3 Reasons to Buy Enterprise Software From A Startup

For some enterprise software selections, the size of the company, the wide footprint a product addresses in the company and risk involved in implementation really requires working with one of a handful of major enterprise resource planning (ERP) companies. Part of this requirement stems from functional requirements, but the scale of implementing across a Fortune 500 company alone will require a vendor with a very deep bench at major consulting organizations.

But for most middle market or even large companies ranging up to a billion dollars, an ERP software company with a decent services partner base will usually be able to handle the complexity of the business and provide resources.

There is a third way though, and the emergence of multi-tenant software-as-a-service (SaaS) has enabled startups to reimagine enterprise software and deliver it in new ways. For any enterprise software category, there are likely products offered by giants, products from middle market software vendors and then products offered by venture-backed or bootstrapped startups.

3 Reasons To Buy Software From a Startup

1. Startups are by definition new. Their technology and the way they structure, package and design their enterprise software should also be new, and drive value in new ways. Some products may leverage disruptive technologies like artificial intelligence (AI) or the internet of things (IoT). So buying enterprise software from a startup should help a company differentiate itself from competitors by adopting new capabilities before the market. It can also reduce technical debt--the drag against the business caused by out-of-date and ineffective technologies that are hard to update and evolve to meet emerging needs. These legacy solutions that create technical debt also are more expensive to integrate with other solutions to deliver a unified process flow across software products.

2. New software will feature new architectures that are more affordable to evolve and easier to integrate with through native application programming interfaces (APIs). Newer software will be built for the cloud rather than operation on-premise, and subscription cloud pricing will move software investments off of CAPEX and onto OPEX. Enterprise software from established vendors may have been in market for years or decades, and the underlying architecture may be outdated. This legacy software may have been designed for operation on-premise, and due to product growth by acquisition or by sporadic functional add-ons, may not offer a consistent user experience from one module or screen to the next. Underlying data structures may also lack consistency and accessibility, and options to evolve the experience or functionality with low-code tools may not be available.

3. A startup software vendor really needs you. You can be a big fish in a small pond and find collaborative opportunities to influence and consult on the product. This openness to customer input can be one of the first thing an enterprise software company loses as they progress from product-led growth under a set of founders to EBITDA optimization under private equity or other corporate ownership.

How To Buy Software From A Startup

Rolling the dice on an unknown may not be the right move for a very large company's general ledger, this is true. But even for core functionality, there are steps a selection team can go through to ensure they realize the benefits of emerging technology and vendor collaboration without hitching their wagon to a vendor destined by shutter prematurely.

For venture-funded startup, one tactic is to wait for the B-round before seriously considering buying from the vendor. Series B investors expect to see product-market fit and a more reliable path to a return based on growing revenue. These savvy investors can be a valuable canary in the software buying coal mine.

Bootstrapped companies will not provide this window of transparency, but asking about the nameplates added and retention rates, and evaluating the product for how it uniquely drives value, will put this insight within reach given just a little homework.

In a talk I had a while back with serial software entrepreneur Raffi Holzer, now focused on his role as co-founder of AI-driven visualization tool Palazzo, a corporate leadership team should have a strategy and process defined to identify emerging software products to trial.

"Before you even get there as an executive at a construction company as they look at whether they are going to scale up with a particular solution, is which of the dozens solutions should they even bother with," Holzer said. "Having a process for determining which of these solutions they should trial, how to trial them and then assuring you can get to an answer on this trial rapidly is really the first step in that process. That is one thing I am helping companies evaluate today ... You raise a good point that a lot of these larger companies are hesitant to work with or certainly scale up with startups, particularly if you don't know how long or if they're going to be around. They're relying on venture funding, they may not be profitable yet."

Holzer also suggested software buyers consider making an equity investment in a startup they see as a key partner. This can further help marry the software vendor's product roadmap to your functional requirements. It will also be the only way for a software buyer to get visibility into the financial stability of the startup. Investing as a corporate fund, and perhaps more importantly rolling out a solution broadly across the company instead of restricting it to a limited footprint, will both serve as self-fulfilling prophesy that the software vendor will be ultimately successful.

Venture capitalist K.P. Reddy meanwhile suggested in a different discussion that customers of a startup investing in their software vendor may not be optimal.

"So a lot of our investors do the same, they'll invest ... alongside with us," Reddy said. "But the motives and risk tolerances are very different. A corporate-owned fund is not a venture fund. They are not really driving high, multiple returns with financial outcomes that are important. They're doing it because it's strategic to the core business, not because it's a financial instrument."

The StartUpside

Software from startups may present some risks, but once a product has reached product-market fit, the likelihood the product will simply disappear are minimal. Strong intellectual property and recurring revenue from a customer base suggest that an exit and liquidity event for founders and investors will come in the form of an acquisition, or very occasionally an initial public offering. The acquiring company may sometimes de-emphasize the product they acquire, but as larger enterprises have learned from past major software mergers and acquisitions, they are likely to have a more intelligent plan in mind to maximize return on their investment.

Holzer, for instance, exited his construction reality capture company Avvir, and according to IRONPROS coverage by Michael Cheng, Hexagon has rolled the product set into its current lineup as Hexagon Construction Analysis Portal. Performing a high-level audit of the value created by a startup offering, the degree to which it is unique in the market and hard to commoditize will help surface the value it offers a would-be acquiring company. Less unique offerings where multiple products offer similar functionality and legacy software offerings will present greater risk.

A large vendor may purchase several competing software companies and then pick winners and losers, or seek to replace all of them with a net new solution. Some less distinctive and unique offerings may become part of private equity rollups, where a large number of products are essentially thrown into a portfolio where they must compete for research and development and marketing resources.

But with a little sleuthing and a lot of well-defined process, enterprise software from startups can deliver unique advantages and put a company ahead of competitors even as they reduce their own technical debt.