Episode 21: Dirk Sahlmer of saas.group
on a Long-Term Approach to Profitable SaaS Company Growth

Episode Transcript

Shiv: Alright, Dirk, welcome to the show. How's it going?

Dirk: Yeah, thanks, Shiv, for the invitation. Glad to be here. And yeah, going fine so far. How about you?

Shiv: Great, yeah, excited to have you on. So why don't we start by telling the audience about SaaS Group and your mandate, and we'll take it from there.

Dirk: Yeah, sounds good. Happy to give a bit of background. So yeah, my role at SaaS Group is in the M&A team. I'm responsible for origination, which means I'm going out and speaking to potential targets, especially to the founders and trying to convince them of our approach and fill up our M&A funnel, basically. 

And yeah, about SaaS Group, the company has been founded by three German tech entrepreneurs. They built and sold previous tech businesses and had very significant exits. And they wanted to put that money to work again. And well, they are passionate entrepreneurs. And so the best way was to start something new in the tech space. But now that they got money, they could take a shortcut and buy an established business. So that's how they got started. And yeah, they tried to improve it and work quite well. 

So they were able to further scale it. And so they thought, hey, why not buy a second one, leverage some synergies. And that's how it started. And yeah, basically we just continued from there and added more companies to the portfolio in the meantime. So it's not a typical private equity fund structure. It's a private company. So we had that benefit of initial capital through the founders. And yeah, we also maybe take a more founder-friendly approach than traditional private equity players.

Shiv: Yeah. And so talk a little bit more about that. Like you mentioned your approach is different than the traditional PE model. So what are the differences between your approach and that company-flipping approach of - that PE firms have?

Dirk: Yeah, so on the one hand, we are targeting smaller SaaS companies. So our revenue sweet spot is between 2 and 10 million AR, while traditional PE firms are targeting bigger companies. It requires, I think, a bit more hands-on mentality compared to bigger organizations. And yeah, the founder-friendly approach I mentioned, I mean, the founders of SaaS Group, they've gone through their own M&A processes, they know how annoying it can be to waste a lot of time, prepare all the documents and stuff and talk to a lot of people, and sometimes spend like months of time before even closing a deal or before a buyer potentially walks away. And so, yeah, our focus is on a very short process, on a very transparent approach. So we're trying to close transactions after six to eight weeks. We have a very high flexibility in terms of how we structure deals. So founders can pick from the boilerplate, whether they want a longer transition period, shorter transition periods, more cash, more earnouts, etc. So we can accommodate to different preferences there. And yeah, I mentioned the evergreen approach - we are not flipping companies. So yeah, the typical PE model would be like, buy a company for cheap, try to improve it, sell it for a higher multiple. And yeah, generate a positive ROI through that. And we want to build a large portfolio. So we just keep adding companies without divesting. And we also give like the - we promise founders to take care of their baby and to keep it for the long run. And so it's more comparable to maybe Constellation software from Canada with that approach of aggregating more and more businesses instead of like, yeah, flipping it.

Shiv: And so then from that standpoint, when you're deploying this capital and buying these companies with the buy and hold strategy, what is the end game to return the fund in your approach? Like Constellation is a public company. They have hundreds of software businesses inside their models. So they're looking at the profit and taking that as the return over time. Is that kind of how you're viewing it as well?

Dirk: Yeah, it's similar. So we want to keep optionality. And as I said, it's not a fund structure, so we don't need to provide liquidity to investors yet. I mean, we are currently undergoing our first financing round, so this may change pretty soon, but it could also become an IPO case, like Constellation software, or we could continue on that path for the next 10, 20 years.

Also an option would be like a trade sale of the whole SaaS portfolio to like a bigger PE firm, for example. But for us, it's not only like cash flow and profitability, like Constellation software, but also organic growth of the company. So we try to find a good balance between growth and profitability.

Shiv: And so with that type of an approach, when you're buying a company, what are some of the things that you're looking at in order to drive more enterprise value within those businesses?

Dirk: Yes, so maybe to tell you a bit more about the acquisition criteria. As I said, we're looking for smaller B2B SaaS companies and we prefer these capital efficient ones, so we're not necessarily looking at highly VC funded targets, but rather like the bootstrap ones. I mean, from time to time we see VC-funded companies that left that VC path and became more sustainable, but like we require a capital efficiency, and we also require profitability. And apart from that, we are still flexible. So we're targeting mainly horizontal businesses, not so much vertical SaaS solutions. And yeah, we've seen different scenarios. So sometimes the company is growing more, maybe a bit less profitable. Sometimes it's like flattening out, even declining, but highly profitable. And we are also trying to build a portfolio that has a mix of both. 

