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Starting an employee retirement plan is not too hard or expensive, even for small businesses.
Plus, these programs offer tax advantages to both the employees and the company, which leave more money in everyone’s account.
Offering such benefits is a great way to attract qualified candidates and gives your top talent a huge reason to stay.
The sooner you start the better.
First, I’ll walk you through the different types of employee retirement plans available. There are more than just 401(k) plans helping people save for post-career life, including some types that are specifically made for small businesses.
Then we’ll take a look at what to consider as you decide on which provider you want to manage your employee retirement plan.
There’s a little bit to know, sure, but a lot to be gained.
For almost everyone, retirement is the largest expense of their lifetime. By offering a plan to help them save, employers provide a much needed sense of security to employees thinking about their family’s future.
Keep reading to start getting better candidates, happier employees, and serious tax-breaks every year.
The Top 4 Options for Employee Retirement Plans
- Guideline – Easiest way to start a 401(k)
- Human Interest – Best 401(k) for small to midsize organizations
- Nationwide – Best for large organizations
- Vanguard – Best SIMPLE IRA
The Different Types of Employee Retirement Plans
In terms of picking an appropriate type of employee retirement plan, employers need to pay attention to a few important details.
For all the tax law and government regulations involved, the choice comes down to the basic structure of each plan, which doesn’t take an MBA to understand.
Plus, after partnering with a good coverage provider, you’ll have someone to help you close gaps in knowledge, forecast what each plan will realize in the years to come, and steer you toward a more appropriate plan if it’s not the right fit.
Let’s dig in.
Qualified employee retirement plans—that is, those that have tax advantages—fall in two major categories, only one of which is used widely today:
- Defined benefits plans are managed entirely by employers. These are also known as pensions and pay out a set benefit each month. These were really popular until the 1980s, but are being phased out because of how expensive they are for employers to maintain.
- Defined contribution plans are much more common today. With these plans, employees contribute money from each paycheck toward their retirement. Companies may choose to match employee contributions, as well.
The amount that employees contribute, the company contributes, and how that money is taxed varies from plan to plan. Companies have some flexibility in how they enact each plan, but many of the basic rules and limits are set by the federal government.
Important note: Plans have different limits for how much employees and employers can contribute each year. These limits change periodically because the government adjusts for cost-of-living increases. The IRS provides current limitations on benefits contribution limits for every type of employee retirement plan limits for benefits and contributions maintained by the IRS.
It’s really important to understand the essential rules of each plan and how it will help people save over the long term.
Let’s go through the most widely-used types of defined contribution plan, how they are different, and which sorts of companies use them. The ones I’m going to cover are:
- 401(k) plans
- Roth 401(k) plans
- SEP plans
- SIMPLE IRA
- Payroll deduction IRA
- Profit Sharing Plans
There are some types of employee retirement plan options that I haven’t covered here, but these are the most common plans available.
A 401(k) plan is an employer-sponsored retirement savings account. Employees contribute a portion of their salary to the account, which may or may not be matched by the employer.
Contributions are pre-tax, which means they are not taxed until the employee withdraws funds from the 401(k), typically after they retire. The amount that employees contribute also reduces their taxable income each year.
The money in a 401(k) grows tax-deferred (as in not taxed until retirement) and sets an employee’s retirement savings on autopilot. A little bit of the gross of each paycheck goes straight into their nest egg each month.
Companies may choose to match the employee contributions, but it doesn’t have to be a 100% match. It is usually based on a formula they set. An example of a common matching formula is an employer who matches 50% of contributions up to 6% of salary.
Matching contributions are tax-deductible, so a 401(k) can be part of a company’s tax strategy, helping both employer and employee save more for the future.
It gets even better.
Thanks to new legislation in 2019, the tax credit for businesses starting a 401(k) is now as much as $5,000 and no less than $500 per year for three years, with an additional $500 for setting up autoenrollment. The credit can go towards setup and administrative costs.
There is a lot more paperwork necessary to get a 401(k) started than with other plans, so this tax credit can help smooth the transition and get everything set up properly. Once it’s established, 401(k) plans let employees contribute a lot more money each year than other types of plans.
Investment options for a 401(k) are determined by the plan the company chooses. Employees may get some say in where they invest the money, though they will most often be choosing from a limited portfolio of options.
Withdrawing funds early (before age 59½) will result in a 10% penalty on top of the taxes owed. There are exceptions to this rule, though, for workers over 55, which allows them to avoid the penalty for early withdrawals. This only includes the 401(k) of the job they leave, not retirement plans with other former companies.
There are also special rules for people who have an “immediate and heavy financial need.” This is known as a hardship distribution and means people can use money from their 401(k) without penalty for things like necessary medical treatment or to avoid foreclosure and eviction.
There are two common variations of the 401(k) available to specific types of workers:
- 403(b) plans: employees of public schools, colleges, universities, churches, tax-exempt, and non-profit organizations
- 457(b) plans: employees of state and local governments
With the exception of a few special rules, these plans are identical to the 401(k)
Roth 401(k) Plans
Employers may choose to sponsor a Roth 401(k), which is virtually identical to a traditional 401(k) except that contributions are made after-tax.
This is an important change that has pros and cons.
Employees are not able to deduct contributions from their taxes, so they’re not decreasing their tax burden as they save, which is a benefit of a traditional 401(k).
