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The Sam M. Walton College of Business

Episode 201: Investing in and Exploring SaaS Companies with Brian Henley

November 16, 2022  |  By Matt Waller

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In this next iteration of the Capital Allocators series, Matt sits down with Brian Henley, Managing Partner of Recurring Capital Partners to discuss his business and the work that they do with SaaS (Software as a Service) companies. They begin by discussing Recurring Capital Partners and how they work with SaaS companies who are looking for growth capital. They then move into the business of SaaS and the massive changes in the industry that has taken place in the past decade. They also delve into how Recurring Capital Partners evaluates companies that they are considering for growth capital including looking at predictable recurring revenue, a sticky customer base and high growth margins. They finish the discussion on the topic of metrics, sales strategies utilized by software companies and when companies should take equity vs. debt capital. 

Episode Transcript

Brian Henley  0:00  
I think that in the industry what, what people found when, when push came to shove, companies were paying their software bill before they were paying their rent.

Matt Waller  0:11  
Excellence, professionalism, innovation and collegiality. These are the values the Sam M. Walton College of Business explores in education, business and the lives of people we meet every day, I'm Matt Waller, Dean of the Walton College and welcome to the Be Epic podcast. For next few episodes, I will share my conversations with capital allocators in the seed, venture and private equity space. They will discuss how their capital allocation works, and provide tips to entrepreneurs on how to stand out. I have with me today. Brian Henley, managing partner at Recurring Capital Partners. Brian has a remarkable experience that- he went to school here as an undergraduate. And he started his career with IBM in sales. But throughout his experience in his career, he has been very involved in mergers and acquisitions. And, and at one company, he was involved in five acquisitions, and exits. And he really became very knowledgeable of SaaS based company SaaS stands for software as a service and the cashflow capacity of those kinds of companies. Brian, thank you so much for joining me today. I really appreciate it.

Brian Henley  1:42  
Thank you, Matt. Happy to be here.

Matt Waller  1:44  
This is part of a series on capital allocation. And typic- typically, when you're thinking about SaaS companies that are trying to scale, they're typically talking about, you know, venture capital and seed funding and those sorts of sources. Your company focuses on providing debt to those types of companies. Tell me a little bit about the history of that how you got into it, and why it's important for SaaS companies.

Brian Henley  2:16  
Sure, so recurring capital, we're about a six year old firm now, investing out of our third fund, worked with about 40 companies in the SaaS world, all over the country, including one in Fayetteville there. And we are in the kind of growth capital part of the finance world. So you have seed funding, venture capital, growth capital, and then private equity. So most of the companies we work with are between five and 20 million of revenue, and are looking to grow their customer base, but they have an established product, and established customer base. You know, throughout my career, what what I've seen is in, especially in the software space, the business model has really changed from the beginnings of the software industry, back when I was selling software at IBM, many, many moons ago that the industry was founded on a license maintenance model, you would create software, and you would sell a perpetual license to that software, essentially ownership of that software to a company where you got most of your money up front. And then you would charge a small annual maintenance fee after that. And, you know, 10 or so years ago, the industry switched over to more of a subscription model hence, software as a service, where companies are essentially renting the software. And you know, you can think about it as you're a consumer, all of the kind of monthly subscriptions you have from Netflix to Spotify. So what that's done if you're a software business now you have a lot more predictability of your cash flows and you're driven by predictability on the revenue. So now what's your revenue gonna be in any quarter? It really is very predictable based on how many customers you start the quarter with. Minus you know how many you're gonna lose in that quarter. What you find today in the software world. If you have a customer base that has some stickiness to it, which is our term- term for you know, are the customers gonna continue using the software. If you have a sticky piece of software, there is an underlying asset there that there are a lot of acquirers of that business, because you can generate a lot of cash flow out of that business, what that's doing is, it allows you to retain a lot more ownership of your business to probably someday sell that business or cash flow and dividend yourself versus a bunch of other investors receiving the benefits of what you build. So it's an interesting evolution in the capital stack of these businesses, and has created, you know, an opportunity for a firm like ours to, to be a an active source of capital for for software companies that really didn't exist 10 years ago. But fundamentally, what, what supports our business and the software businesses, the thing you have to understand is, businesses hate to change their software, which has been true for 40 or 50 years in the history of business software. And so that that kind of underlying friction of companies changing software allows for quite a bit of stability, which is what creates a lot of value in these businesses. And so we're, we're part of a source of growth capital for a bunch of really interesting companies, none of which probably most of the audience would have heard of, we're not we're not financing consumer related businesses, but more fundamental back office or, you know, kind of vertical software, businesses, and but, you know, it's part of what makes the world go round. And part of the productivity that you're seeing in every industry, the digitization of every business out there, doesn't matter whether it's a railroad business, or a high tech manufacturer, every business in the world right now is, is being changed by software. And it's underpinned by a lot of innovation that's coming from entrepreneurs in the software world that are solving problems that used to be kind of managed with spreadsheets and you know, homegrown systems. And now people are building kind of custom SaaS software that's solving some very niche problems in a lot of different industries.

