It’s a busy time in tech, with billions of dollars of value incinerated in recent days: FTX is at death’s door, while Twitter, recently sold at a price that no longer made sense once the transaction closed, is either slouching toward insolvency or not, depending on how you vet its new owner’s recent comments.
But while there are a great many shiny things vying for our attention, the larger (and more boring) world of B2B software is going through a fascinating year. Recall that when COVID-19 first swept the world, there was doubt that tech companies would perform well. Those concerns were misplaced; as it turns out, businesses of all sizes still needed tech solutions to run their operations, meaning that while much of the economy suffered, tech companies picked up extra momentum.
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The market ran a bit too far with the idea last year, pushing valuations into the stratosphere and betting that a great number of smaller tech companies were the next Microsoft when in reality, the number of truly massive winners in a venture context will remain limited.
Regardless, valuations have come down and the growth reported by some public tech companies has decelerated. But looking at Q3 results, it’s not too hard to see elements of strength amid warnings from executives that the economy could remain rather wobbly in the coming quarters.
Investors are getting stricter with their marks this year, so we’re getting more granular. Today, let’s peek at some recent tech results — with a focus on gross retention — from companies that sell to big and small corporations alike. We’ll also weave in notes from a chat with the CEO of Appian the other week, as well as some new data from GGV about where SMBs intend to spend. This gives us a modestly well-rounded perspective on where the software market — which accounts for much of the larger tech industry itself — is today, and where it may be heading next year.
We care because if we’re seeing one slice of the software world do far better than the other, segmented along target customer size, we may be able to intuit which startups will perform better next year; this will help us grok funding rounds, investor interest, founder focus and even exit velocity.
Sounds good? Let’s have some fun.
The never-ending SMB question
Among the old venture capital chestnuts that lost clout during the 2021 boom was that SMBs make for tricky customers. Why? Small businesses may be less tech savvy than their larger peers, making them harder to sell to; they tend to go out of business more frequently; and they can entail lower contract values that can make S&M spending tricky.
Fans of SMB tech, however, point to a number of successes like Bill.com and HubSpot when it comes to the possibility of building a sizable small-business-focused effort.
That HubSpot is a common example among SMB fans makes good sense. Worth some $15 billion, it has managed to build a massive company with decacorn value even after the 2022 tech stock selloff. And its earnings make it clear that the company is still chugging along. With $444 million in Q3 2022 revenue, up 31% year on year (36% without forex shifts), it’s at scale and still, well, scaling.
Is that an indication that selling to small businesses (HubSpot argues in its earnings report that “the SMB market is underserved”) is going to be fine? Some folks think so.
GGV, a venture capital firm, tracks SMB sentiment. Naturally, the group is not making the effort for fun — it has investments in the space. Still, the venture collective sent over a few data points that provide some useful context regarding what SMBs are going to do next year.
If you are looking for reasons for optimism, look no further than GGV’s finding that “SMBs expect to spend the same or more on software in 2023.”
Stable revenue from SMBs is not exactly enough for venture-backed software companies, though, so the most encouraging figure from GGV’s sample is that 44% of respondents forecast that their software spending will increase in 2023.
There’s also some positivity to draw from a not-as-bad-as-expected data point: Only 7% of respondents are using fewer software vendors than they did in the last 12 months. This shows that the SaaS sprawl is here to stay, which is arguably good news for the growing number of “SaaS for SaaS” startups that help manage services and aggregate billing — and perhaps a sign that they’ll find luck outside of the enterprise segment and among SMBs. After all, there’s mounting proof that SMBs aren’t to be dreaded.
What about the enterprise?
The Exchange chats with Appian CEO Matt Calkins most quarters. We do this because it’s good to have some longitudinal conversations with a handful of tech leaders so that we can track their perspective and tone as their market evolves. But also because Appian itself includes a neat number of trendy tech matters, including RPA, no-code and process mining.