On the flipside, with a Roth 401(k) they get to withdraw both their contributions and earnings tax-free once they reach retirement.
Another nice perk is that you can make withdrawals tax free once the plan has been established for five years. You would still have to pay taxes on earnings for an early withdrawal, but not the money you have already paid taxes on.
So that’s the tradeoff. With a Roth 401(k) you pay taxes now, but when you retire, all of the savings and earnings are yours without a haircut from Uncle Sam..
This could work very well for a young employee who thinks they are going to earn more later in life. They pay taxes on income now and avoid paying when they’re in a higher bracket.
It’s not the best for everyone, though, as senior employees may not want to pay taxes at their current bracket. For them, it’s likely better to pay upon retirement and take the deductions now.
Some companies may choose to offer both a Roth and traditional 401(k), allowing employees to choose how best to save for retirement.
A simplified employee pension (SEP) is a type of individual retirement account (IRA) offered by an employer.
It’s a lot less complex to manage than a 401(k), which makes it ideal for smaller businesses and people who are self-employed.
Only employers contribute to the SEP and these contributions are tax-deductible. The money is held in an IRA in the employee’s name and grows tax-deferred.
The contribution limits are much higher for a SEP than for a personal IRA, allowing people to set aside a lot more money than they could otherwise. There are also fewer rules about income limits, which make it good for high earners.
SEP plans are nice because of their flexibility. Companies have to contribute the same percentage to all eligible employees each year, but that percentage can change.
During a good year, for example, an employer may choose to max out contributions, whereas they might not contribute anything if the business is strapped for cash.
Because these plans are easier to manage and they let businesses contribute flexible amounts each year, SEP plans are great for smaller businesses that want to grow and help their employees save at the same time.
A SIMPLE IRA is an employee retirement plan for businesses with 100 employees or fewer that doesn’t offer another qualified retirement plan, like a 401(k).
SIMPLE stands for “Savings Incentive Match PLan for Employees,” and is appropriately named because the plan requires very little administrative paperwork. It’s really just the initial plan and annual disclosures.
Employees can choose to contribute a portion of their salary to the SIMPLE IRA and employers are required to either:
- Match employee contributions dollar for dollar up to 3% of an employee’s compensation, or
- Make a fixed contribution of 2% of compensation for all eligible employees, regardless of whether the employees contribute themselves.
The low startup costs and administrative burden make it ideal for smaller companies that want the tax advantages of a retirement plan without the legwork that goes into a 401(k).
The downsides to a SIMPLE IRA are the contribution limits—which are less than a 401(k)—and the 25% the penalties for early withdrawal are steep during the first two years.
Payroll Deduction IRA
A payroll deduction IRA allows companies to set up an employee retirement plan without filing anything with the government.
Employers work with a financial institution to make it so employees can automatically divert part of their paycheck to an IRA. The employer can designate one or multiple IRA providers to receive distributions, but they don’t have a say in the investment options.
In this plan employees make all the contributions. There is no matching, but contributions are tax deductible, which can help employees save each year.
A payroll deduction IRA is a low-cost, zero-risk way for a company to encourage their employees to save for retirement.
Profit Sharing Plans
Profit sharing plans (PSPs) can be set up by employers or with help from a financial institution. Each year, the employer contributes to the plan based on business conditions, effectively sharing profits with employees.
Employers decide how much, if anything, they want to contribute each year.
All of the assets in the plan are held in a trust, which is overseen by a trustee who ensures the integrity of contributions, participants, distributions, and reporting.
Employers have a large degree of freedom in terms of how these plans are structured, but they require more oversight than a SEP plan or SIMPLE IRA. This is true even if an employer is sharing the responsibility with a financial institution.
Profit sharing plans can be set up in addition to other qualified employee retirement plans, like a 401(k). They are a good option for profitable companies that want to help employees save more and decrease their current tax burden.
How to Choose the Best Employee Retirement Plan Option for You
Once you know which employee retirement plan—or set of plans—makes sense with your goals and resources, it’s time to select a financial institution to help you make it a reality.
Banks, mutual funds, and insurance companies are all appropriate options that can help businesses set up and manage an employee retirement plan.
How do you choose the right one to be your coverage provider?
While institutions offer the same basic set of employee retirement plans, the levels of service they provide are not identical by any means. They have varying degrees of support, charge fees according to their own rules, and offer different kinds of investments.
All of these factors can have a big impact on tax strategy and the health of a retirement fund over time.
Before we look at the top providers for employee retirement plans, I want to highlight the major criteria you can use to evaluate how it will work for your company.
Some of the simpler employee retirement plans are attractive because there is not a lot of administrative overhead. Other plans, like a 401(k) or profit sharing plan, have a lot of moving parts and regulatory requirements.
After the plan is set up, there are a variety of things that have to happen, including:
- Preparing benefit statements, returns, and reports required by law
- Allocating contributions
- Processing distributions (employee payouts)
- Assessing compliance with contribution limits and non-discrimination
- Amending plan documents
As you search for different plans, it’s important to understand what the employer is responsible for, what the provider is going to do, and how much all of that is going to cost.
With payroll deduction, SEP and SIMPLE IRA plans, there’s not a ton of administrative paperwork or fees. For those plans, there are likely to be low yearly rates and then other fees depending on how employees invest their money.
