Software Investing Resources for Newbies: A Thread 🧵
Software Investing Resources for Newbies: A Thread 🧵
☁️ There are 3 good topics that those looking to get into Software Investing need to understand from the start. 1st is understanding the shift of the Software industry to the Cloud from On Premise. 2nd is understanding how Subscription models work and the important forward leading metrics. 3rd is understanding how this Software company sells their product. Below you’ll find an introduction of the main topics in the Software industry, as well as books, podcasts, and other resources that are helpful for those looking to learn the world of Software. Thanks to those that sent recommendations, please let me know if you have any others you would add! Hope this is helpful 🙏
⭐️ Where to Start? I recommend every new software investor start off by listening to a $MSFT earnings call (pre 2023/AI because too much fluff) and reading through their 10-K to understand all the segments in software. Would also recommend reading Marc Andreessen’s famous article called “Why Software Is Eating the World” from 2011. Bessemer Venture Partners also has some great Investment Memos (bvp.com/memos) of the Software businesses they invested in that became large business today. There are few books that are very helpful in understanding the industry history and the subscription model. The first book I read when learning the space was The Phoenix Project, a fictional story that explains how IT organizations and DevOps works. There are several Substacks that help with keeping up with recent news/SaaS research(@jaminball, @TechFundies, @techfund1, @StackInvesting), explaining Software technology concepts in a very easy to understand way (@readtechnically, @hhhypergrowth), interesting software stock pitches (@dalibali2 @akramsrazor), as well as @BreakingSaaS and @DavidSacks substacks which help easily breakdown Software KPI’s/Financial Statements. Lastly @publiccomps is a great free resource to compile/compare different Software businesses metrics.
📱Helpful Twitter Accounts. Lots of smart Software investors that I recommend you follow including but not limited to: @JaredSleeper @MRatable @ChairliftCap @lfg_cap @BucknSF @S_curvecap @Klaudnin3 @nottigeranalyst @LEJCapital @ArdaCapital @acemoney21 @dalibali2 @akramsrazor @TwannsWorld @TechFundies @BreakingSaaS @_clarktang @SaaS_Monkey @DanBartus @viggy_krishnan @MetacriticCap @VetTechTrader @StackInvesting *please add any I might have missed!*
📍Main Software Segments. There are various splits in Software but the main ones to be understood at first are listed below (Note security not included, would be considered more Infra Software).
⁃Horizontal vs Vertical Software: Horizontal software is designed to be used across various industries (Microsoft Office is a good example). Vertical software is designed to serve a specific industry (for example $PCOR serves the construction industry only)
⁃Application vs Infrastructure: Application Software companies create the software that you and I use today including $MSFT, $ZM, $WDAY $MNDY. Infrastructure companies are often not visible to the end user of Application Software, but are very important in the building of technology in an enterprise. The Infrastructure Software space is more complicated than Applications as it often includes customers making technology architecture decisions. Hyperscalers like AWS and Azure provide the backbone for developers to deploy their applications. Infrastructure Software has a few categories including Observability (monitoring your Cloud estate with $DDOG $DT), Analytics (using data from your customer/enterprise to make better business decisions with $SNOW, Databricks), Integration tools (help make sure data is flowing across different applications $CFLT $INFA), Developer Tools (facilitates software development $TEAM $GTLB)
*The image above from Investing1012 Blog is a very good summary*
💡 Why does analyzing tech stack matter? Software companies can often be posting eye opening growth rates even at $300m-$500m. However given the amount of VC money out there & speed at which others can develop products, there are often viable competitors that offer similar products. Having a first mover advantage, is no longer good enough in technology, especially in Software. Similar to Porters 5 Forces, investors need to understand if there is any real moat from the underlying technology.
🌎Why does TAM matter? Given a lot of these business are early in driving adoption of their technology, investors need to understand what is the Total Addressable Market or TAM. Mgmt teams will often give very large TAM numbers (not uncommon to see companies pointing to $50b TAM), meaning that XYZ company of $500m in scale is only 10% penetrated into their TAM. The smartest investors figure out what the real TAM is through different frameworks. If the true TAM is significantly lower than mgmt numbers this could make it harder to grow and profitably scale the business.
