer systems?Technology is inherently deflationary. Companies that raised hundreds of millions of dollars to build a tech stack in the last decade will be able to refactor their entire code base for a fraction of that by the use of tools like CoPilot or other GenAI solutions.Maybe not today, but soon. We are in what I like to call the "1996 of the internet." Imagine the velocity of change we saw in the late 90s.The change over the next 5 years will be POWERS higher than that.And if we agree that technology is deflationary, the the costs for new players to enter any market to compete will decrease precipitously.If that happens, price of services and solutions will inevitably in the long run approach zero. And if prices approach zero, businesses models will die. So how do we counter this? Start with proprietary. What do you have that is so unique to you that no one can copy it no matter how hard they try? Technology doesn't count. Neither do patents. Nor does your unique hard working workforce or badass culture. Then move to embeddedness. C Suite executives hate changing software systems. It sucks. How deeply are your customer tooling embedded into with your systems. What are the number of API calls you are receiving on a daily basis from your customers and is that number increasing. It doesn't need to be technology only. Moody's Credit Ratings are written into legal documents of securitizations. You have to use them no matter what. Fully embedded.Product-driven CEOs should be maniacally focused on these two metrics.Otherwise their companies will go the way of the Rule of 40...extinct.
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David Spitz
6mo
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Provocative post. I like it.... Proprietary is pretty tough in this day and age... Just about everything can be copied.... No? Still, I think you're right that if you have it, you're golden!As for pushing the Rule of 40/50 to higher profits... I still think high growth with some profits and demonstrable ability to flip easily to lower growth/higher profits... is best... If you can step on the gas effectively (meaning grow fast)... you should!.. Until you're Adobe or Salesforce, your company is valued as a multiple of revenues/ARR -- Better to move that needle when the getting is good.Just my 2¢
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Great post. Proprietary has been a strong driver of value forever. In my Series seed through B rounds 2018-2021, "what's your moat?" was a constant area of focus by investors. Proprietary is underpinned by technology and will become cheaper and tougher as a barrier to entry. Embeddedness will become the crucial differentiator. Not just in terms of tech but also in terms of sales and marketing processes.
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Prashant Gokhale
6mo
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Interesting points, thanks for sharing.. The problems are that like multiples (P/E, P/B and EV/EBITDA), the rule of 40 is a shortcut. Created to fit a narrative because the traditional multiples dont work. The premise is that cost increases will lag revenue growth eventually, leading to a hockey stick in profits. Twitter and Zoom show that, this is not necessarily true. How do you measure "Embeddedness" and "Propreitary" easily and in a manner that is comparable across companies? I am curious...I agree with your premise in general.
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Ziv Peled
4x Top 25 Customer Success Influencer 2020 - 2023 | Chief Customer Officer. People, value and relationships obsessed. I support people in their career, happy to help anyone. Feel free to contact me.
6mo
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Love it, I think it’s time to develop a parallel equation for B2B SaaS to coexist with the rules of 40/50 which will determine and drive how important your value is for your customers and how much it’s recurring over time, the positive trend of it should be the key for the rule of 40/50.
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David B.
UI/Full Stack Developer (TypeScript/JS, C#/.NET Core, Vue.js) at Projetech ☁
6mo
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Lol @ github coplit allowing massive refactorings in fraction of time. Copilot is a glorified code snippet generator at best. No doubt it saves some keystrokes but it's not as intelligent (yet) to be an actual productivity multiplier.
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Kevin Hixson, MBA, MS
Strategy & Planning Leader Focused On Value Transformation
6mo
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Great thoughts, your perspective mimics the old MBA logic! You will stay in business as long as what you are building is hard to replicate and the switching costs are too high. Makes complete sense and there are a lot of platforms that are going to reduce the impact of switching costs soon with the same rationale as code-AI adoption / platform replication. So, better get cracking on innovation ASAP, only way to stay ahead.
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Thomas Brown
Curious Contrarian with more questions than answers
6mo
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SaaS goalposts come with wheels.
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Richard Sosa
Merger Arbitrage and Event-Driven Sales at The Capitol Forum
6mo
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Thanks for sharing, Kent. Can you share a screenshot of an API clause from a legal docket?
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Irnest Kaplan, CFA
Top-rated technology equity analyst. Investor. Tech companies. Electrical Engineer. CFA Charterholder. Took that photo above in the Kruger Park in Jun '17. Lovely cheetah!
6mo
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Great points raised Kent Collier , interesting, thank you
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C. Earl Peek, CPA
Founder/Managing Partner-Diamond Ventures
6mo
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Deep.
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Tony Threatt, PhD
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1) How proprietary is your data and content?2) How embedded is your technology, workflow into customer systems?Important and principled questions to ask as you build out your product.
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Interesting take on the Rule of 40 and how AI could impact what was once seen as the holy grail of measurements.
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1) How proprietary is your data and content?2) How embedded is your technology, workflow into customer systems?
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