Matt Waller  7:44  
It reminds me of that one of my favorite articles in The Wall Street Journal, by Marc Andreessen, 10 or 11 years ago, was called "Why Software's Eating the World". I don't know if you remember that, pretty famous article. But yeah, you see it in all industries. So let me ask you a couple questions about firms. I understand you, your you look for firms, with recurring revenue streams, like SaaS companies. And I see the analogy to commercial real estate, do you have any guidelines around firms that you will provide capital debt to based on how they've been financed up to that point?

Brian Henley  8:41  
Yeah, we're unusual in that we, we don't really look to the existing investors or shareholders to be there to provide additional capital in the future, we kind of assume that's not going to happen. So really, what we look for is a management team that that has a pretty big stake, equity stake in the business, so that they, they would be willing to make tough decisions like cutting costs, if you know, we have a big recession and you know, a lot of companies right now are kind of struggling with are we, you know, should we keep investing in sales and marketing as much as we have been because are our target customers are they're going to be making purchasing decisions right now in an environment where everybody's getting conservative? You know, debt financing becomes the first money out when there's a liquidity event. So the key is for, for an entrepreneur or ownership team is to make sure they they have more value than the than the debt on an exit, if if a company has sold, so you know, the things we're looking for, as I mentioned, predictable, recurring revenue, we, one of the things that really determines whether you have a software company or not, is do you have high gross margins, low gross margin businesses are more difficult to finance with debt, because you have a lot fewer levers to pull on the expense side. Because you just need a lot of people to service those businesses. So we're looking for, you know, gross margins, kind of, in the 70% plus range, which most software businesses have, which gives you a lot of flexibility in that operating expenses are, are somewhat variable, below that gross profit line. So sticky customer base, high gross margins. You know, in our due diligence, what we're always trying to understand is why do their- the software companies customers need this software? And is it a nice to have or a need to have, we definitely like need to have software. So, you know, you think about software, to run payroll for, for a business, for example, you know, a soft sell for a company that uses soft, a certain set of software for payroll, they can't just say, I'm not going to do payroll, you got to do payroll, our typical structure is a four year term loan. And so we always have to assume there's going to be a recession, some time in the next four years. So we're always looking at, okay, what happens to the customer base in a recession, for this type of business, and that that kind of makes us more conservative with regard to cyclical industries, cyclical industries are often tied to consumer spending, it doesn't mean we wouldn't invest in a business like that, it just means we would be more conservative, because we have to assume they're going to lose some revenue in a recession. But certainly, you know, in COVID, two years ago, it was a great proof point, for the stability of software. There was, you know, I think the, in the industry, what, what people found when, when push came to shove, companies were paying their software bill before they were paying their rent. Because they couldn't run their business without their software, they learned that, hey, we can actually run our business without office space, which, you know, was one of the big shifts, but we we certainly found a very stable revenue base in our customers during COVID in a very disruptive time, and the market we're in today is pretty shaky I would say, a lot of customers are slowing purchasing decisions. But we haven't seen you know, people not renewing their software. Because they, you know, are continuing to run their business, but they're just running them a little bit more conservatively.