And yeah, as you can see, like the typical target, which we also have now in the portfolio is like two to three million ARR, 20% plus profit margin, sometimes growth of like 10 to 20%. But yeah, there are different variations of that. And yeah.

Shiv: But that's - sorry, go ahead. I was going to say that that's rare, right? Like to have 20 to 30% growth and be profitable and be around 20 to, sorry, two to 3 million in ARR, those are very unique characteristics. So, excuse me, how are you finding those businesses? And I would imagine that they're kind of counterintuitive, right? To be growing 20 to 30% when you're to two to three million ARR, odds are you're not profitable.

Dirk: Yeah, I mean, as I said, there are variations. So sometimes you also have flat businesses that are more profitable, but actually in that whole bootstrapper space where we are quite active, it's not so rare that you see these targets. I mean, of course you have to go out and find these because they are not announcing their numbers somewhere, but they definitely exist and you can see it in a portfolio. And we usually take like the rule of 40 as kind of the baseline. So either the company we look at is above the rule of 40 already or if we have a strong hypothesis on how to get them above that line, this would still represent a good acquisition target for us.

Shiv: And are you finding that these companies are still software companies? Because - the reason I'm digging deep here is just the software acquisition model, in essence is you're investing a customer acquisition cost upfront. And then the recurring revenue kind of helps you break even over time. And so to be profitable, you kind of have to be growing either at a slower rate or your payback periods have to be like less than six months in a lot of cases. Otherwise, you kind of have to keep reinvesting to get the next customer. So talk a little bit about that.

Dirk: Yeah, there's maybe one point I forgot to mention. The company profiles, or the go-to-market approach the companies we look at have is product growth rather than sales growth. So we're not looking that much at heavy enterprise sales SaaS companies, but rather like the product growth companies. And their custom acquisition cost is usually quite low. So they have a strong organic growth. And it's usually a mix of maybe some paid ads, content marketing, but not so much about like having an outbound sales team. In the meantime, we also added more enterprise SaaS companies, but our focus stays with PLG companies.

Shiv: And inside those PLG companies, again, I guess I want to talk about this cost of acquisition piece. How closely are you looking at the acquisition model and payback periods? Because that's really what's going to drive profitability. And then on the back end, looking at net revenue retention to make sure that those customers are staying. Because usually in PLG models, the gross retention numbers are lower, right? So bridging all of that, like, how do you look at that?

Dirk: Yeah. Yeah, definitely. I mean, that's also one reason why probably most PE firms are focusing on like vertical niche businesses, because they tend to be a bit stickier, tend to drive a higher retention metrics. And yeah, we are focusing on these horizontal businesses, they are usually serving SMBs. So their churn is definitely higher than enterprise SaaS solutions. And so I would say like usually net dollar retention is like 80ish, sometimes a bit lower, sometimes slightly higher, but you will rarely see like 100% plus net dollar retention. So that's quite rare. It definitely exists. So I've seen a few but it's super rare. And, of course, we are looking at all metrics when we dig deeper and when we do our first analysis with the numbers. So what we usually ask for is revenue and customer movements on a monthly basis. And so we prefer to calculate all that core SaaS KPIs ourselves to see how it looks like.

Shiv: Right. And when you're coming in and let's say you find a company that does fit that acquisition profile that you're referring to, what are some of the places that you're starting to optimize? Do you more try to optimize on the retention side or do you try to optimize on the acquisition side?

Dirk: I would say there's not that one playbook which we execute on after every acquisition. So it really depends on the specific case. I can give you an example. We bought a company called Prerender.io. They do prerendering of JavaScript websites so it can be picked up faster by the Google search bot. And they've wired one million per year to AWS for hosting. And we were able to cut the costs by 80%, I think. So now it's like 200k. And it drove profitability to a much higher level. With some other companies, it's more top-line related. So we're trying to accelerate growth rather than optimizing on profitability. And so it's a mix. But I would say the biggest, biggest lever for us is pricing.

