Mark McQueen, CEO of well-respected Wellington Financial, told BNN viewers last week that Halogen Software is the best high-quality Canadian initial public offering prospect in the last two years.
By Bruce Lazenby.
So why does the OBJ report that “the numbers aren’t all good” after seeing 24 straight months of financial losses from Halogen?
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OBJ can easily be forgiven for its view, as the business model used by Halogen and other software-as-a-service firms is significantly different than what was employed by their predecessors.
In my software days, we sold “perpetual” software licenses. So maybe we had a $100,000 up-front sale to the customer and a 15 per cent annual maintenance fee per year after that.
We installed the software on the customers’ servers, and the client managed their network and database. So we would collect $115,000 up front, and recognize that amount in the first year as revenue. Nice effect on the profit and loss statement, and on the balance sheet.
Ahhh, the good ol’ days.
Now, when cash is king, companies don’t want to “buy” the software. They just want to rent it, and they want the vendor to manage the servers and network and just deliver the functionality when and where the customer needs it. Sounds hard? It is.
So companies like Halogen don’t get the $115,000 up front. Maybe they only get $40,000 per year. This sucks in the short term. But if you can keep the customer for more than four years, it becomes much more profitable because you collect $40,000 every year instead of the old $15,000. And as your clients grow and start using more licenses and modules, the $40,000 grows to $45,000 or $50,000 or more.
In the SaaS world, the trick is to sign up a bunch of customers fast and treat them so well they want to stay and pay you forever. Did I mention that Halogen has won several awards for highest customer satisfaction in their market?
So why doesn’t everyone do this?
First, one needs a product that is hard to switch out. If your competitor can convince your customers to switch to its product easily, then a price war starts and all vendors lose.
Secondly, although the revenue is deferred, the expenses aren’t. Product development, marketing and hosting costs are real and now. So this means that SaaS companies need very deep pockets with lots of cash – something an IPO can provide.
So spending lots of money early – and losing lots of money – is exactly what great SaaS companies should do. Look as Salesforce as an example.
I have no idea if the Halogen IPO will be great or not, but I love that they are going for it.
Having more large public companies headquartered in Ottawa is a very good thing for us all. I’m cheering for Halogen – and you should too.
Bruce Lazenby is president and CEO of Invest Ottawa.