💰 SaaS Metrics. Bookings (based on RPO/CRPO) and Billings (based on Deferred Revenue) are key metrics to understand future revenue growth, but there are many efficiency and unit economic KPI’s that investors focus on in Software. Highly recommend the following as great starting points to learn the basics:
1) @BreakingSaaS (breakingsaas.substack.com/p/diving-into-…, breakingsaas.substack.com/p/arr-book-101…)
2)@DavidSacks (sacks.substack.com/p/the-saas-met… )
3) @TheSaaSCFO who goes into more specific topics.
📋Key Software Metrics List
⁃Revenue: Most Software companies sell under an annual subscription model. If a customer pays $100 for a 1 year contract, this will be recognized as revenue equally over 4 quarters (12 months)
⁃Gross Margins: Usually very high (80%+) as software companies don’t need to product any physical products. High gross margins allow companies to invest into sales teams and build new products
⁃Incremental EBIT Margins: For every additional $ in revenue, how much $ dropped to bottom line. Investors are willing to look through margins being negative as long as incremental margins are improving
⁃RPO: Represents the total amount of backlog from committed contracts from customers, including those not on the balance sheet
⁃CRPO: The portion of RPO that will be recognized in 12 months
⁃Deferred Revenue: These are contracts that are already billed by the customer, but are on the balance sheet waiting to be recognized
⁃Churn: Pretty self explanatory but VERY important. In Software quality of customer is often more important than quantity of customers
⁃NRR: Net Revenue Retention or Net Expansion Rate, measures the amount of growth of the existing customer base from a year ago. This can be driven by new product adoption, pricing, or new seats being purchased.
🚀 Breaking down Revenue Growth. Software companies do not give investors much information or detail. So often investors may just look at total revenue growth, but the more important part is understand the composition of that growth and how sustainable it is. One can break this down by:
1) Pricing
2) License growth in the form of seats/consumption
3) Existing customer expansion into new products
4) New customers
Understanding the composition of this growth also affects the multiple the market will value the business at (more price could be viewed in a negative light if price increases made to mask slowing unit growth).
♟️Sales and Marketing (S&M) Strategy
The selling strategy for a Software company can often be more important than the product itself. Identifying what the S&M strategy is crucial to understanding success over a longer period of time. Does this company use a freemium model, that allows customers to use certain features for free and then get them hooked to upgrade ($ZM) or do they spend $ on trying to sell to Heads of IT at large enterprises with higher LTV ($NOW, $WDAY). @repvue has very interesting data on product/market fit, S&M strategy/success @thaAdamLittle. @thedealdirector has a newsletter exclusively focused on B2B SaaS selling which is good here as well. Interesting piece by @DavidSacks on how to setup a sales team (sacks.substack.com/p/simple-math-…)
🔑 Recommended companies to analyze at first to learn evolution in the industry.
⁃$ORCL: This is the equivalent of INTC in Semis, but ORCL has a fighting chance to survive. ORCL went from serving Databases to offering Enterprise Apps. At one time was considered the industry behemoth, but missed the transition to the cloud specifically on the infrastructure side to AWS/MSFT. Now the company is trying to catch up with AWS/Azure through their OCI product. There were a lot of decisions that made ORCL rise to prominence, but many others that made them lose their technological edge.
⁃$ADBE: was the pioneer of the Subscription model transition and the first large company to recognize this is where the industry was going.
⁃$HUBS: A best in class software company that successfully scaled from a single product company serving small business, to a multi product company winning deals with large customers.
⁃$CRWD: Great example of the network effect and product expansion. Their gross margin progression and ultimately FCF margin progression help show the powerful nature of scaling in Software.
List of Resources Below 👇
📕 Books
1.⭐️ The Phoenix Project (Great way to learn how DevOps and IT organization works through a fictional story)
2.Softwar - An Intimate Portrait of Larry Ellison and Oracle (Details ORCL’s vision for the future through Larry Ellison in the early 2000’s and ORCL’s expansion from an Infrastructure company to having Application software solutions)
3.Behind the Cloud: The Untold Story of How Salesforce.com (Explains the moves Salesforce founder Benioff made to become the largest scaled Subscription software business)
4.⭐️ Engines That Move Markets (Technology investing classic, talks about major technological changes starting with the Industry Revolution, and how to analise new technology)
5.⭐️ Innovators Dilemma (A very good book about disruptive technologies and what established firms must do to either adapt or die with this new wave of technologies)
6.Subscribed: Why the Subscription Model Will Be Your Company's Future (Written by the Zuora Founder in 2018, explains in detail how subscription model works and why it’s good for customers)
📝Substacks/Blogs
Breaking SaaS (breakingsaas.substack.com) - Free. Written by a former Sellside Equity Analyst and now SaaS Operator, gives very good breakdowns of metrics, valuation, and other topics.
