Fresh off the heels of a report from Globalization Partners about international expansion not slowing down anytime soon in spite of the global pandemic, I was excited to open up a new research report from Frontline Ventures on the topic of expanding into Europe. Their research looked at 300,000 expansion-related data points from 175 B2B software companies expanding into Europe over the past 15 years. They also conducted interviews with more than 20 heads of European offices at B2B SaaS companies. In this post, I’ll provide a summary of relevant findings for readers of this blog, most of whom work in international expansion, sales, marketing, and localization roles at US-based tech companies. I’d also encourage you to read the full report, Global Ambition: How B2B Software Companies Win and Lose in Europe.
European Expansion Is Part of the Classic IPO Path
The Frontline report flags an important finding for tech company CEOs and other company executives. The researchers found that most US-based SaaS companies should derive 25 to 35% of their global revenue from Europe by the time they go public. What this means for a typical IPO candidate in the SaaS space is that approximately $80M of ARR should come from European markets by the time they go public."Most successful SaaS company IPO candidates obtain approximately $80M or 25-35% of their revenue from Europe by the time they go public." via @frontlinevc Click To Tweet
I believe this is a very important finding. I’ve written before that SaaS companies are destined to be global. But those that are headed toward an IPO would be well-served to think about how much revenue they will need to obtain from Europe in order to hit that target range and facilitate their global expansion in a more precise and strategic way. Overall, when it comes to an IPO path, I think the European revenue range is not so critical as a quantitative value, but rather, what it says from a qualitative perspective about the company’s viability and strength of its business fundamentals.
From an analyst perspective, when a SaaS company can hit that “magic number” of 1/4 to 1/3 of global annual recurring revenue (ARR) from Europe, it has more solid sea legs. Having a good percentage of revenue from Europe says to investors, “We’ve figured this out in more than one country. We can scale globally and address key markets.” Hitting that recommended range of ARR from Europe is basically another proof point of a solid business foundation. It’s a reassuring sign for investors to know that you’ve achieved product-market fit, or at least early traction, in markets outside of your home country. Savvy investors know that international markets are critical to drive sustainable and continued revenue growth for tech companies.
(Related: See the Biggest SaaS companies and How Many Languages They Offer)
Early European Office Mix: 60% Sales and 40% Engineering Roles
The Frontline report also explains that, counter to the prevailing narrative, most tech companies do not expand to Europe just for sales opportunity alone. Often, the first story you’ll hear about with tech companies and new international offices is that they are hiring sales people. But in reality, most successful tech companies build both sales and engineering teams simultaneously, from their earliest office opening.
To determine this, Frontline looked at the composition of SaaS companies when their European offices had 15 employees. The graphic above from their report shows the breakdown, which confirms that most tech companies “land” in Europe with a certain “sweet spot” ratio. 60% of their roles focused on customer-facing activities such as sales and customer success, while the other 40% are focused on product and engineering."The typical headcount split for early European offices of US-based SaaS companies is 60% sales and 40% engineering." via @frontlinevc Click To Tweet
I think this is another very important finding from Frontline’s research. In the early days of expansion into a new country, the “founding team” can behave very much like a start-up. For the early-stage international office to succeed, it’s often helpful for there to be a solid communication channel between Sales and Product. This is especially true if the person leading the local office does not have much past direct experience with the product or the general tech category.
In addition, as a company expands its presence in Europe, it becomes more and more important for companies to have local costs incurred directly in the countries and regions (and currencies) they are operating in to create a natural hedging effect where possible and to limit exposure to risk. Planting employment seeds early in two of the largest teams at most SaaS companies can create a foundation for those teams to grow bigger over time. For companies that care about their LTV:CAC ratios (which is every SaaS company), having the cost basis more directly linked to the size of the install base can help increase the likelihood of a healthy LTV:CAC ratio.
When to Expand to Europe? Post Series B and 8+ Years from Founding
I looked at this chart from the Frontline report with great interest, because the question of when to open up your first European office is one many companies wrestle with. What they found is that companies are better funded today when they expand into Europe than they were about a decade ago, and they are waiting a bit longer than they did in the past. Most companies are waiting until they are beyond their Series B raise and lately, are holding off until they are about 8+ years from their founding. Not long ago, they opened up those offices at an earlier point, at around year 6.
Getting the timing right and knowing when to open up a European office (versus just continuing to grow in Europe from outside of Europe) can be a very difficult decision to make. International growth in general is not for the faint of heart. Opening up new offices is a next-level undertaking, because it involves changing up your operations considerably and introducing more complexity into your business. It takes significant time, commitment, and resources to make it a success. That usually comes at the expense of devoting attention to other things, such as domestic growth or expanding product footprint."Most US-based SaaS companies open up their first European office post Series B and ~8 years after founding." via @frontlinevc Click To Tweet
The reason the timing matters so much is that entering new markets becomes harder as you get bigger for many reasons. When you are well-funded and growing fast during the phase in which you’ve achieved product-market fit and see your domestic business light on fire is precisely when you want to start looking at European office opening opportunities. As you get bigger, you might have less cash to burn, or you might need to keep a closer eye on the ROI time horizon for investments than when you’re in earlier phases of expansion and it’s easier to get approval for the outlays of cash required to set up an office.
