Dear Fellow Shareholder,
I hope this letter finds you safe and healthy. As many long-term investors know, I work hard to make SharpSpring as much of an open book as possible. Historically, this has been through attempts to be available for investor calls, participating in conferences, and ongoing communication. More recently, it has taken the form of letters like these – the first of which I wrote as the pandemic began taking hold.
At the time, I wrote about the reasons why I believed we would fare well during the pandemic and in deteriorating economic conditions. I spoke about four separate factors that gave me confidence our customers would stick with us and that, while all companies would face pressures in this new environment, we’d work through these times by keeping attrition in check, successfully selling to new customers, and ultimately continuing to grow. Thankfully, we’ve executed well against those expectations. After weathering an initial uptick in attrition and slowdown in agency expansion it Q2, things have largely returned to pre-Covid levels. Further, we’ve remained on track for a solid year of growth, and continued to set the stage for future years. We’ve also been fiscally responsible and taken large steps toward reaching EBITDA and cash flow profitability. If you’ve not read that note, the information is still very relevant, and I strongly encourage you to do so here.
Today, I am writing because we’re excited to be unveiling a revamped investor presentation. My hope is our new deck will clearly illustrate why, with very few leaps of faith, we know we are building a strong, high-growth, and high-margin business. To get you there, we’ve peeled back the onion on our historical cohort trends and provided several lenses through which to view our performance. While the slide deck should speak for itself, I am going to provide commentary on some of the key slides here as well as a few other slides that didn’t make the deck. My intent is to provide those of you with significant holdings some insight and detail as to how I think about the business. With that said, this letter is on the longer side. Needless to say, if the detail covered here is too much, you can just stick with the deck.
As a summary, we are providing additional information on:
- Attractive Margins at Scale: We believe our model supports 80%+ gross margins and operating margins of 20%+ at scale.
- Cohort Data: The deck provides cohort data from 2014-2020 for our agency customers.
- LTV/CAC Ratios: Our metrics are best-in-class and even more favorable when looking at customers who stick with SharpSpring for one year or longer.
- High-Quality Platform: We benchmark ourselves via 600+ customer reviews versus the competition, including HubSpot, Pardot, and Act-On.
- Large and Growing Total Addressable Market: We have penetrated approximately 2,000 of the 60,000+ digital marketing agencies in North America and Europe.
- Long-Term, Defensible Position: There are significant barriers to entry in marketing automation and, given our lower pricing relative to our competitors, we are well positioned to continue to take share.
Life of an Agency Cohort
Perhaps the most misunderstood aspect of our business revolves around our logo churn. As anyone who invests in SaaS businesses knows, companies with high logo churn often have problems growing over the long run. To be a bit cliché, eventually enough apples are falling off the back of the cart to offset the new customers added each month. At this point, companies with high logo churn typically stagnate.
Our logo churn is on the high side (roughly 3% per month), and it has been since we first began to sell SharpSpring at any real sales volume. This perception gives investors who aren’t familiar with our business model reason for concern. However, logo churn is the wrong metric with which to understand our company.
It is important to know that when we sign up a new agency partner, we are effectively signing up a business that serves as a reseller. This is fundamentally different than most SaaS companies whose business models revolve around selling to end users.
Anyone who has ever run a channel organization understands that a large portion of a company’s resellers fail to deliver substantial sales, while a few resellers really take off and drive much, if not most, of the sales that flow through the channel. SharpSpring’s agency channel is no different – the difference between a high-value and low-value agency is enormous.
The chart below is based on more than 4,400 historical month-one data points going back to the beginning of our business in 2014. When we sign an agency partner, we go through a period of high logo churn. Like any channel organization, agencies join us with intentions of selling marketing automation to their clients. However, a high number do not succeed. The reasons for this are many, and it’s safe to say most explanations represent an opportunity for us to improve upon in the future. But for the purposes of this conversation, I’d like to just stick with the description of our historical cohort performance.