With any type of 401(k) plan, on the other hand, there is a lot more paperwork, larger amounts of money at stake, and fees can really impact people’s savings over time.
How these fees break down can be incredibly complex, especially when there are multiple providers servicing the plan.
Fortunately for employers, all covered service providers are required by law to explain how they are compensated in a 408(b)(2) disclosure.
This will show how every party is being paid out of the 401(k), including:
- Direct compensation: fees paid directly to the provider
- Indirect compensation: fees paid from plan investments
Direct fees are easy to identify, but indirect compensation fees can be more difficult to figure out. This could include revenue sharing, where a financial advisor’s management fee is paid out of investment earnings rather than directly.
This means revenue sharing will show up as a percentage of plan assets rather than a hard dollar amount.
These fees should be explained on the 408(b)(2) in order for employers to make an informed decision, and the government encourages providers to walk employers through all of the fees.
At the end of the day, however, providers can hide fees in ways that can be really challenging to track down, even if you know what you are looking for.
This is why it is so valuable to find a retirement plan provider who is transparent and upfront about fees.
Once you have established a 401(k), you will want to keep a close eye on your 404(a)(5) Participant Fee Disclosure. This will show all of the fees that your plan faces.
Where is all of this money going to go? It’s not just getting parked in a savings account.
Depending on the plan you choose, your employees will have different types of options about where and how their money is invested. Typically, these include:
- Bond funds
- Foreign funds
- Index funds,
- Large-cap and small-cap funds
- Mutual funds
- Real estate funds
These options tend to include relatively safe and stable investment opportunities, but may include more aggressive growth funds as well.
With simpler plans, there are usually less options than with a 401(k). Depending on the provider you choose, you may be able to offer a limited portfolio of choices or wide selection of investment options to your employees.
Generally speaking, a wider range of investment options requires more oversight, paperwork, and fees.
Some will offer brokerage windows, which allow employees to self-direct the investment of their retirement funds.
This allows companies to offer a wider range of options and control to their employees without necessarily having to absorb any extra responsibility. Employees will make their own decisions and take their own risks.
This can be really attractive because people may want to save differently, depending on where they are in their career.
It’s a healthy practice to diversify types of investments for retirement to more easily weather shocks to individual slices of the market.
Giving employees more choice is good, but it comes at a cost. You might be surprised at how diverse a portfolio can be created from the relatively narrow options in a plan like Human Interest.
Find an employee retirement plan that integrates with your payroll. I’m talking about seamless, direct integration where your provider is communicating directly with your payroll service. You never have to update information yourself.
A lot of the time you are going to see hands-free or no-touch solutions. That’s only true if it integrates directly with your payroll or HR services.
If not, there’s going to be a lot of data entry and administrative tasks involved with managing a 401(k). It’s worth seriously considering switching to a different payroll service if you can’t find something that integrates with a plan you like.
It could be a huge pain, especially if you are working with a HR service or PEO, but what are the consequences of choosing a plan with less-than-ideal benefits? They could be massive, in the long-term.
Plus, you might wind up having to employ full-time staff to manage payroll functions that could be automated.
Not having payroll integration might be okay for a SEP or SIMPLE IRA, as they don’t have as much administrative overhead.
At the same time, the integration would eliminate dozens of steps to process monthly contributions for every employee. What small business owner wouldn’t want to save a few hours a month making sure the retirement fund is in order?
If everything goes well, the relationship between your business and retirement plan provider is going to last a long time. Over the years, the quality of communication and support you receive are going to have a major impact.
Be aware that you may have to pay extra for the type of support you want.
Human Interest, for example, will provide different levels of customer service depending on the pricing tier. It’s no accident that their different plans are called Essentials, Complete, and Concierge.
With Essentials, employers pay less, but have to do more on their own. Concierge, on the other hand, comes with dedicated account management at a higher price tag.
Another thing to do is read online reviews from current customers to get a sense of how dependable providers are. This can give you a more authentic picture of what to expect than a provider’s marketing material, though you should take reviews with a grain of salt.
#1 – Guideline — Easiest Way to Start a 401(k)
Guideline is a 401(k) provider that doesn’t charge any fees on investments and handles all of the administrative paperwork. This makes Guideline both one of the most affordable and one of the easiest ways to start a 401(k) for your employees.
It can help employers set up both traditional and Roth 401(k) plans, with or without matching options. Employers can also create profit sharing plans that work as a year-end contribution to an employee’s 401(k), like a bonus.
The way the pricing works is that Guideline charges a base fee per month, plus $8/month per employee. There is no extra charge for annual reports, government filings, or custodial services.
This flat monthly fee makes the pricing predictable, which is markedly different from most other employee retirement plan options. There’s no complicated revenue sharing or third-party fees eating into people’s savings.
The reason that Guideline is so inexpensive is that they have built software that automates almost every 401(k) administrative task.
Guideline has direct integrations with eight of the best payroll services, like ADP, Gusto QuickBooks, and Square. These sync your payroll and HR data in real time with no work on your part.
Guideline also provides intuitive dashboards for employers and employees, so they can monitor their retirement account and can choose from more than 40 index funds in which they can invest their money.
