Marketing Automation Venture Funding: Profitable or Profligate?

I’ve talked to a lot of marketing automation vendors in the last year, and the topic of venture capital comes up often. Some vendors are proudly announcing new rounds, while others are deriding the fundraising as reckless and unsustainable.

I’m not exactly a Silicon Valley insider, so I decided to dig a little deeper into the topic.

On one end of the spectrum, you’ve got Marketo, which has raised $58 million to-date and $35 million of that in the last twelve months. They position these venture rounds as validation of their momentum in the market. They say the capital will be well-spent on product development and building an enduring company. Time will tell, but they seem to be doing very well.

On the other end of the spectrum are a dozen or so vendors who claim to be struggling with the VC math. Why do you need that much money to build a software company? Does it really cost that much to acquire a new customer? Wouldn’t a more “organic” approach to corporate development make sense?

VCs invested over $396 million in marketing automation vendors since 1998.

While marketing databases, data mining, and campaign management tools have been around for decades, the modern marketing automation market really started attracting venture funding during the dot com era (1). Of course, that bubble burst and there was little funding for a few years (2). However, activity picked up in a big way in 2005 as the economy recovered and investors became smitten with all things cloud (3). The financial crisis of 2008 and 2009 slowed funding again, but that was short lived (4). 2010 saw the largest flow of dollars into marketing automation vendors, including two sizable rounds by Marketo (5).

Why are VCs investing?

VCs recognize that marketing is changing rapidly. The Web has dramatically changed the way businesses market and advertise, and it has greatly improved the ability to measure these activities. The stories that marketing automation vendors are pitching to VCs – optimal execution and measurement of marketing in the Internet era – are matching with what those investors hear from marketing VPs at their other portfolio companies.

Second, VCs are enamored with all things cloud. Almost all of the marketing automation vendors are cloud-based and they have made great use of the cloud architecture. The subscription business model that most marketing automation vendors follow is also extremely attractive.

Is this money well spent?

A half dozen companies have taken in the majority of marketing automation venture funding. Below, I break them down, showing funding in relation to their revenue and customer base. In addition to detailing who took how much capital, we also attempted to analyze how effective they have been in turning this capital into revenue and customers.

Certainly, we don’t have all the data we would need to perform a detailed internal rate of return (IRR). In fact, these revenue and customer numbers are our estimates, so we might even be wrong in some cases. However, I think we’re in the right ballpark on each vendor and we can see some interesting information come to light.

First, Aprimo and Unica lead the chart by raising $76 million and $66 million, respectively. Both established pretty decent customer bases and revenues. During the past couple years, both firms had decent exit events of roughly $500 million. Neither was a home run, by VC standards, but they were the kind of double or triple that can make a fund look pretty good. I’d say the venture route worked out pretty well for these guys.

Eloqua and Marketo are the two market leaders that remain independent and they have raised $41 million and $58 million, respectively. Both of these vendors are enjoying good market momentum and have built customer bases and revenues that are on track to rival those of Aprimo and Unica. I would expect that either could be on track for a half billion exit, but both companies’ executives claim to be aiming for >$1 billion IPOs that will support a long-term, standalone company.

Siverpop and Genius have both raised significant amounts of venture capital, but it doesn’t appear that they have gained the same market momentum as Eloqua or Marketo.

What does a home run look like?

What makes Eloqua and Marketo think they can pull off billion dollar IPOs and knock it out of the park? We suspect that these companies executives’ and investors look to a small set of publicly traded cloud application companies for precedent. Specifically, Salesforce, SuccessFactors, and NetSuite have all executed successful IPOs and traded up to attractive valuations – an extraordinary valuation, in the case of Salesforce.

As of May 8th, Salesforce trades at $17.6 billion, Successfactors trades at $2.6 billion, and NetSuite trades at $2.2 billion. While they’d love to get a Salesforce valuation, I think any marketing automation software vendor would be excited to reach a $2 billion market cap.

What will it take to get there?

We went back and looked at these three public comparable companies’ historical financials to get a sense of what type of performance market automation leaders would have to pull together to earn a similar valuation.

Note: SFDC reports on a January fiscal year; NetSuite and SuccessFactors reports the calendar year, hence the funny alignment of years in my table.

Clearly, all three of these cloud vendor have built substantial revenues through consistent growth. However, what we find most interesting is the bottom line. SuccessFactors and NetSuite are still unprofitable, and Salesforce.com is only marginally profitable with a 6% operating margin. Compare that to SAP’s operating margin of 32% and Oracle’s 36%. What gives?

Well, Wall Street clearly likes the cloud computing model as much as their VC peers. By assigning premium valuations to unprofitable or marginally profitable companies, they are telling cloud executives, “Nevermind today’s profits; go for the big leagues. Invest in R&D, sales, and marketing to own cloud computing.”

The chart illustrates that each of these vendors are indeed investing a very large percentage of their revenues into sales & marketing and research & development. They are betting that if they invest enough money, in the right places, they can lock up the cloud computing opportunity before SAP and Oracle can turn their ships.

What does this all tell us?

Basically, it’s go big or go home. Marketing automation vendors that want to own their market, emerge as a cloud computing leader, and earn a ten figure valuation need to invest a lot of capital today to ensure their vision. They have the support of venture capitalists and Wall Street investors. Moreover, there is adequate precedent set by Salesforce, SuccessFactors and NetSuite. Raise a lot of money and execute well.

We don’t doubt that we’ll see some spectacular flame outs, but raising a lot of capital and investing aggressively is the most likely strategy to produce another cloud computing home run.

We want to hear what you think. Provide your responses in the comment section below.