Matt Waller  13:33  
I know, sometimes financiers will with software companies will look at, they'll take a set of customers from one year. And they'll look over time to see what that set of customers does, you know, how many are you retaining? What's the change in revenue and gross profit and various things like that, on that set of customers kind of as a measure of switching costs. An indication-

Brian Henley  15:09  

Matt Waller  15:09  
Do you look at those kinds of things?

Brian Henley  15:10  
Yeah, we call that cohort analysis.

Matt Waller  15:37  

Brian Henley  14:09  
So you will, you will look over time at, you know, you can do it monthly or quarterly, or, or annually and say, you know, from the customers they acquired in Q1 of 2020, how many of those are still here? You know, two years later, and you can kind of build these cohort graphs to see trends. Are- are the customers sticking around the way they have historically, you know, we see companies all the time that they're trying to grow so they're experimenting with new markets. So you know, not their core customer they started with but they're, they're trying some new customer verticals or our sources of customers. And you have to be careful because you know, you can spend a lot of money go on acquiring a new set of customers, but they, they might not have the same need for the software, and the retention will drop compared to what you had before. So that's definitely part of our analysis, or anybody investing in the software space today. You know, and it's not rocket science, again, I think it's, you know, it's easier to predict these businesses now than it used to be when you were just selling the software, and people could run it, you know, without really communicating with you. And now, you know, all of our companies, they're getting minute by minute usage data, because they're hosting the software. So they see how many users are logging in. And an indication of are you going to lose a customer is hey wow they used to have 10 users a day logging in, and now they've only got one. Well, you should probably go check with that customer, something's going on. They're not using the software as much as they did before. So there's a lot of sophistication, not just from the investor side, but from the operating side of this businesses that is really keeping a very close tab on, you know, what, what is the customer activity? And are they getting value from the software?

Matt Waller  16:17  
So a related kind of thing that's of interest many times in these situations is that there's lots of ways to measure it but the efficiency of sales where you take, like, gross part profit, say, and mart- and period two minus gross profit in period one divided by the amount spent on sales and marketing and period one to kind of look at how efficient is that? Is that very important to you? Those kinds of metrics?

Brian Henley  16:53  
Sure, you know, it, it's a, it's kind of a sister analysis to the retention side, is you have to, you have to take into account, what is the lifetime value of a customer, like how long on average are those customers going to stick around, you know, there's, you know, there's reasons you lose customers, you know, for example, we do a lot of software, and that companies that sell to hospitals, and, you know, hospitals hate to change their software, but one hospital system acquires another hospital system, and they have a different set of set of software they use and the bigger acquirer is going to say hey you're going to use our software now. So it can help and hurt, you know, you can have customers to go acquire other businesses and bring them to you. But you can also lose customers. And so, you know, there's, it's important to what is the customer acquisition costs related to the lifetime value of the customers and, you know, we have some companies that, that have annual contracts that are hundreds of 1000s of dollars a year, and we have others that are, you know, 10s of 1000s of dollars a year. And if you're selling software to a small business, just by nature, you're going to lose more customers, because small businesses go out of business and they get acquired more, you know, there's a lot more churn in an SMB market than there is in an enterprise market. But if you have an efficient customer acquisition model, and that, you know, you have a viral word of mouth source of new customers, you're not having to spend a lot of money, you can support a lower renewal rate. But, and then conversely, you know, if you're selling big enterprise accounts, you have expensive salespeople, and you're going to conferences, and you know, there's a lot of expense around getting enterprise customers, but they tend to be more sticky. Because Johnson and Johnson is not likely to get acquired, you know, next year, they're, they're probably more likely to be acquiring another, another company. So selling to those enterprise clients is more stable, but conversely, it's more expensive. So that those those things go hand in hand, you have to look at both sides of the coin.