Alternatively, they can invest in a managed portfolio of stocks and bonds.
Managed portfolios are entirely overseen by Guideline, so there is not a lot of freedom to pick individual investments. They simply pick the risk level—like conservative, moderate, or very aggressive—and they are automatically invested in a range of stocks, bonds, and funds that meet their goals.
This eliminates any work for employees. Portfolios are rebalanced automatically, which ensures that people are always investing in a diverse, risk-tolerant set of assets.
For Guideline, the base fee is $39/month (plus the aforementioned $8/month per employee), which includes all of the administrative fees, live customer support, and employee onboarding.
Guideline Prime has a $99/month base fee with the same per-employee charge, and comes with a dedicated account manager, customizable financial and billing reports, and additional tools for profit sharing plans.
Any company of any size can get started with Guideline today and have an employee retirement plan in place tomorrow.
#2 – Human Interest — Best 401(k) for Small to Midsize Organizations
Human Interest provides a low-cost, hands-off 401(k) solution that works really well for startups and SMBs.
The interface is modern, easy to navigate, and effortless to set up. They can handle all the administrative tasks, including recordkeeping and IRS compliance, while boasting more than 50 payroll integrations.
The major tradeoff with this fully managed provider is the lack of investment options and retirement plans. They only offer 401(k) plans, profit sharing plans, and 403(b) plans for employees of public schools and tax-exempt organizations.
There are more than 30,000 mutual and index funds to choose from, but no other types of investment options.
Larger organizations might find the lack of diversity an issue, but companies that just want to set up a stable, no-frills retirement plan will find Human Interest to be a high-quality option.
The simplicity of the platform keeps costs low and administrative overhead to a minimum.
I recommend it for people who want to put their employee retirement plan on auto-pilot. They can focus on work and the savings will take care of itself in the long run. Low-risk index funds and mutual funds will build wealth over time with no special attention necessary.
It’s particularly effective for people who don’t want to learn about financial markets. Retirement funds are managed entirely by Human Interest, though they do make self-directed options available.
There are three different pricing tiers available, which are based on the level of administrative support:
- Essentials: $120/month base fee, plus $4/month per employee
- Complete: $150/month base fee, plus $6/month per employee
- Concierge: $150/month base fee, plus $8/month per employee
The Essentials tier offers a phenomenal price for an all-in-one 401(k) solution. Adding eligible employees at $4/month is less than even Guideline, though Human Interest’s monthly base fee is higher.
For small and midsize companies that are trying to grow, Human Interest lets them offer an affordable plan to attract good workers. As they scale that plan, costs remain low and predictable.
With Complete, Human Interest takes over a lot more of the administrative work, including signing and filing all of your IRS documents. Concierge comes with all of that, plus dedicated account management.
You can get started with Human Interest in fifteen minutes, the company says. Think about the difference those fifteen minutes could make fifteen years down the road.
#3 – Nationwide — Best for Large Organizations
Nationwide Mutual Insurance Company is one of the largest insurance and financial services groups in the United States and a member of the Fortune 100.
They offer every type of employee retirement plan I’ve talked about and they can administer other types of benefits as well, such as health savings accounts (HSAs).
They also provide a rich selection of investment options, as well, including a wide array of funds, bonds, and stocks.
Employees have a lot of say in how their investments are handled. They can choose a hands-off approach—like professional account management—where employees just sit back and let advisors drive.
These accounts are nice for employees who are not experienced investors, though they should understand how much they are paying for management. Most of these fees will be indirect, but Nationwide prides themselves on explaining all plan fees as clearly as possible.
Nationwide offers other options that give employees more control. At the hands-on end of the spectrum, employees can open up a self-directed brokerage account and invest in virtually any publicly-traded mutual fund, exchange-traded fund (ETF), bond or stock.
I like it for large organizations because of the wide array of plan and investment options. Large organizations need to be able to offer employee retirement plans that suit workers of all ages and abilities.
Rank and file workers have the freedom to invest how they want, and employers can create special benefits packages for top talent.
Nationwide also supports multiple types of auto enrollment. This can help increase plan participation in a way that makes sense for both the employee and employer.
You’ll have to get in touch with Nationwide for pricing. Because they already service more than 2.5 million participants and $141 billion in retirement assets, you can be confident that they will help your company grow its savings as well.
#4 – Vanguard — Best SIMPLE IRA
Vanguard is one of the world’s largest investment companies. They offer virtually every type of employee retirement plan available and give people a huge range of investments to choose from.
I recommend Vanguard for businesses that qualify for a SIMPLE IRA and want to set one up. This includes self-employed individuals, small business owners, and businesses with less than 100 people that don’t have another qualified retirement plan.
Vanguard doesn’t charge you anything to set up an account. There is a $25 annual fee for each fund in the SIMPLE IRA, but no additional costs beyond that.
And, once you have $50,000 of qualifying assets in your Vanguard fund, the $25 fees are waived. The annual fee then shifts to 0.30% of the total assets managed.
When it comes to administrative support, there’s not much to worry about with a SIMPLE IRA. There are no reporting requirements for the IRS, although there are certain employee notifications required.
In the event that something goes wrong, however, Vanguard has a stellar reputation for customer service and investor support.
Another reason to choose Vanguard is the wealth of investment options. This is true for companies that want to set up a 401(k), SEP, or other retirement plan, not just a SIMPLE IRA.