As part of their initial agreement with us, each agency receives three licenses – one for each of their first three clients. When we first sign an agency, we see very little expansion because new agencies are getting to know how to use the platform for themselves and beginning the process of selling to and implementing the platform for these first three clients. Only when they add their fourth license to the platform do we begin to see expansion revenue. In later years, we see logo churn drop to ~1.5%, and agencies that were paying $600 in monthly recurring revenue (MRR) when they started with us are now paying us $1,500 to $5,000 or more since they have worked though their initial license pack and added many additional licenses.
Across the agencies in each cohort, the dynamics are all happening at the same time. Some agencies take off in the first year – I will show you these “high-value” agencies in detail in a moment – while many others, as much as 40% of them in the first 18 months, churn quickly. The latter group is comprised of the extremely low-value agencies that never take off, never exceed their original $600 MRR, and are responsible for the consistently high logo churn you see on a monthly basis. With each passing month, because we are adding a whole new cohort of agencies, we will continue to see the high logo churn created by these low-value agencies as they wash through this cycle.
Unfortunately, these low-value agencies create noise that obfuscates the performance of the high-value agencies that expand to many times their original MRR and on which our business model is based:
The chart above is the product of the attrition and expansion characteristics I have been discussing thus far and illustrates the performance of a cohort of 100 agencies with an original MRR of $60,000. As you can see, in early years the logo churn of low-value agencies is the dominant factor. In this stage, revenue retention is ~80% – which is already far better than logo churn. But as those agencies are attriting, under the hood the high-value agencies are expanding. By year three, expansion outstrips attrition, and the cohorts settle in at 100% year over year revenue retention.
The chart below shows each cohort’s revenue retention as of today. You’ll note that the newer cohorts, which are in their high-attrition and low-expansion phase, are just above 80% revenue retention, while later cohorts are averaging 100% revenue retention. You’ll also note that agencies keep expanding as they age, with the 2014 and 2015 cohorts having the highest average MRR.
New Cohorts are Out-Performing Older Cohorts
For several reasons, new cohorts are substantially outperforming our older cohorts, and we expect this out-performance to increase over time. When we launched SharpSpring to the market in 2014, we offered agencies a 5-pack of licenses for $500/month. At the beginning of 2018, we adjusted our price to agencies by offering a 3-pack of license for $600/mo. In addition to the fact that we’ve doubled the wholesale price of our license, we are receiving 20% more MRR out of the gates from these new cohorts. Perhaps more important, these cohorts will likely hit expansion revenue 40% sooner as they only need to work through their initial 3-pack, rather than five, before buying additional licenses.
LTV and LTV:CAC Ratio
As you know, SaaS businesses like SharpSpring live and die based on their ability to deliver solid unit economics over the long term. As the charts above show, we estimate the historical lifetime value of our agencies to be over $59,000. I emphasize historical, because we believe both the current agencies we have today and the future cohorts of agencies we sign tomorrow will be worth considerably more. When we say the historical LTV is $59,000, we are basing it on the actual attrition and expansion behavior of over 4,400 current and past customers. This is inclusive of all the logo churn from low-value customers that create noise and keep logo churn hovering around 3% as we continually add new cohorts.
As you think about this historical LTV, realize that these data points reflect the trials and tribulations of a start-up. When we launched in 2014, we did not even have an email feature included in our platform! As we grew rapidly in 2015 and 2016, we ran into significant challenges scaling our infrastructure as fast as we needed to. It was not uncommon for our service to go down and for us to lose leads and other client data. In the summer of 2017, as our customers began to send a significant number of emails through our platform, we ran afoul of anti-spam organizations, who for several weeks effectively brought our email sending capability to a halt by blocking our IPs and sending domains. All along, we were playing catch-up with companies that had a nearly 10-year head start on us. Our product was weaker and missing many of the features of the companies with whom we compete. All these factors led to the attrition characteristics that we had at the time, and to be conservative, we have baked all these data points into our LTV model.