Matt Waller  19:29  
I've seen some strategies lately. I just came across this and maybe it's been around for a while and I haven't noticed it as much but one software service that I use to analyze something here at the university. A few months, maybe a year ago, they said look, instead of paying this monthly rate, which wasn't very high, I could buy a lifetime membership. for a certain amount of money, that was an option that they gave, I took it, I think it's worth it. They've continued to, you know, upgrade their features and functionality and, and I really like it, you know, so for me, it was probably a good idea. But I, I wonder about that strategy are you are you seeing very much of that?

Brian Henley  20:25  
Well, it's, it happens from time to time. You know, if you're a software company and you, you want to generate cash, you can go to your customers and an offer a program like that. And essentially, you know, we kind of call that pre pre selling the future. You know, so they, they get that cast today, but they have a liability, which is to service you forever. So, you know, in our business that we have to look at that as deferred revenue. So a simpler version, which happens quite often is, hey, if you'll pay us up front for three years, we'll give you a 25% discount. So we collect three years worth of revenue today, but we owe you service for three years. So there is short term deferred revenue, which would be somebody that sells an annual contract that you pay up front, so you pay up front for 12 months, that the next 11 months is short term, deferred revenue. But if you if you collected three years, year two and three, revenue is deferred revenue. On the balance sheet, which if somebody is acquiring a company, or someone like ourselves is looking at the p&l of a company, they might recognize that revenue over the next three years, but they've already collected the cash, so there's not going to be cash coming in. So you have to do an adjusted P&L to really factor in what are the cash flows coming in the next three years, that's what investors are really focused on. And by the way, the- the CFO of that company needs to be careful of, hey, you know, my revenue is going to be stable, because I'm gonna recognize some some type of value of your contract over some longer period of time. But I got the cash today, which is good today, but it's not going to be there tomorrow. So from a, from a purchaser of software, you know, can be a pretty good deal. But you have to understand it's, it's a short term cash injection for that company, that, you know, if they can't kind of continue to generate cash, it could- it could jeopardize the company in the long term.

Matt Waller  23:00  
So, Brian, why would someone want to take capital from Recurring Capital Partners debt versus equity capital?

Brian Henley  23:11  
You know, there's a very valid reason to take equity capital, because they have a team of operators that are going to help you grow your business, we do a little bit of that, but it's much more around, you know, the, the financing side of the business, the, you know, helping helping you manage cash and things like that we don't have big enough margins to go have a staff of operating partners that are gonna go, you know, kind of help you grow your business. So that's a difference between equity and debt. That I don't, you know, I don't disagree that, you know, there, there are reasons to raise equity capital, I'm not saying but it's, you know, there's, depending where you are in a business of whether you need that kind of help or not, obviously, you're trying to preserve your ownership of the business versus selling a piece of it. There's reasons to bring on equity investors, especially if you have the opportunity to bring some industry expertise, you know, and not just to help you grow your business in that industry, but also there there is expertise and how do you grow a software business? You know, when do you hire a VP of HR and when do you bring on a real CFO versus a controller? You know, there's a there's a science and ex- expertise around growing software businesses, you know, it's very different running a 10 person software company versus a 75 person software company versus a 500 person software company, and there's different equity investors that have a lot of expertise at those different stages. And so, like we, we work alongside firms like that all the time, and they can be very valuable, we can be valuable on, you know, kind of the financing strategy of the business of, you know, what are the sources of cash, and, you know, my m&a background, I often helping our portfolio companies figure out when to exit how to exit should you hire an investment banker? You know, how do you think about strategic investment buyers versus financial buyers? We do a lot of help with companies on the, on the financial side of the business,

Matt Waller  25:46  
I'll tell you one I thought of closing question is about investors in your company, you know, how do you find investors? What are you looking for?