Employees using Vanguard for retirement may invest in more than 100 different mutual funds. This includes some of Vanguard’s index funds, which have generated incredibly consistent returns for investors year after year.
The sooner you begin an employee retirement plan the sooner everyone can start saving. It provides employees with an unrivaled sense of security and helps them keep a long-term perspective when the day-to-day gets tough.
Both Guideline and Human Interest are going to work for self-employed individuals, small business owners, and midsize businesses.
Guideline has the more diverse investment options, and a lower base fee each month. Human interest has the ability to support 403(b) plans in addition to 401(k), and may come at a lower monthly cost per employee.
For larger organizations, or smaller organizations that want to start a different type of retirement plan than a 401(k), Nationwide and Vanguard offer a wide range of options.
Nationwide is my top pick for organizations because of the deep range of investment opportunities. Individual employees save on their own terms, and employers can build out plans that help them make the most of every dollar.
While Vanguard has the resources to help any company save for the future, I wanted to call out their SIMPLE IRA because it is such a good deal for qualified small businesses. If the 401(k) is too daunting, a SIMPLE IRA with Vanguard is just the plan to start saving.
Extra Crunch roundup: Antitrust jitters, SPAC odyssey, white-hot IPOs, more
Some time ago, I gave up on the idea of finding a thread that connects each story in the weekly Extra Crunch roundup; there are no unified theories of technology news.
The stories that left the deepest impression were related to two news pegs that dominated the week — Visa and Plaid calling off their $5.3 billion acquisition agreement, and sizzling-hot IPOs for Affirm and Poshmark.
Watching Plaid and Visa sing “Let’s Call The Whole Thing Off” in harmony after the U.S. Department of Justice filed a lawsuit to block their deal wasn’t shocking. But I was surprised to find myself editing an interview Alex Wilhelm conducted with Plaid CEO Zach Perret the next day in which the executive said growing the company on its own is “once again” the correct strategy.
Full Extra Crunch articles are only available to members
Use discount code ECFriday to save 20% off a one- or two-year subscription
In an analysis for Extra Crunch, Managing Editor Danny Crichton suggested that federal regulators’ new interest in antitrust enforcement will affect valuations going forward. For example, Procter & Gamble and women’s beauty D2C brand Billie also called off their planned merger last week after the Federal Trade Commission raised objections in December.
Given the FTC’s moves last year to prevent Billie and Harry’s from being acquired, “it seems clear that U.S. antitrust authorities want broad competition for consumers in household goods,” Danny concluded, and I suspect that applies to Plaid as well.
In December, C3.ai, Doordash and Airbnb burst into the public markets to much acclaim. This week, used clothing marketplace Poshmark saw a 140% pop in its first day of trading and consumer-financing company Affirm “priced its IPO above its raised range at $49 per share,” reported Alex.
In a post titled “A theory about the current IPO market”, he identified eight key ingredients for brewing a debut with a big first-day pop, which includes “exist in a climate of near-zero interest rates” and “keep companies private longer.” Truly, words to live by!
Come back next week for more coverage of the public markets in The Exchange, an interview with Bustle CEO Bryan Goldberg where he shares his plans for taking the company public, a comprehensive post that will unpack the regulatory hurdles facing D2C consumer brands, and much more.
If you live in the U.S., enjoy your MLK Day holiday weekend, and wherever you are: Thanks very much for reading Extra Crunch.
Senior Editor, TechCrunch
Rapid growth in 2020 reveals OKR software market’s untapped potential
After spending much of the week covering 2021’s frothy IPO market, Alex Wilhelm devoted this morning’s column to studying the OKR-focused software sector.
Measuring objectives and key results are core to every enterprise, perhaps more so these days since knowledge workers began working remotely in greater numbers last year.
A sign of the times: This week, enterprise orchestration SaaS platform Gtmhub announced that it raised a $30 million Series B.
To get a sense of how large the TAM is for OKR, Alex reached out to several companies and asked them to share new and historical growth metrics:
“Some OKR-focused startups didn’t get back to us, and some leaders wanted to share the best stuff off the record, which we grant at times for candor amongst startup executives,” he wrote.
5 consumer hardware VCs share their 2021 investment strategies
For our latest investor survey, Matt Burns interviewed five VCs who actively fund consumer electronics startups:
- Hans Tung, managing partner, GGV Capital
- Dayna Grayson, co-founder and general partner, Construct Capital
- Cyril Ebersweiler, general partner, SOSV
- Bilal Zuberi, partner, Lux Capital
- Rob Coneybeer, managing director, Shasta Ventures
“Consumer hardware has always been a tough market to crack, but the COVID-19 crisis made it even harder,” says Matt, noting that the pandemic fueled wide interest in fitness startups like Mirror, Peloton and Tonal.
Bonus: Many VCs listed the founders, investors and companies that are taking the lead in consumer hardware innovation.
A theory about the current IPO market
If you’re looking for insight into “why everything feels so damn silly this year” in the public markets, a post Alex wrote Thursday afternoon might offer some perspective.
As someone who pays close attention to late-stage venture markets, he’s identified eight factors that are pushing debuts for unicorns like Affirm and Poshmark into the stratosphere.