David Sacks (sacks.substack.com) Free - Written by a prominent VC in the space, dives in both explaining metrics as well as Sales strategies.
Clouded Judgement (cloudedjudgement.substack.com) - Free. Written by one of Altimeter’s analysts, gives good weekly overview of what happened in the Software Equity Market, and valuation multiples.
Hypergrowthhh (hhhypergrowth.com) - $500/year. Former technologist that helps explain the products and direction public software companies are taking.
TheSaasCFO (thesaascfo.com) - Free. Very good resource for those trying to understand the intricacies of Software metrics and their impact on Financial Statements.
Technically (substack.com/@technically) - $80/year. Helps explain in very easy to understand language technology/software concepts.
🎧 Podcasts - @InvestLikeBest has some great podcasts with VC’s and Operators on how to successfully run and scale a Software business. Just like in my Semi’s thread, both @bizbreakdowns and @AcquiredFM have great podcasts on specific companies.
Industry Podcasts
AI and Software (Invest Like the Best) podcasts.apple.com/us/podcast/inv…
Software Building - Benchmark (Invest Like the Best) podcasts.apple.com/us/podcast/inv…
⭐️ Investing in Vertical Software (Invest Like the Best) podcasts.apple.com/us/podcast/inv…
⭐️ Orlando Bravo - Software Buyouts (Invest Like the Best)
podcasts.apple.com/us/podcast/inv…
David Sacks - How to Operate a SaaS Startup (Invest like the Best)
podcasts.apple.com/us/podcast/inv…
DNA of Software Companies - Benchmark (Invest like the Best) podcasts.apple.com/us/podcast/inv…
Altimeter (Acquired) podcasts.apple.com/us/podcast/acq…
Company Specific Podcasts
AWS (Acquired) - podcasts.apple.com/us/podcast/acq…
⭐️ CRM - (Business Breakdowns): podcasts.apple.com/us/podcast/bus…
CRWD (Business Breakdowns): podcasts.apple.com/us/podcast/bus…
DDOG - (Business Breakdowns): podcasts.apple.com/us/podcast/bus…
Databricks (Business Breakdowns) podcasts.apple.com/us/podcast/bus…
INTU (Business Breakdowns) podcasts.apple.com/us/podcast/bus…
GitHub (Acquired) podcasts.apple.com/us/podcast/acq…
MDB (Business Breakdowns): podcasts.apple.com/us/podcast/bus…
MDB CEO (Invest Like the Best): podcasts.apple.com/us/podcast/inv…
MSFT (Acquired) - podcasts.apple.com/us/podcast/acq…
SHOP - (Business Breakdowns): podcasts.apple.com/us/podcast/bus…
Slack + Salesforce M&A (Acquired) podcasts.apple.com/us/podcast/acq…
Abram’s Razor (the-razors-edge.ghost.io/author/akramsr…) - $600/year, some free posts. His piece on $SPT Short and $ESTC Long are worth the read.
DB Software Musings (softwaremusings.substack.com) - Free. Recommend reading his ORCL piece.
Sleeper Thoughts (Sleeperthoughts.com)- Free. Former Coatue IP with some interesting takes on multiples and other software debates
Arda Capital (substack.com/@tidalwave) - Free. Very well articulate Software investor with interesting thought pieces.
Buck Software (buckonsoftware.substack.com)- Free. Very well articulate Software investor with interesting thought pieces.
John Luttig (substack.com/@luttig) - Free. Partner @ Founders Fund that goes into specific Tech/Software concepts/debates.
Tidemark (tidemarkcap.com/vskp) - Free. Go to resource for anyone looking to understand about Vertical Software businesses.
Techfund.one (techfund.one) - Free. Goes over specific investor debates, among many other interesting software research.
Meritech Capital (meritechcapital.com/insights) - Free. Gives first look at S-1’s when companies are doing an IPO