Yet, today, new customers to SharpSpring will not experience any of these problems.
In addition to a much stronger, more feature-rich platform, we now have better onboarding processes, account management and tech support, and a number of upselling and cross-selling opportunities (think Perfect Audience advertising) in the platform. All of these should serve to make the customers we add today more valuable because they should attrit less and have more expansion revenue opportunity than our historical cohorts have had to date.
As far as the details go, we use the very conservative “double discounted” LTV calculation used by Matrix Partners and many other PE and VC firms. It is discounted with both a cost of capital (we use 10%) as well as our long-term gross margin. Here, we use 80%, though we believe we can reach 83% over time.
Our CAC calculation is similarly fair and conservative. Here we include the all-in core SharpSpring sales and marketing expenses from the previous quarter, divided the new sales achievement (in units) from the current quarter. Our entire marketing team, program costs, and all sales costs and commissions related to new client acquisition are included.
The result of all if this is an 8.0X LTV:CAC ratio. If you are familiar with these SaaS benchmarks, this is a pretty fantastic ratio, and it implies we are very efficient (perhaps too much so) with our marketing efforts.
An Alternative View
If you’ve been reading closely, perhaps you just said to yourself, “Yeah, but Rick, you just said you sign up a lot of low-value customers, and you lose them through early attrition. So, isn’t your CAC much higher for the customers that matter?” Great question.
To answer, we have provided an entirely new view that removes this “noise” by only looking at agencies that stay with us for more than a year.
Through this lens, our already solid unit economics actually improve. As illustrated below, CAC naturally goes up as you divide the same, all-in sales and marketing costs by a smaller denominator of customers, meaning only those that last at least a year with us.
While CAC has gone up by nearly $2,000, first-year logo attrition by definition is zero, and first-year revenue retention is 127%. Moreover, the MRR stays above or near the original MRR level for many years. This leads to an LTV for these customers of $86,091 and a new LTV:CAC ratio of 9.2.
Cohort Performance Yields Predictable Revenue Growth Over Time
With a thorough discussion of the behavior of our cohorts and associated unit economics in place, let’s look at what it all means at the macro level. First and foremost, the following slides DO NOT represent guidance in any way. To put a finer point on it, they do not reflect the effects of the current pandemic on 2021, for example. They include only hand-wave, placeholder numbers for our Perfect Audience business unit, and a rough estimate for onboarding fees from new customers added in any given year. For these reasons, please review these slides as solely illustrative of the potential of our business model.
That said, the charts should serve as compelling illustrations of how simply layering on cohorts that behave like our historical LTV model should yield long-term sustainable revenue growth. The first chart below uses a modest average annual increase starting in 2022 of 20 new sales units as compared to each previous year – so ~120 for 2022, ~140 for 2023, and so on.
Here is another chart that includes a more optimistic sales acceleration in future years, coupled with a 10% improvement to the model for both attrition and expansion. There are reasons to believe all of this is within reach as we build our brand and capitalize on the improvements we’ve already made and will continue to make in the future.
And here is a third with further acceleration of sales in 2022 and beyond.
In summary, while our logo churn and really all aspects of our business can be improved, and we are working hard to do so, logo churn is not the way to look at our business. When SharpSpring acquires a new agency partner, it is as though we are acquiring a reseller. While many of them will not work out and will, therefore, attrit quickly, others will become high-value customers that expand to many times their original MRR, and stick with us for many years, fueling our long-term growth.
Today, we have about 2,000 agency partners that work with us. We estimate that our largest competitor has roughly the same number, while everyone else in the space each has only a couple of hundred. In total, we estimate that about 6,000 agencies are actively using marketing automation themselves and/or are bringing it to their clients. This estimate does not consider the overlap created by agencies using multiple marketing automation (MA) solutions.