TL;DR? “Lots of demand, little supply, boom goes the price.”
Poshmark prices IPO above range as public markets continue to YOLO startups
Clothing resale marketplace Poshmark closed up more than 140% on its first trading day yesterday.
In Thursday’s edition of The Exchange, Alex noted that Poshmark boosted its valuation by selling 6.6 million shares at its IPO price, scooping up $277.2 million in the process.
Poshmark’s surge in trading is good news for its employees and stockholders, but it reflects poorly on “the venture-focused money people who we suppose know what they are talking about when it comes to equity in private companies,” he says.
Will startup valuations change given rising antitrust concerns?
This week, Visa announced it would drop its planned acquisition of Plaid after the U.S. Department of Justice filed suit to block it last fall.
Last week, Procter & Gamble called off its purchase of Billie, a women’s beauty products startup — in December, the U.S. Federal Trade Commission sued to block that deal, too.
Once upon a time, the U.S. government took an arm’s-length approach to enforcing antitrust laws, but the tide has turned, says Managing Editor Danny Crichton.
Going forward, “antitrust won’t kill acquisitions in general, but it could prevent the buyers with the highest reserve prices from entering the fray.”
Dear Sophie: What’s the new minimum salary required for H-1B visa applicants?
I’m a grad student currently working on F-1 STEM OPT. The company I work for has indicated it will sponsor me for an H-1B visa this year.
I hear the random H-1B lottery will be replaced with a new system that selects H-1B candidates based on their salaries.
How will this new process work?
— Positive in Palo Alto
Venture capitalists react to Visa-Plaid deal meltdown
After news broke that Visa’s $5.3 billion purchase of API startup Plaid fell apart, Alex Wilhelm and Ron Miller interviewed several investors to get their reactions:
- Anshu Sharma, co-founder and CEO, SkyflowAPI
- Amy Cheetham, principal, Costanoa Ventures
- Sheel Mohnot, co-founder, Better Tomorrow Ventures
- Lucas Timberlake, partner, Fintech Ventures
- Nico Berardi, founder and general partner, ANIMO Ventures
- Allen Miller, VC, Oak HC/FT
- Sri Muppidi, VC, Sierra Ventures
- Christian Lassonde, VC, Impression Ventures
Plaid CEO touts new ‘clarity’ after failed Visa acquisition
Alex Wilhelm interviewed Plaid CEO Zach Perret after the Visa acquisition was called off to learn more about his mindset and the company’s short-term plans.
Perret, who noted that the last few years have been a “roller coaster,” said the Visa deal was the right decision at the time, but going it alone is “once again” Plaid’s best way forward.
2021: A SPAC odyssey
In Tuesday’s edition of The Exchange, Alex Wilhelm took a closer look at blank-check offerings for digital asset marketplace Bakkt and personal finance platform SoFi.
To create a detailed analysis of the investor presentations for both offerings, he tried to answer two questions:
- Are special purpose acquisition companies a path to public markets for “potentially promising companies that lacked obvious, near-term growth stories?”
- Given the number of unicorns and the limited number of companies that can IPO at any given time, “maybe SPACS would help close the liquidity gap?”
Flexible VC: A new model for startups targeting profitability
12 ‘flexible VCs’ who operate where equity meets revenue share
Growth-stage startups in search of funding have a new option: “flexible VC” investors.
An amalgam of revenue-based investment and traditional VC, investors who fall into this category let entrepreneurs “access immediate risk capital while preserving exit, growth trajectory and ownership optionality.”
In a comprehensive explainer, fund managers David Teten and Jamie Finney present different investment structures so founders can get a clear sense of how flexible VC compares to other venture capital models. In a follow-up post, they share a list of a dozen active investors who offer funding via these nontraditional routes.
These 5 VCs have high hopes for cannabis in 2021
For some consumers, “cannabis has always been essential,” writes Matt Burns, but once local governments allowed dispensaries to remain open during the pandemic, it signaled a shift in the regulatory environment and investors took notice.
Matt asked five VCs about where they think the industry is heading in 2021 and what advice they’re offering their portfolio companies:
- Morgan Paxhia, managing director, Poseidon Investment Management
- Emily Paxhia, managing partner, Poseidon Investment Management
- Anthony Coniglio, CEO, NewLake Capital
- Matt Shalhoub, managing partner, Green Acre Capital
- Jerel Registre, managing director, Curio WMBE Fund
How to Collaborate, Manage, and Work with Developers featuring Twilio’s Jeff Lawson
Maybe you think developers are weird beasts that type on a keyboard pushing out code, and then as soon as they become indispensable, they quit. In fact, many founders and CEOs struggle with simply talking to their engineers and communicating their needs. You may ask, “When can we ship this?” and receive an answer that sounds like gibberish to you. The mysterious nature of engineers is also their superpower as they build products that make the seemingly impossible possible.
At his core, Jeff Lawson is a software developer first, and the CEO of Twilio second. He knows both sides of the executive & engineering equation intimately. He gets what goes on in a developer’s brain and the detailed process of building software, but he understands that businesses are motivated to move quickly. In turn, developers need to adapt.
Also, an all-time SaaStr fan-favorite, Jeff Lawson recently chatted with SaaStr CEO Jason Lemkin to discuss his thoughts on collaborating, managing and working with developers. Here are his top pieces of advice.