A lot of companies we speak to have never changed their pricing or it's still highly under-optimized. And yeah, the second point is definitely marketing. So a lot of founders or startups we talked to, they've experimented with paid ads a bit, but not to an extent that it was like effective. And they are doing some content marketing. But either the founders wrote the articles themselves or they hired a freelancer for a couple of hours to do it, but it's like, there's so much potential still to ramp up marketing initiatives. And, yeah, now in the meantime, we've grown a few portfolio companies to a level where it also makes sense to start with outbound activities and like build a sales motion on top.

Shiv: Yeah, we've seen this as well where companies are, whatever, one, two, 10, some sometimes even a hundred million in revenue and they're underinvested on, on the fundamental playbook of - playbook or playbooks of marketing that they should be doing. So just being out there on all the core ad platforms when potential buyers are searching for you and, and looking for a solution and having content that corresponds to different stages of the buyer journey is something that a lot of SaaS companies are not doing. So especially with PLG, doing that right can be a huge value add to the acquisition engine.

Dirk: Yeah, and I mean that the founder type I usually talk to is very tech-oriented. So these are more of the like indie hacker type of guys and yeah, they often scratch their own itch. So they had a small problem they solved by like writing a small software and it's - they started to offer it like for people outside and it got traction. And then it has grown to a decent size and a decent SaaS business.

But their goal was never to like build a unicorn or build like a hundred million plus company. And they usually also don't feel comfortable like managing a bigger team. So the team sizes of the companies we acquire are usually like 10, 15, 20, 25 people, but not more. And that's why they have such a strong product because that's their passion. That's what they're really good at. But in terms of other things like marketing, pricing, etc. It's usually under-optimized.

Shiv: Mm-hmm. And so when you go in, are you on the SaaS Group side doing this work for the companies? Are you hiring a CMO? Are you bringing in external resources? How do you approach solving problems like that?

Dirk: Yeah, so we always take over the teams as is. And of course, they are lacking certain resources usually. And over time, we've built up a big central operations team within SaaS Group. So there are now roughly 50 people in different departments. So we have a big marketing team, which is, I think, the biggest of the central teams. We have a product team, and we have like standard things like HR, finance, et cetera. Now we are building up sales knowledge internally and also customer success, customer support, AI. So all like the core functions you may need from time to time, but it doesn't really make sense to hire it as like a full-time employee. And with the central team, we are supporting our portfolio companies. And this way we can keep the portfolio companies quite lean from a setup perspective. And so they stay like productive and there's not a lot of overheads, but at the same time, they can get the resources and the help whenever they need it.

Shiv: And so I'm looking at your about page and there are a lot of people on this team for the size of fund that you are. Like we've seen PE firms have much smaller teams. So is that cost being paid for entirely by SaaS Group? Is it being paid for by the portfolio companies? Like how do you guys manage your cost structure model to be able to support these companies efficiently?

Dirk: Yeah, in the beginning, I would say we had more of like a startup-like approach, and we wanted to keep it less bureaucratic. And so we at SaaS Group level paid for it. However, in the meantime - this just happened last year. It now lands on the P&Ls of the respective companies also to make the leaders of the respective brands more cost-sensitive. So this is currently an ongoing transition. But yeah, previously it was just on SaaS Group.

Shiv: So it's kind of like, yeah, you're - you kind of have two arms of this business. One is the investing arm and then the operations arm and the operations arm is almost like consultants to your portfolio companies that you're - you're passing those costs on. Okay. That, that makes sense. And so with this kind of a model, you're able to build a center of expertise and, and bring the same group of experts across all your portfolio companies. So how do you decide which items to prioritize between companies? And then, second question is within a particular company, like marketing is just one level, right? You have sales efficiency, you have pricing, you have product roadmap stuff. So how are you prioritizing between all of those different, different avenues for growth?

Dirk: Yeah, so I would say also like in the beginning it was less bureaucratic so people could just ask for help when they got it and like if they said hey we need a new website can you do it and then the people from the central team said either yes or no depending on their available time. However, now, over time, we established more and more rules like how much they can ask for and to what extent and like - The example with marketing, so if the resources they need exceed a certain level, they need to hire someone full-time for their team, instead of drawing resources from the central team. And you will see the same for other teams. So this consulting thing only happens to a certain extent, but if their demand is higher than the resources that can be provided, then they need to hire someone.

And yeah, that's how we can prioritize and can shift resources how we need it.

