Q2 2024 Pavilion Pulse Report
Data in the latest Pavilion Pulse Report (from Josh Carter + team) inspired this edition’s “Messy Middle” theme.
With a challenging Q2 broadly (63% missed revenue plan in Q2, vs 42% in Q1)…
the $30m-$100m revenue cohort had the worst performance - by far. By YTD Attainment:
$0-$10m revenue: 54% below target
$10m-$30m: 62% below target
$30m-$100m: 71% below target
$100m+: 50% below target
As you can see, the Pavilion report is interactive and filterable. The report includes sales cycle and quota attainment information from RepVue and our Cloud Ratings SaaS Employment Index (n = 3,500+ private software companies). As always, go read the Pavilion report.
The Pavilion data parallels other industry reports - for example, ICONIQ Capital’s recent “State of Go-to-Market in 2024” report showed new logo velocity turning negative - even at the top quartile! - for the $25m-$100m ARR cohort:
The Messy Middle + Industry Implications
A glut of companies in the subscale and slowing “Messy Middle” phase has implications for the broader software industry structure and capital/M&A markets.
covered this here:
Today, unfortunately, the private markets are flooded with companies that might not have a right to exist in 5-10 years. More and more of my conversations with other venture investors include some form of “what’s going to happen to all the zombie private companies?!”
What’s a zombie? A zombie is a company that (in it’s current form) is not attractive to public markets or acquirers. There are so many companies sitting in the $50m - $300m ARR range, growing <20%, and burning money or barely breakeven. Lower growth is OK if you’ve hit significant scale and have shown platform power (ie super sticky / hard to rip out revenue). Being subscale with low growth is a difficult combo. So what’s the exit path for that profile? In public markets it’s hard to see those companies trading >2-3x revenue. Low growth businesses tend to trade on a profitability metric not a revenue metric. On the acquisition side, there are different challenges. For strategic buyers (ie other software companies), they may be interested in these acquisitions, but again at lower multiples. And they generally prefer smaller acquisitions where it’s easier to integrate the product. Financial buyers (private equity) probably don’t find the low growth / limited profitability attractive. They’re great at “professionalizing” companies and removing costs to drive margins. But it’s A LOT harder to re-accelerate growth (let alone do both at the same time). So again, they MAY be buyers, but not at high multiples.
I agree with BucknSF’s addition to Jamin’s post:
The next Vista Equity / Thoma Bravo will run the smash two best of breeds together play successfully IMO. …Companies can’t really do this themselves in a merger of equals because they lack integration expertise and need someone to manage restacking the cap table.”
My own take:
The “Messy Middle” / “zombies” are consistent with my “software = a growth industry maturing” theme (see my Bowery Capital Annual Meeting slides).
These growth slowdowns will often occur in categories with too little greenspace relative to their absolute dollar TAM.
Regardless of growth rate, the “Messy Middle” software vendors will still fill up prospects' inboxes with cold emails, compete for trade show sponsorships, bid on the same Google Adwords, etc. This glut is then seen in sales productivity metrics (like SDR quality conversations or AE quota attainment) and profitability / Rule of 40 measures.
The long tail of software apps has more absolute market share (~50%) AND more stability than you might think. Data from Scott Brinker and Frans Riemersma in “MarTech For 2024” for the MarTech universe:
With ~75% gross margins, the “Messy Middle” / “zombies” can survive for years, further gumming up a software category. Breaking the status quo likely requires the horizontal consolidation that BucknSF mentioned.
Edward Robson + 2717 Partners Perspective
Given the topic of this edition, I invited Edward Robson (his LinkedIn + Twitter), Founder + CIO of 2717 Partners, a constructivist manager with a focus on technology and software, to share his overall industry and M&A perspectives (bolding = mine):
The past two earnings for small-cap SaaS have been brutal. The pressure to develop an “AI strategy” has led to budget mix shift, reallocating savings generated in recent quarters from vendor consolidation (from point solutions to platforms) and headcount reduction. The compounding effect for higher-growth businesses that once led to record-level NRR numbers has led to an accelerated unwind. Headcount ramp for per-seat business models was a key driver of expansion revenue, more so for companies with fast-growth technology customers. Sales cycle elongation has a downstream impact, as hiring trends will not recover until revenue growth can re-accelerate. Historically, layoffs tend to happen at the end of quarters and can accelerate in the back half of the year. If the environment does not improve in the next few months, it will get worse before it gets better.