Calkins is also more outspoken about his economic views than most CEOs, so we’re aware that he’s not exactly optimistic about the domestic economy in the near term. The combination of an interesting product mix and his honesty regarding the macro climate make for an illuminating conversation.
During our chat after his company reported Q3 2022 results, Calkins told TechCrunch that in the quarter, the impacts of what he expects to be “a real recession next year” are “trivial” thus far. How modest? “I can think of one deal that slipped for reasons I would characterize as economic, and that’s all,” Calkins added.
Per its Q2 earnings report, Appian posted more Q3 revenues than it forecasted earlier in the year ($117.9 million versus guidance of “between $115.0 million and $117.0 million”), though it appeared to miss its cloud subscription revenue forecast over the same period ($60.6 million versus guidance of “between $60.8 million and $61.3 million”).
Appian was worth $2.8 billion in pre-market trading today, per Google Finance data. That’s about 6x its Q3 2022 annualized run rate, meaning that it’s somewhat middle-of-the-road when it comes to present-day valuation norms.
What about other companies? Identity company Okta is another firm that we keep tabs on, given its ascent during the pandemic. It last reported earnings in late August for its quarter ending July 31, 2022. In that report, per a Fool transcript, the company had the following to say regarding the macro climate:
As we evaluated our Q2 results, there were three primary areas we dug into more closely. [ … ] The second area was any discernible impact from the evolving macro environment. We are starting to notice some tightening of IT budgets and lengthening sales cycles relative to last quarter. This leads us to believe that the weakening economy is having some impact on our business.
It would be easy to say that the GGV data indicating that SMBs are going to remain strong software buyers in 2023 would make companies serving that customer cohort more attractive next year than their enterprise-facing peers, given the caution we’re seeing from Calkins and Okta.
We wonder. Are SMBs as savvy when it comes to forecasting their next-year buying? SMBs are smaller by definition, and, we’d argue, perhaps younger on average than the enterprise-scale customers that some tech firms target. Can we trust their 2023 plans while still in 2022? I think we can presume that they are honest, but also macro-variable, a fancy way of saying that if the economy goes to hell next year, SMBs may be more in the proverbial handbasket than anticipated.
Software companies targeting enterprise-scale customers could have the same issue. Our vibe, then, after looking around the market, listening and collecting data, is that there’s good reason to expect that no matter the customer cohort in question, software companies have reason to be optimistic.
If the SMB data holds up, the HubSpots of the world will be fine. Furthermore, the last time we had a recessionary period enterprise software companies did more than fine, so it’s hard to predict doom this time ‘round. Sure, Okta is seeing some tremors, and Appian is hardly anticipating that the economy will surprise to the upside, but that’s not lethal.
Perhaps the best way to consider the market would be to track how gross retention holds up — or not — in the two customer cohorts. Appian is proud of the fact that its gross retention is 99%. HubSpot, in its most recent earnings call, noted that “despite the more challenging macro environment, we maintained a healthy growth retention rate, in the high 80s, as customers look to HubSpot’s platforms to drive increased efficiencies.”
Sure, HubSpot also noted that it “did see an incrementally more challenging environment from a demand perspective in Q3 than we saw in Q2,” but increments aren’t enough to stall a tech company. Slow it, perhaps, but not much more.
Up top, we asked which customer segment is going to do better next year. It’s tough, given that neither is completely durable nor seemingly in a particular pickle. That said, if we had to make a choice, we’d wonder if SMB-facing companies might have more ability to surprise the market than their enterprise-leaning siblings.
Why? Because the expectation that a worse economy will harm smaller, less wealthy companies is likely a common one. So if that customer group winds up spending as much next year on software as expected, it could take some investors by surprise.
We’ll keep tabs on gross retention and overall growth metrics in Q4 and into 2023, but today we retain our general vibe that while tech stocks have lost much of their value, the companies behind the ticker symbols retain momentum. Good news for startups, in other words.
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