Brian Henley  25:53  
You know, essentially, I'm running a, I created this business as a startup and I had to go, you know, find investors. You know, it's, it's fascinating, I mean, I've created a lot of businesses over time, and this one has been very satisfying, because it's, it's offering something investors really want, which is kind of a great risk return, and not likely to lose my money.

Matt Waller  26:31  

Brian Henley  26:32  
But I get a good yield. And then it's, it's a great service for entrepreneurs, wow, you can help me grow my business and get new customers but retain ownership. And in my more ownership in my business, and so it's very satisfying to find a business that, you know, there's, there's nobody can really say, you know, that business is terrible, or you're, you're hurting this business, in- in exchange for growing your business, it's been fun to, to, to work with both the investor side, and the customer side for us, which is, which are these entrepreneurs all over the country that, you know, I used to be an entrepreneur, in, in that sense of building, building a company, and one of the biggest satisfactions I've had, is to have a half a dozen or so of our portfolio companies have really successful exits. And the first thing that founders do, who've actually made a lot of money is come back and say, Brian, can I invest in the next Recurring Capital Fund, because I know what you guys do, and I know how thorough you are and, and how little risk you took in our company, because I knew I knew how much value we had in our company. And so we've had a, I call that kind of full circle of, you know, helping help an entrepreneur and get get to successful exit to wealth and then helping them preserve their wealth with with our kind of credit fund investing.

Matt Waller  28:17  
Well, Brian, thank you so much for taking time to visit with us today about Recurring Capital Partners. Very interesting business, and successful business you've created that helps investors and software as a service company, so congratulations on this huge success.

Brian Henley  28:38  
Oh, thank you. And I have to tell you, you know, when I graduated high school in Crossett, Arkansas, I told my dad I, I wanted to go into business. And he was he graduated from the University of Arkansas, chemical engineering degree. And he kind of gave me a great set of choices. He said, you could go to any college you want that has a Razorback, as a mascot, and you can major in major in any engineering degree you want. And so I got an industrial engineering degree from the University of Arkansas, and then later got a MBA from Harvard. But I always envied my friends who were during undergrad, were studying some really interesting stuff at the business school and I was stuck, stuck quote in the science stuff that was not near as much fun.

Matt Waller  29:46  
Well, you're getting to live it out now. So congratulations. Good talking to you.

Brian Henley  29:51  
Great to talk to you Matt.

Matt Waller  29:54  
On behalf of the Sam M Walton College of Business, I want to thank everyone for spending time with us for another engaging conversation you can subscribe by going to your favorite podcast service and searching be epic. B E E P I C.

Matt WallerMatthew A. Waller is the dean of the Sam M. Walton College of Business, Sam M. Walton Leadership Chair and professor of supply chain management. He is also the host for the Be EPIC Podcast for Walton College.


Walton College's EPIC values -- Excellence, Professionalism, Innovation and Collegiality -- are the heart of Dean Waller’s podcast. Since the beginning of the series, Waller has interviewed business professionals, industry experts, CEOs and Walton College students to bring listeners first-hand accounts directly from the entrepreneurial world.


Waller is an SEC Academic Leadership Fellow and coauthor of “The Definitive Guide to Inventory Management: Principles and Strategies for the Efficient Flow of Inventory across the Supply Chain,” published by Pearson Education. He is the former co-editor-in-chief of Journal of Business Logistics. His opinion pieces have appeared in Wall Street Journal Asia and Financial Times.


Waller received an M.S. and Ph.D. from Pennsylvania State University and a B.S.B.A., summa cum laude, from the University of Missouri.

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Walton College of Business

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We're sitting down with innovators and business mavericks to discuss strategy, leadership and entrepreneurship. The Be EPIC Podcast is hosted by Matthew Waller, dean of the Sam M. Walton College of Business at the University of Arkansas. Learn more...

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