May by D’Ornano + Co.: From Rule of 40 to Rule of 55: the New Normal for SaaS Companies with GenAI, the Core Characteristics of a Successful Venture Buyout Candidate, and Why GenAI Requires Patience
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Dear all,
I recently attended the Milken Conference in early May, where amongst many fascinating panels and discussions, I had the opportunity to listen to a conversation between Elon Musk and Michael Milken on perspectives for the future, just a few days before xAI announced that it had raised $6 billion, positioning it to compete with the likes of OpenAI and Anthropic in the foundational model race.
At the heart of the Milken Conference discussions was the potential revival of deals later this year or in 2025. However, the spotlight was also on genAI and its far-reaching implications for private markets. The debate was intense, with investors questioning the existence of a bubble at the Venture Capital level, the possibility of a 2021 hype resurgence, and the transformative power of the technology beyond the genAI tech stack, extending to 'material world' companies. The consensus was clear: genAI heralds a significant technology shift, akin to the commercialization of the internet with the browser, and far surpassing the move to the cloud. As with any technology shift, there are both disruptors and disruptees.
The race for innovation is on across the entire genAI tech stack, from foundation models to the application stack. The key question is the value creation potential of genAI for Venture Capital through investments in startups capable of building robust economic models with true moats, be they technological or commercial as ARR starts to build up. While many of these startups may face hurdles or even fail, a small fraction is expected to yield significant returns. This is the time for strategic cherry-picking, guided by a comprehensive understanding of the economics of these companies.
At the disruptee level, all businesses, particularly technology businesses, are expected to be disrupted. According to Ravi Mhatre in conversation with Open AI COO Brad Lightcap, "Any business that has a technology element is going to be disrupted, and quickly." Within Technology, SaaS businesses are particularly vulnerable to disruption, while they were until recently considered a haven of stability with predictable recurring revenue streams. It is now unclear whether the value will shift from SaaS incumbents to native genAI companies or if the opposite will occur. To recall, when the SaaS wave emerged in the 2010’s, native SaaS companies took the lion's share. It is not certain that genAI native companies (putting aside foundation models) will win. Indeed, SaaS incumbents have the data and the workflows, as Marc Benioff recently recalled in a recent Salesforce earnings call. But though many incumbents could become AI winners, patience is vital, and AI-led revenue increases through new features or products should still take a couple of months to unfold while costs are already here.
Beyond the disruption of how SaaS companies operate and the winners/losers, genAI is bringing another form of disruption: that of valuations. For years, SaaS companies have been valued per the Rule of 40, which marks a valuation frontier between those companies that surpass the Rule of 40 when adding up LTM revenue growth and operating cash-flow margin, and does that not. We unveil an article in which we envision a move from a Rule of 40 to a Rule of 55. While genAI should allow for growth acceleration, most of the 15pp leap will result from productivity gains at the S&M, R&D, and G&A levels, while the impact on gross margin should remain minimal. Hence, genAI comes with new standards, and the bar has risen for SaaS companies. CEOs need to prepare for this upcoming shift and ensure that their businesses can capture the technology's transformative potential and deliver higher operating leverage through it.
Operating leverage. That is the key word behind a new form of buyouts that we are poised to see more importantly: venture buyouts, i.e., buyouts by large Private Equity players of companies previously sitting in the Venture World and who now with a decelerated growth (but still growing double-digit levels) are choosing the Private Equity route. These deals – for which the recent Lumapps buyout provides a perfect example - do not resemble the traditional buyout due to i) higher levels of growth implying higher risk and specific to those businesses and ii) margins that are close to zero or still in negative territory. We propose a framework of analysis for successful operations of this sort, resting on a double conviction of durable growth and operating leverage to reach Private equity Tech Buyouts standards.
Thank you for reading!
From Rule of 40 to Rule of 55: How GenAI is disrupting SaaS valuations
A few weeks ago we produced at the firm a report on how generative AI was changing the well-known Rule of 40 for SaaS companies due to its implications both on growth levels and profitability, and how we might go from a Rule of 40 to a Rule of 55.
I felt that there were a few themes worth highlighting, which I do in this piece. Please reach-out as this is a fascinating topic with massive impacts on how SaaS companies are valued, both for high-growth and for more mature companies.
The PE buyout opportunity amid tech’s reckoning
The tech industry continues to go through a difficult reset following the investing frenzy that drove unsustainable valuations. As I noted previously, a large number of high-growth Disruptive Technology companies are facing an existential funding crisis that will either end in collapse or M&A at a severely depressed value.
Many Private Equity investors have reacted by pulling back their growth-stage investment activity. But amid this reckoning, a critical opportunity is emerging that PE managers should recognize: venture-backed buyouts or “Venture buyouts,” i.e., buyouts of companies that were previously venture-capital backed. We had the privilege to advise Bridgepoint Advisers in its recent acquisition of Lumapps, constituting a perfect case study for a successful operation in the field.
I dive into what makes a good Venture Buyout candidate in this article.
Salesforce, which has revolutionized the enterprise software industry with its cloud-based CRM solutions and is seeking to position itself as an AI winner, had its stock drop massively last week as it missed its earnings due to weaker-than-expected sales. This case is a compelling demonstration of the non-immediate nature of genAI gains. It stresses the need for leaders to be patient as their companies incur massive upfront costs to implement genAI while waiting for the results.
Computing workloads for new technology like generative AI are pushing energy consumption and costs up even further. Data centers’ share of global electricity consumption is projected to increase rapidly in the coming years per CB Insights data. To cope in the long-term, there are more calls for data centers to find ways to survive off-grid. This articles explore how.
LumApps
D’Ornano + Co. acted as strategic advisor to Bridgepoint in its acquisition of LumApps, a cloud platform improving employee engagement and productivity. Founded in 2017, LumApps has so far attracted over 700 customers to serve more than 5 million users globally. Our firm supported Bridgepoint with our flagship Advanced Growth Intelligence solution, designed to decode patterns of durable growth of disruptive technology companies.
Kings League
D’Ornano + Co. advised Left Lane Capital in leading the €60M early-stage round of Kings League Santander. Designed by Gérard Piqué, the Kings League is a 12-team 7-a-side soccer competition based on innovative playing rules. Broadcast live on streaming platforms, its has been extremely popular with viewers, totaling over 13m online followers and 82 million views on TikTok.
Resilience
D’Ornano + Co. supported Red River West and Picus Capital in leading Resilience $25M Series B. Resilience is developing a remote oncology patient monitoring platform and a mobile app to improve cancer care by providing continuous monitoring and personalized support.
Natural Cycles
D’Ornano + Co. advised Lauxera Capital Partners in leading Natural Cycles $55M Series C, with participation from Point72 Private Investments. Founded in 2013, Natural Cycles created the first direct-to-consumer contraceptive app and remains the only digital birth control cleared by regulatory bodies in the U.S., Europe, Canada, Australia, Singapore, and South Korea.
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