Shiv: Got it, got it. Okay, and then on the analysis or diligence side, as you're looking at a company and building this value creation plan for your companies, do you have a unique methodology or something that's unique to your approach in terms of how you go about maximizing that value and as like an order of operations to figure out where to deploy your efforts?

Dirk: Yeah, so I mean that the fact that we are not flipping companies, I mean, you know how it works in private equity. So you can either like increase the value and get your ROI through that, or you can like take the dividends out of the business over the holding period. And since we focus on holding the companies forever, the focus is definitely on the letter. So we need these cash flows and we cannot like run the company on break even for 10 years. That doesn't really work for us. So value creation doesn't mean for us only growing top line, but also, as I said, this rule of 40 capital efficiency thing. And in the due diligence process, I said we have a very short process. We are also always getting help from the central team. So me and my colleagues, we will, of course, look at the numbers, look at the SaaS KPIs, at the financial cost structure. And then we will like have certain conclusions in regards to maybe cost savings or like changes, adjustments we can make and things we could potentially improve. But then there's also the part from the central team, like HR due diligence. Does it make sense to do any changes in regards to org structure? Or marketing due diligence, so, what's the potential? What do they see as like a realistic growth rate going forward? Product due diligence, so, can we make certain UX, UI tweaks to improve the product on short notice? So there are a lot of things that come together in that short due diligence process.

Shiv: So yeah, let's dig deeper into some of these. So walk us through what you're doing on the marketing due diligence side and what are all the things that you're looking at there.

Dirk: Yes, so I mean, I'm not a marketing expert, but we would look at the current setup. What have they done historically? How did it work out? How does their Google Analytics look like? So we look at all the accounts they have, the channels they use to acquire new customers, see how profitable they are, how it all works out. And we also make an analysis like in regards to keywords they rank for, et cetera. And then… Yeah, we try to find out where we can do better or maybe also channels we can drop because they are just not possible or don't make sense. And yeah, this, of course, like, is, is just one of the things we look at, but then also product and everything together then gives us some hypothesis on - a good hypothesis on how the business will develop going forward and how much impact we can have on like top line and bottom line.

Shiv: Got it. And how - do you find that the companies that you're investing in, they have enough data? Because we’re brought in for marketing due diligence often, and we find that companies are just not looking at overall marketing spend through to closed-won revenue to truly understand what's working and what's not working. And so wondering if you're seeing that in the companies that you're investing in and how much of an effort you're putting in to actually rectify that.

Dirk: Yeah, so it's not only in regards to marketing, to be honest. So I think like, in general, the data they can often provide is not sufficient to draw the right conclusions. Also, like retention metrics. And to be honest, sometimes I'm really surprised how founders or managers can steer their company like that. So it's like it's mainly based on gut feeling rather than like valid data they look at and, yeah, actionable insights. And so very often, it's a mess, to be honest, in terms of financials, in terms of SaaS KPIs, in terms of marketing data, et cetera. And that's why we rather ask for raw data. Sometimes they even just send us screenshots from their Google accounts and stuff. So I think that's just something you have to accept if you look at smaller SaaS businesses and they don't have like investors or other people that look at it and say, hey, you need to improve it. And so they usually come to us without ever being challenged on it. And so it is like it is.

Shiv: And how much of an effort then are you putting into post-close professionalizing the data operations of the business so that the right metrics are being tracked, the right dashboards are set up and the right reporting is coming back to the board?

Dirk: Actually a lot of efforts. I mean in terms of integration since we keep the businesses as-is, so we keep the team, we keep the brand, we keep the name. There's not so much integration efforts in terms of like product integration etc. So we can put more focus on stuff like that and we even have like our own data team in-house and they are working on it. Yeah, and they're already starting once we get closer to the closing date to see if we can like, yeah.

Shiv: Right. And what are some of those, some of those core dashboards and, and metrics that you try to put in place? And just from our experience, what we try to do is try to get a full understanding of pipeline generation and sources of pipeline and closed won deals and which activities are actually moving the needle. And then being able to analyze channels and campaigns and seeing what's more profitable than others and reallocating budget, potentially cutting inefficient budget and maximizing things that haven't been maximized. So those are some of the things that we're doing on our side, but I'm just curious to see like what, what are - and that's just on the marketing and sales side, but there's other stuff for product, there's financials, there's general UX stuff that you need to look at. So, curious, what are the - how, what is the work that you're doing on the data side to, to professionalize that?.

