HR technology is one of the fastest growing segments of the enterprise software space.
The industry is experiencing a serious inflow of venture capital and an increasing amount of M&A activity. Insiders and analysts, however, understand that the quality of this activity is far from perfect.
Research shows that 97% of exits in the HR technology history are trade sale, and most of them look pretty much the same—well-funded startups with a functional product that fails to evolve into sustainable businesses and get acquired by big platform providers like Workday, Cornerstone or SuccessFactors/SAP.
A number of major deals were completed in 2011, when HR technology providers were acquired by software powerhouses like SAP, Oracle or IBM for billions of dollars.
But in the last few years—with the exception of a few deals—many deals are significantly below $50M and assume little or no return for founders and investors (partially because these companies have raised excess amounts of VC money).
Why many startups fail to evolve into sustainable businesses
Big players are acquiring smaller startups on the edge of insolvency for little to no premium.
They understand that they do not need to pay extra to buy out a company with a great product or a strong team—they can just wait six months until the company starts experiencing problems with runway.
This is a learned behavior and this is exactly how big HR technology vendors design their acquisition strategies today.
It became easier for them to buy products (often with existing clients) rather than run risk of building product extensions and MVPs inside their own companies. They learned to be patient.
Why do all of these startups fail to evolve into sustainable businesses?
The “symptom” is always the same—revenue. Not even profits, (that has never been the key metric for SaaS companies), but revenue.
The problem; however, goes much deeper than that. There can be plenty of reasons why companies fail to deliver projected revenue growth, but let’s try to define those that are specific to the HR technology space.
Channels
Sales is all about getting your channels right; however, in the HR industry, sales require significant human intervention and relationship management.
Most HR technology startups I’ve researched sell $15k product to the enterprise and still go through numerous rounds of sales meeting with clients. In the meantime, according to data from Emergence Capital, a healthy average check for an enterprise client is $100k+, $50k for mid-market and $15k+ for the SME segment.
Of course, the latter should not require a monstrous sales process with excess human interaction, but rather an online sale; otherwise, your acquisition cost is unbearably high. Unfortunately, I have not yet seen a company that nailed this problem (if you have, please mail me at taraspolik@gmail.com).
Cycles
The often exhausting sales cycles in the enterprise software space should come as no surprise, but the HR industry goes even beyond that.
It is quite typical that the period between initial reach out and a signed contract is longer than six months. At the same time, startups need to move fast. Startups typically cannot afford an extensive sales team that would keep ongoing conversation with multiple clients.
This longish and painful process often results in HR technology companies that can’t get enough momentum to achieve “escape velocity” and grow into billion dollar companies.
Products
The problem with many emerging HR technology startups is there inability to charge a premium for their products. As a result, they have a ridiculously low average check for enterprise software, but still have to go through the same cycles and hand holding with their clients. A provider can only have leverage in setting prices when offering a holistic solution to clients that supports a major part of their workflow and delivers measurable and preferably immediate value – something that is often not the case with most of the point solutions.
Buyers
The HR technology buyer is a very different kind of animal: not necessarily technology savvy, has been getting knocks and bumps for current solutions (remember that in most companies recruiting is basically firefighting) and is not really interested in experimenting with new products.
Generally, early adopter clients in the HR space make a much lower percentage than in IT or even marketing, while early adopters and “innovators” are crucial for any product to gain initial momentum.
I have also heard a very interesting perspective on buyer behavior in HR and recruitment from Michael Beygelman, CEO of Joberate—he suggests that there are two types of behavior: people either seek pleasure or avoid pain.
From his experience, most HR professionals are of the second type—they prefer to buy products and services that give them an immediate relief from their pain (i.e. hire a recruitment company), not those that make their life better or more efficient.
Eliminating barriers for growing startups
Here is the good news: None of these are unbreakable barriers. Here are some things your startup can do to overcome them:
Add services into the offering to get a more stable cash position.
Many entrepreneurs choose to build additional services around their products; however, this can be a double-edged sword. On one hand, it allows companies to better satisfy the needs of their clients (in fact, historically in the HR technology space most clients are more willing to pay for services than for products) and provides additional revenue streams. On the other hand, this approach further increases the amount of human interaction required to serve clients and most VCs and acquirers tend to apply lower multiples to services revenue.
Build a platform that covers a significant chunk of organizational workflow and has the opportunity to become an industry standard.
Think about LinkedIn charging $5k per year for one recruiter seat.
This piece of advice can be a bit controversial because startups generally operate with limited resources and entrepreneurs prefer to have very strong focus. However, only a very significant improvement in efficiency or reduction in pain will allow you to charge premium for a product.
Learn to integrate seamlessly with other products.
According to research by KeyInterval, an average HR user has from seven to 20 different HR systems and points of login.
In the meantime, they all beg for a single user interface and for full compatibility and transferability of data (otherwise, it is meaningless and sits in silos). In order to deliver, smaller products have to work on their APIs and break barriers between their products and other solutions.
With proliferation of technology in HR, organizations will learn how to consume HR technology products and some of these problems will slowly fade away.
Recently, I have been meeting an increasing number of HR professionals from this rare early adopter type that are keen to experiment with new tools. I value those people like diamonds and always try to keep in touch and introduce them to products that in my opinion are not only cool to play with, but can actually add value to an organization.
The issues I described have very significant influence on our investment decisions and the things that we look for in startups. We tend to dig deep into the key sales metrics like booking growth, renewal rates, average check and contract value and customer acquisition cost.
Of course, we always talk to the clients to collect references and understand the customer journey.
For more business and finance tips, check our entrepreneurship and finance sections and subscribe to our weekly newsletters.