How these SaaS startups are making life harder for everyone else

A few years ago, $100 million in annual recurring revenue was often enough to set cloud companies on the path to larger late-stage rounds at lofty valuations and perhaps even an initial public offering. Institutional investors viewed it as the mark of businesses that could keep growing and deliver a significant return.

Then the goal posts moved.

Higher interest rates and slowing growth for software businesses have pushed institutional investors to raise their sights to $300 million in ARR, according to Asheem Chandna, a partner at venture-capital firm Greylock Partners.

That was no problem for cybersecurity startup Wiz, which reached $100 million in annual recurring revenue 18 months after its launch in 2020 and barreled on to a current ARR of $500 million. Wiz this May raised $1 billion in venture capital at a $12 billion valuation. Alphabet earlier this year was even in advanced talks to purchase the company for $23 billion, although the effort fell apart and Wiz said it would pursue an eventual IPO instead.

Rubrik, another cybersecurity firm, reported $919.1 million in annualized subscription revenue in the quarter ended July 31 and said it expects to exceed $1 billion in subscription ARR this fiscal year. Its IPO in April was the largest public offering of a software company since 2021.

ARR is a nonstandard accounting term, to be sure, with varying definitions. Some companies, like Rubrik, calculate it on the rosy assumption that any contract that expires during the next 12 months will be renewed on existing terms.

Even so, Greylock’s Chandna finds it useful. “I and other VCs view it as very important and as a leading indicator of business size and top line," he said.

Rubrik and Wiz follow an earlier generation of supercharged software-as-a-service successes including Salesforce, ServiceNow and Workday. As customers today shift spending toward a small group of AI companies and cut back elsewhere, however, the environment has become challenging for many software-as-a-service companies.

Secret weapon

Fewer than one in 1,000 enterprise software companies backed by top venture-capital firms achieve $100 million in annual revenue, according to Chandna, who sits on Rubrik’s board.

But Wiz and Rubrik had exceptional factors working in their favor, as well as a certain degree of luck. Their success was at least as much about people as technology or product.

Wiz benefited from founders who sold their first startup to Microsoft and worked for several years at the software giant, leading the cloud security team. That plus help from well-connected early investors such as Cyberstarts, Index Ventures, Sequoia Capital and Insight Partners enabled Wiz to target large enterprise customers from the start and work with them to hone their product.

Rubrik co-founder Bipul Sinha had extensive experience as an Oracle engineer and venture-capital investor at Blumberg Capital and Lightspeed. But it was his personal ability to draw top people to a seemingly sleepy market that allowed the company to attract the talent it needed to grow.

Both Wiz and Rubrik were also able to follow the startup playbook of burning cash to reach escape velocity, much as a rocket burns a lot of fuel to break from the pull of Earth. Rubrik, for one, reported a $354 million net loss in the latest fiscal year. It couldn’t have grown so fast without spending a significant amount.

But venture-capital firms are putting increasing pressure on startups to limit the spending upon which their growth depends.

Burn limits

In prior years, it wasn’t uncommon for startups to burn $4 or $5 to acquire $1 in new annual recurring revenue, according to Nina Achadjian, a partner at Index Ventures.

Since interest rates started climbing in 2022, investors have generally pressed startups to control their spending. Jeremy Burton, the chief executive of data startup Observe, said that when he was raising money earlier this year some investors wanted him to spend only $2 to acquire $1 in new annual recurring revenue. The company helps clients troubleshoot applications by observing the digital “exhaust fumes" that they omit.

It’s unreasonable to expect an enterprise software company to scale up while limiting its cash burn in such an extreme way, given the need for a broad set of features, engineers and salespeople, according to Burton, whose company offers both subscription- and usage-based pricing.

“We had a really, really great year. And yet still it was incredibly difficult to raise money," Burton said.

Observe raised a $115 million Series B round in March, led by Sutter Hill Ventures, which founded and incubated the company. Other participants included Capital One Ventures and Madrona, both existing investors, and Snowflake, where Burton sits on the board. Observe said it expects annual recurring revenue, now $21 million, to be over $30 million by year’s end.

Startups that lack such committed investors may struggle to fund their growth.

“If you don’t have good investors, and you are being held to those kinds of metrics, there’s not going to be many B and C rounds that get done," Burton said.

That raises the prospect of selling to private equity or a stronger startup at a price that wipes out some or even all of the equity of team members and investors.

Lacework, a cybersecurity startup that was founded in 2015 and valued at $8.3 billion in a 2021 funding round, achieved annual recurring revenue in the range of $80 million to $100 million. This year it signed a letter of intent to be acquired by Wiz.

After due diligence, however, Wiz said it was reconsidering its offer, according to a person familiar with the matter. If a deal goes forward, that person said, it would likely value Lacework at less than $100 million.

In a market where a big exit is elusive, startups will need to cultivate strong management and steadfast investors as never before.

Write to Steven Rosenbush at steven.rosenbush@wsj.com