Dirk: Yeah, so I would say, on the one hand - and we are using Metabase internally to build the dashboards for the SaaS KPIs. And so there's a unified dashboard where you can see all of the brands, how they are doing in terms of new MRR, like total MRR movements, et cetera. So you can look at all the SaaS data. Then we have the internal finance accounting team, they are looking at the financials, and then the marketing team is overseeing all of the marketing-related data of the respective brands, and so if something pops up, they can of course like give advice and like get involved and help them fix it. So yeah, it's like they're sitting in front of their like big dashboards of in the meantime 17 brands and yeah overseeing every channel and how it looks with pipeline generation, etc

Shiv: Yeah. And at a top level, like what are some of the main KPIs that you're actually tracking or keeping an eye on as investors?

Dirk: Yeah, so definitely new MRR growth. I think that's also like the core KPI of the marketing team to see how like ads are performing, if they are able to acquire new customers profitably. So that's for them. But then we also have like a quarterly review where we look at financials, where we look at all the SaaS KPIs with the brands. I'm not involved in this process, so this is being done by the board and the respective brand leaders and I think finance, accounting. And so they look at what's the status quo, also like reflecting on the hypothesis we had when we acquired the company. Is it like on-plan? Do we need to make adjustments on the budget or on the forecast? And stuff like that. And then yeah, we're definitely looking at like revenue growth. Of course, that's the most obvious. Then profitability as well, but then also like retention, conversion rates etc. So yeah, basically everything.

Shiv: And with how the markets have changed, are you changing your approach on how you look at some of these metrics? Because obviously, there's been a downturn in valuations, down increase in interest rates and how companies are being valued overall. So how has that changed your approach?

Dirk: Yeah, I mean, on the one hand, we're also leveraging our deals with debt. So for us, it will also become more expensive to get external money to finance our deals. I think this will definitely have an influence on how we can value companies we want to acquire. And then the retention thing, which I described in the beginning. So most of the companies we have in the portfolio are targeting SMBs. So the retention is worse compared to enterprise SaaS solutions. And that's why we also decided to become more open also for acquisitions of enterprise SaaS solutions. And so you already see like two to three companies, Crosstalent from France as one example. They are purely enterprise and this way we can balance the overall portfolio retention. So I think for us also in the future, we may look - we put more focus on retention than we did previously. And this is of course churn, but also like expansion revenue, contraction, how it all looks like. And I would say in the past, we sometimes accepted like high churn because we thought we can fix it. I think that now places a higher risk than it was previously. And we would factor that in when we look at targets. But yeah.

Shiv: Right. And with the fact that you're leveraging debt, are you seeing more pressure being put on your companies to generate more free cash flow, or even just on your side as investors, your amount of debt service is increasing? So how does that impact how you look at the optimization of these companies?

Dirk: Yeah, so in the past, we also considered a few SaaS companies that were close to break even, so they were still burning a bit of cash, but had a clear path to profitability in the short term. I think we would rather walk away from such opportunities right now and wait until they became profitable. So I think profitability became much more important when looking at acquisition targets right now.

We still, like - our plan is to acquire different portfolio profiles this year. So we may still look at like companies with higher growth and like less profit margin but yeah, as you said we still uh need to make sure that like that whole debt thing is not imploding and we're generating enough free cash flow

Shiv: Right. Yeah. I think, I think that's a, that's a great takeaway. And I think that's a good place to end the interview, but before we do, if there's a founder listening that fits the type of profile that you're, you're investing in, what's the best way to reach you guys?

Dirk: Yeah, I'm an email type of guy, so feel free to reach out via email, [email protected]. There's also a website form on our website where you can reach out. And yeah, of course, LinkedIn is always open for you as well. So feel free to drop me a LinkedIn DM. And this also applies, of course, to my colleagues. So if there's any other person from SaaS Group, you can contact them as well.

Shiv: Awesome. And yeah, we'll be sure to link the website and your profiles in the show notes. So - and so if any founder is interested, they'll be, they'll be reaching out. So with that said, Dirk, thank you so much for doing this - a pretty insightful interview to understand kind of how you approach your investments. And I hope the audience learned a ton from it. So thanks for doing this.

Dirk: Yeah. Thanks again for having me.