We know with certainty that there are between 60,000 and 100,000 English-speaking agencies around the world. We have built a proprietary web crawler that scans the web and identifies them and adds them to our database. The range is wide because at the low end, an agency might only have 2-3 employees, while the 60,000 number represents agencies that we believe have 5+ employees. We also know this market is growing 20%+ a year as the marketing field becomes more complex and the need for these agencies will only increase with time.
The market today remains largely greenfield. Many agencies have yet to move from an arcane strategy of “duct taping” together point solutions (email, form builders, landing page builders, social media management, CRM, chatbots, analytics, etc.) that were never designed to work together. This inefficient market is simply due to the inertia generated by following old habits and the mistaken belief that marketing automation is too expensive. As you likely know, we address the latter issue completely. As for the inertia, I have no doubt that everyone will adopt marketing automation or complete sales and marketing platforms like SharpSpring as the years go by. In short, we believe we have a long-term sustainable market on which we can continue to fuel our growth.
High Gross Margin Business
From the start, we’ve built our business to operate with high margins over the long term. Our business model has built-in operational leverage that we are gradually realizing with scale, which is why our margins have improved from the high 50s early on to ~76% for our core business this past quarter.
In our gross margin calculation, we include support, onboarding, account management, and network and hosting costs. Among these input areas, certain line items have a pronounced impact now but will lessen in importance as our overall revenues increase.
Perhaps an obvious point but one worth mentioning: our highest support burden is with a new agency that is getting onboarded to our platform. Less obvious though: an agency with 15 clients on the platform paying $3,000 a month is no more, and often less of a support burden for us. Keep in mind that these agencies provide first-tier support for their clients, so as their MRR grows with us as they add clients, their support burden usually does not. Put plainly, after their first few clients, they have “been there and done that” and, therefore, do not need support at the same level as a new agency going through everything for the first time.
Another big factor toward our long-term gross margin perspective is that we build everything into our platform ourselves. This development philosophy means we are not burdened by third-party license fees paid that grow with the size of our userbase. Instead, we build something, and other than the minimal costs to maintain or improve upon it, it is essentially costless from that point forward, regardless of the number of customers using it.
With these points in mind, it becomes clear how cost categories, which have a pronounced impact, decrease in importance as our overall revenues increase. For example, support costs account for approximately 25% of cost of revenues today, but as discussed above, as the customer base becomes more mature, customers often require less support.
Long-Term, Defensible Position
As I’ve covered earlier, marketing automation is here to stay. In the same way that CRM revolutionized sales management, so, too, does marketing automation revolutionize the marketing function. But none of that speaks to SharpSpring’s staying power within the market. The slide below covers this important point:
First, let me cover the possibility of new entrants. We’ve seen only one meaningful new entrant into the space in the last eight-and-a-half years – Active Campaign. Even this company is a very old email company that managed to transition into a full-fledged MA platform over many years. There is one simple reason for this:
Marketing automation is exceedingly difficult from a technical perspective.
As you read this letter today, our rules engine is evaluating every page visit, from every visitor, on every one of our customers’ thousands of websites. The same is true for every email click on every email sent through our platform. Each of these events might be evaluated in real-time by more than 100,000 automation rules that our customers have created within our platform. Each might be the trigger for an automated event, such as assigning a lead, increasing a lead score, sending an email notification, or adding a lead to a drip campaign. In all, our tracking servers and rules engine will do more than a billion calculations on behalf of our customers today. To do this reliably and in real-time is the stuff of computer science textbooks.
In addition to the core tracking and automation engine, the scope of functionality of a modern MA platform has become enormous. Today, SharpSpring and our competitors incorporate more than 15 categories of tools – each representing functionality that entire companies are built around – CRM, social media management, email, analytics, advertising, chatbots, landing page builders, call tracking, forms, and blogging, just to name a few. On top of these features, each platform has hundreds of integrations and robust APIs to connect with unique customer infrastructure.