If you look at the recent take-privates, the focus has been on vertical-market software with a few key characteristics: (i) durable, recurring demand drivers, (ii) sizable market whitespace, and (iii) platforms operating in fragmented markets. In combination, these three characteristics provide several benefits: downside protection, lower friction sales cycles, and optionality to leverage accretive M&A to expand platform value proposition for customers and drive cross-selling.
Recession-resistant customer end-markets (e.g., EdTech, GovTech, GRC) tend to be more resilient. EdTech (PowerSchool and Instructure) has been attractive given long-term contracts (e.g., three-plus years) and provides strong revenue visibility in an uncertain economic environment. GovTech (mdfCommerce) has a significant market opportunity for continued technology adoption, replacing the 3Ps (pen, paper, and people), to create operational efficiencies for a customer base that is not scrambling to develop an AI strategy. Lastly, GRC (Marlowe) is considered “mission-critical” due to the high cost of failure and benefits from growing complexity (e.g., supply-chain, payments modalities, etc.).
Regarding publicized rumors around take privates, most have been on lower quality assets, where growth has pulled back significantly, and the bulk of the return drivers are from cost-savings opportunities under private ownership. However, private equity has shifted its focus over time to quality, and the buyer universe for >$1bn value P2Ps has shrunk in recent years. Growthier assets have become challenging to underwrite, given the returns are highly sensitive to top-line re-acceleration in an uncertain environment during an election year. The issues around PE fundraising are real. The cost of failure for overpaying for an asset that continues to decelerate is high.
July 2024 Demand Index
We’re excited to update the SaaS Demand Index with data through July 2024.
For our new readers: the Demand Index is derived from high-intent Google Search volume data. Due to an ongoing, partial shift in Google’s methodology, this month’s sample consists of 92 companies (versus our usual 340). However, all graphs are pro forma on a historical basis (i.e. apples to apples).
Reminder: this is a directional, free, and ever-evolving* analysis → always do your own due diligence. Moreover, the data captured here is best characterized as top-of-funnel or dark funnel → factoring in sales cycle length, do NOT use this Demand Index as a predictor of near-term financial results and/or financial guidance.
Industry-Wide Data
High-intent search volumes were up +21% year-over-year and +1% month-over-month.
The YoY graph below compares the high-intent search trends to Gartner’s 2024 cloud spending forecast only to give context. In the footnotes, we note possible “apples versus oranges” dynamics when comparing the SaaS Demand Index versus Gartner.**
Tying this newsletter edition together and factoring in sales cycles, the weak 2H 2023 Demand Index trends align with the poor revenue attainment / forecast misses in the 1H 2024 Pavilion Pulse report.
About Cloud Ratings
In case you missed it, we recently announced a research partnership with G2 - more here:
with this slide showing how our G2-enhanced Quadrants, this newsletter, our podcasts, and our growing True ROI practice area (see Ivan Arizaga’s appointment as a Principal Analyst) all fit within our modern analyst firm:
*To publish closest to month end, we are accessing the underlying API data “early” (relative to the typical SEO and PPC users that do not require such immediacy). Therefore data should be considered “provisional” (i.e. subject to revision by our data provider) and create volatility in the data presented in the 2 most recent months.
**Demand Index vs Gartner SaaS Revenue possible “apples versus oranges” dynamics:
potential buying journey shifts away from Google search and now starting on review platforms (like G2) and - to a lesser extent in terms of measurable impact - community recommendations (like private executive Slack groups).
a general trend for Google search volumes to plateau with scale. We’ve also observed this dynamic with retailers.
most importantly, the SaaS Demand Index is a *forward indicator*, whereas Gartner’s market sizing and growth capture *realized revenue* → given sales cycles, “lagging” our SaaS Demand Index is the right way to examine correlation.