# 1 You don’t need to be big. The engine of progress is a small team focused on a particular problem that’s dedicated to the customer’s needs. Start small and do it well. Plus, the best talent in the field doesn’t want to be lost in the company. Make things meaningful.
#2 Keep close to the customer and the problem. Twilio’s developers take turns doing regular customer support to know what users are struggling with and to develop an intuitive understanding of what’s needed. You might also include developers on sales calls from time to time — it makes everyone feel heard. Your team must be intimately familiar with the customer’s problems.
#3 Assign problems, not tasks. Often, business teams decide what to build and send a blueprint to the developers. But if a developer doesn’t understand the customer’s dilemma, they won’t be motivated or able to adjust. Include them in the heart of the problem and leverage the breadth and ingenuity of your team. Twilio couldn’t match offers from Google and Apple. Still, they offered their developers problem solving, responsibility, and the awareness that they were vital for the company’s future, not just the back button on Chrome.
#4 Provide executive enthusiasm. The CEO of Dominoes recruited his Head of Technology personally, telling him that his realm was the most critical thing Dominoes was going to do in the next decade. He took the job and recruited an incredible team with the same enthusiasm, building his boss’s vision. A phone call goes a long way.
#5 A sense of ownership solves the small stuff. Instead of “I need you to fix bugs,” lead with, “I need you to own this item that our customers care about and make sure it operates at the level it needs to every day.” And review the different strengths of each member of your team to get the right people in the right seat.
#6 Put the pieces within the puzzle. Help your teams understand where their projects fit in. If your developer builds what they think is a core feature, but it’s just a widget in the top corner, they might have to change things last minute, from fonts to framework.
#7 Let your teams play with different toys. Many software tools require no real upfront investment, and developers can test different tools and see what really hits home. Jeff stresses that “experimentation is the prerequisite to innovation.” The more experiments you run, the more likely your developers are to make the next big thing.
#8 Create a reliable infrastructure. You wouldn’t send your salespeople out with only a notebook. Equip your developers with the right infrastructure and processes to help them write code, ship it, test it, make sure that it’s stable, etc.
#9 Take a point of view. Even if your developers are distributed across locations, make sure they have a working style they can unite around. Not every team needs to work the same way, but the people in them need to have a functional identity. And, ideally, keep within three time zones…
You can get more of Jeff’s wisdom and advice in his new book, “Ask Your Developer: How to Harness the Power of Software Developers and Win in the 21st Century,” available now.
5 Interesting Learnings from Qualtrics at $800m+ in ARR
Qualtrics is one of our favorite SaaS stories at SaaStr. Like Atlassian, Qualtrics bootstrapped all the way to the growth stage, and did it outside of the SF Bay Area. Founder and Chairman Ryan Smith is also one of the most engaging and transparent CEOs out there, and we’ve had 3 amazing SaaStr sessions with him:
And most interestingly … they’ve gotten a second chance to IPO. After selling to SAP for a record $8 Billion at the time in the midst of an IPO roadshow, they then got the opportunity to spin out into a public company after all, at a far higher valuation.
How many of us get a second chance at an IPO? Qualtrics did. I’m almost jealous 🙂
They were at a $723m run-rate in Q3’20, so that should put them soon at $1B in ARR:
Here are 5 Interesting Learnings for us founders and execs:
#1. Only annual contracts, and plenty of professional services (25% of revenue). Qualtrics does have a long tail of 12,000+ customers, but many of its motions are pretty enterprise. 99% of its customers are on annual contracts, and 25% of its revenue is from professional services. 25% of revenue from services may sound high, but it’s a fairly standard ratio in true enterprise software.
Importantly, Qualtrics’ margins remain high so it’s not losing money on its services. Gross margins on services are about 35%. Not the 80%+ in software, but high enough to be profitable and not be a drag on the business. Blended margins are 73%, which is plenty high enough.
#2. Spending more on R&D at scale, not less. Qualtrics as a stand-alone company was spending about 16% of revenue on engineering (i.e., R&D) … and that ballooned to as much as 44% under SAP (re-investing in product) … and now has come down to 31% as the company marches again to being a stand-alone company. There are a lot of mini-lessons here on the ability to invest when you don’t have to worry about being public, etc., but the biggest reminder and take-away is you have to invest heavily in your product forever.
#3. From $35m in revenue in 2012 to $800m in 2021, leveraging 120% NRR. Just think about that for a minute. Let the power of 120% NRR and strong growth compounding over 8 or so years sink in 🙂
#4. About $250,000 revenue per employee. With 3,370 employees and $800m in revenue, Qualtrics does about $250,000 in revenue per employee. This is pretty consistent with other Cloud leaders at scale.
#5. 64 $1M+ Customers, and 1,200 $100k+ Customers (a 1:20 ratio). This is how a lot of us end up looking at scale. Qualtrics grew from 27 $1m customers in 2018 to 64 $1m customers today. Assuming they add up to say $100m ARR total, that means perhaps 15% of their revenue comes from $1m+ deals. But for every $1m customer, they have 20 $100k customers. That 1:20 ratio is pretty interesting and roughly what many vendors that sell to enterprises of different sizes, and in silos, see.