For all of these reasons, we have not seen any new meaningful entrants into the space besides SharpSpring and Active Campaign in the last 8.5 years. In essence, we compete with the same companies today that I listed in the business plan I wrote in 2011.
Second, we should consider competition from the incumbents. We know these competitors are neither willing nor able to compete with us on price. We offer our highly rated, award-winning platform for as little as one-tenth the cost (for our agency partners) of competing platforms like HubSpot, Marketo, Pardot, and Act-On. These companies were the first movers in our industry, and rightly enjoyed first mover pricing. Needless to say, they are all successful and have built solid revenue streams that they now need to protect. In addition to the revenues, these companies have built up equally high cost centers – highly paid field sales, engineering, and support organizations. Put simply, our pricing protects us from these incumbents today and will continue to do so moving forward.
Nothing I have discussed so far is possible without a dedication to product. It is our product and the value it provides to our customers that makes our business. In the last 6.5 years, we have built a brand based on producing an innovative and highly functional platform, priced as the best value in the industry.
SharpSpring is a platform. It is at the heart of our customers’ entire sales and marketing processes and is at the center of their customers’ experiences with them.
Today, our platform is highly scalable, our email delivery is top-notch, and our product features are on par with the very best products on the market. In fact, according to more than 600 independent reviews across multiple software review sites, we are often rated higher than incumbent solutions.
SHSP vs. HUBS
As an emerging leader in the marketing automation space (more accurately sales and marketing platform space), we are often compared with HubSpot (NASDAQ: HUBS). We believe this comparison is both highly flattering and fairly warranted. HubSpot has done amazing things for our industry and for investors alike. There are many similarities between the companies, the most important of which is the long-term potential for success.
That said, there are significant differences between the two companies as well. For one, SharpSpring is a young company and has only been to market for about 6.5 years. HubSpot, along with Marketo (purchased by Adobe), Eloqua (purchased by Oracle), and Pardot (purchased by Salesforce), were all founded nearly a decade earlier. This caveat has a number of implications related to attrition and net revenue retention as companies with older user bases benefit from the stability of a large set of mature customers. As I have described in great detail above, we are already seeing, and will continue to see, those same patterns with our business.
Another large difference is the efficiency with which we grew. As of the writing of this investor letter, SharpSpring is positioned to reach profitability within the next few quarters. We have built an extraordinarily efficient customer acquisition model (8:1 LTV:CAC), while continuing to grow aggressively and burning much less cash in the process. We believe this responsible growth will benefit shareholders in the long run in the form of far less equity dilution. At the same time, we’ve been building a highly capable product, and a brand known for quality and value, both of which position us well for accelerating growth in the future.
In closing, I hope and trust we’ve done a better job of pulling back the curtain and providing you with the information you need to see the business the way we do. SharpSpring is still a young company, and we have a tremendous future ahead of us. We’re continuing to focus on a number of areas to improve the metrics I’ve discussed, but even at our current pace, we’re on a great trajectory and ahead of our most notable peers at the same stage. As we continue to mature as a business, our agency partners will be doing so alongside us, providing a clear path for growth and sustainability over time.
We launched our product to market just 6.5 years ago, and a lot has happened between then and now. We’ve gone from a marketing automation startup to a $30+ million revenue run rate public company with over 250 employees, 2,000 agency customers, and over 10,000 businesses using our platform. I am incredibly proud of the work our team has accomplished in such a short time frame, and I appreciate the support we’ve received from each and every one of you.
Important Cautions Regarding Forward-Looking Statements
The information posted in this release may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. You can identify these statements by use of the words “may,” “will,” “should,” “plans,” “explores,” “expects,” “anticipates,” “continues,” “estimates,” “projects,” “intends,” and similar expressions. Forward-looking statements are neither historical facts nor assurances of future performance. Instead, they are based only on our current beliefs, expectations and assumptions regarding the future of our business, future plans and strategies, projections, anticipated events and trends, the economy and other future conditions. Because forward-looking statem