And a few bonus points:
#6. NRR consistent at 122%. We’ve seen some SaaS leaders NRR stay world-class, but decline a bit around $1B in ARR. Not Qualtrics. NRR is basically the same 120%+- for past 3+ years.
#7. Largest customers not growing faster than smaller ones. While Qualtrics has expanded its $1+ customers dramatically, growth in smaller customers actually has kept up nicely. Overall growth rate for “large customers” is 29% Year-over-Year, which with 120%+ NRR, should fuel Qualtrics’ growth for years to come. But smaller customers have kept up, and are still 90% of the total customer base of 12,000:
#8. The merger with SAP did seem to work. While I’m super excited Qualtrics is spinning out into its own public company, the company grew subscriptions an impressive 46% last year under SAP. It’s very hard to be critical of those results the first full year after M&A. Most folks slow down then, e.g. as LinkedIn did for a year or so after the Microsoft acquisition.
#9. No customer concentration, even with almost 100 $1m deals. This is interesting as we’ve seen a lot of customer concentration in recent SaaS leaders. But even being enterprise, no customer is more than 2% of Qualtrics’ revenue.
Also, while most value statements are pretty generic … I like Qualtrics’ a lot. Take a look here:
And a fun back look at the earlier days at Qualtrics here:
Doing 5, 6 or 7 Figure Deals? Don’t Forget the Services Revenue
25% of revenue from professional services may sound high, but it’s a fairly standard ratio in true enterprise software.
Importantly, Qualtrics’ margins remain high so it’s not losing money on its services. Gross margins on services are about 35%.
— Jason ✨BeKind✨ Lemkin ⚫️ (@jasonlk) January 15, 2021
If you’re doing SaaS for the first time (or even the second), the whole idea of charging for “Services” may seem an anathema. It sure did to me.
- If your product is so easy to use that you barely need sales people, why in the world would you need to charge for implementation? For support? For training and engagement?
- And isn’t it a bit unseemly to charge for services? Doesn’t it sort of say your product is Old School? SAP-level clunky?
- And isn’t services revenue a friction-full waste of time anyway? I mean, it’s not recurring. It’s not true ARR. Does it even count? I’m a SaaS company.
Maybe. Maybe for the 15% of the world that is like you and me, charging for services doesn’t make any sense, perhaps even anti-sense.
Turns out though, that in the vast majority of six-figure contracts, virtually every seven-figure contract, and quite a few five-figure contracts … there’s always a services component.
And it almost always seems to average out to 15-20% of the ACV.
I remember the first time I experienced this confusion myself, on one our first high-five figure contracts. We had a brutal negotiation over price. And then, at the end, they sent us a Schedule for Services. After getting beat down on pricing on the annual contract price … the Schedule for Services they sent us (without me even asking) guaranteed us another $20k a year in services, with $250 an hour as the assumed price for the services.
I didn’t fully understand what was going on here until I became a VP in a Fortune 500 tech company.
But the answer, it turns out, is simple once you get it.
First, in medium and larger customers, there’s always change management to deal with when bringing in a new vendor. And they not only understand there’s a cost associated with that (soft even more than hard) … your buyer wants to do the least amount of change management herself as possible. If you can do the training for her for a few bucks and saves her a ton of time … that’s an amazing deal.
Second, in medium and larger customers, they often have no one to do the implementation work themselves. So even if you weren’t saving your customer theoretical money by helping with implementation, roll-out, support etc. … they probably have no one to do this internally anyway. You’re going to be doing some, a lot, or all of this for them. They are OK paying for this, in the enterprise at least.
And most importantly … it’s how business is done. And — budgeted. When most larger companies enter a new vendor into their ERP system, they typically add an additional budget item or two along with the core contract price. One additional line item for service and implementation, in most cases. And in some cases, an additional budget for other add-ons necessary to make the implementation a success (e.g., an EchoSign on top of Salesforce). Both of these are often line-item budgeted at 15-20% of the core contract value for the product.
So net net …
- You probably can’t charge another 15-20% for services and implementation and training for a $99 a month product. Well, maybe you could, but it’s probably unprofitable and not worth it.
- But, as soon as the sale gets into the five figures, considering adding 15-20% for Services. You’ll probably get it.
- And plan for charging, and delivering, additional services revenue in mid-five figure and larger deals. The customers are happy to pay, and in fact, will expect it.
And if you don’t charge … you’re just leaving money on the table. You’ll have to do the work anyway. You may send negative signaling that you aren’t “enterprise” enough, that you aren’t a serious enough vendor.
And importantly, this extra services revenue still “counts” as recurring revenue if it’s < 25% or so of your revenues. I don’t mean that literally (it doesn’t recur), but what I mean is that Wall Street and VCs and acquirers and everyone will still consider you a 100% SaaS company if <= 25% of your revenues are nonrecurring. And you’ll get the same SaaS ARR multiple on those extra services revenues.
Same multiple. No extra work. 10-25% more revenue.
Don’t leave the services revenue on the table.
This is really true. We tend to disregard service revenues like 2nd class. But well designed services speed up adoption, remove fear to change, lock in customers and provide customer insights to better design the product. Qualtrics (below by @jasonlk ) and Carto are good examples https://t.co/RJATL2EHot
— Aquilino Peña (@Aquilino) January 15, 2021
(note: an updated SaaStr Classic post)
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