Also, very often, your business won’t even feel the impact of these early decisions until you start to scale. The later phase, a few years after you first open up offices on the ground in region, is when international feels heavier and harder. The bigger you get, the more those early decisions and complexity actually can cause your business to strain at the seams.
The Five European Office Readiness Questions Every CEO Should Ask
Because the decision of whether or not, and when to expand with a European office can be tricky, I greatly appreciate the five questions a CEO can ask as a European readiness test that Frontline offers in the report:
- Is the US business humming?
- Are we well-funded?
- Is there demand from Europe?
- Is my exec team strong and deep?
- Is globalizing the company a top personal priority?
Frontline believes the CEO should be able to say “yes” to all five questions before they expand. Often, as the report mentions, companies expand too late out of fear, using the “growing US market” as a way to rationalize and procrastinate. Note especially question #5. The authors of the Frontline report share their observation that Google decided to prioritize international expansion even though their US business was booming, because it was a top personal priority for the CEO.
I truly believe that CEO conviction is the single most important enabler of international expansion. If the CEO truly believes that international growth matters for global success, everyone more easily aligns to support the international expansion cause. It helps if the CEO has direct experience with international growth too, ideally in a prior international role or at a company with significant international presence. Best of all is when the CEO has lived abroad or actually hails from another country."No amount of advocacy for globalization, no matter how passionate or data-driven, can succeed without the express endorsement of the CEO. Going global starts from the top." Click To Tweet
European Engineering Talent Matters Hugely for Size and Future Scale
Engineering talent matters for other reasons beyond just the founding team mix. It’s important to remember that engineering talent availability is often a major factor in deciding where to set up a company’s international office within Europe (or anywhere). Frequently, it’s heavily weighted in the criteria used for an international office selection.
Even though the pandemic has highlighted the importance of remote work, companies still have to take into account employment law and corporate tax questions. This decision needs to be made at the country level and city level, not at the “Europe” level. As a result, the decision of where to put an office can depend not just on current engineering and tech talent availability, but also the country’s long-term commitments (and past history) of producing tech talent. As a recurring theme here, the bigger you get, the more these early choices matter.
Also, Frontline points out that US companies often run into the “Bay Area bottleneck” with engineering talent. Sometimes, having an additional location in Europe can offer the advantages of making it easier to grow engineering teams due to lower levels of competition in some European cities than in the Bay area. It also creates more logistical hassle for US-based engineering leaders to deal with time zones, but the pros usually outweigh the cons, especially as the company gets bigger.
Lastly, having engineering talent directly in your European offices matters for another reason as you get bigger. The more of your Product team sits in Europe, the easier it will be for them to understand and influence strategic product direction, as well as important web application localization details. You don’t want your product design to be so US-centric that it inhibits your international expansion. This is a common pitfall for many US-based companies, who simply don’t realize that internationalization matters for the same reason extensibility and open APIs do. To truly get your global product groove going later, place engineering talent directly in your first European office as early as you can.
Strategy Often Doesn’t Enter the International Picture Until Later On
The Frontline report also states, “We find the majority of companies end up in Europe by stealth, not strategy.” They go on to explain that often, an entrepreneurial sales rep based in the United States will start booking deals in Europe, or an early employee will live out their dream of living in another country. Sometimes, an early acquisition leads to a presence in Europe. But it’s less common for a tech company to make a strategic decision to go into Europe. It often happens in a more ad hoc way.
Their findings match perfectly with my own observations. In addition to the reasons cited in the Frontline report, I observed that some companies expanded internationally because of a pre-existing founder or C-level connection to a given part of the world, a relationship to a country through a partner, or in some cases, because some other business they admired did well there, even if it wasn’t a company in the same industry. Going into a market in reaction to demand or “market pull” is another common reason for companies to expand.
So, the theme that Frontline highlights here is on point. I speak frequently with a dozen or so international expansion leaders at US-based tech companies. At most of these companies, early expansion decisions are not based on a thorough understanding of the markets a company wants to target. It’s even less common for them to be informed by a comprehensive strategy. Very few companies use even a simple 2×2 international expansion model like this one. The ones with a more evolved strategy are even less common, especially among companies below the US$500M revenue range.
Why does strategy matter? Imagine how much faster these companies could grow if they made these choices a bit more thoughtfully and intentionally, earlier. US-based companies that do decide to make international moves often “get to yes” quickly, but then move into a market with what I would describe as a “brute force” approach. They rarely do the necessary market research to truly understand what the local customer really wants, and how to sell to them more quickly and easily.
When these US-based tech companies fail to do what amounts to a tiny bit of homework in the grand scheme of things in a rush to get started, they actually grow at a less aggressive pace than they would if they went in with a well-informed growth strategy. Ironically, a solid strategy tends to be more common at a bigger company that is more mature and simply can’t afford to take the same risks as a company can when they are smaller and have more cash fluidity. The pace matters because it can dictate how fast a company will cross the IPO finish line (which is also a starting line for the next phase of growth).
See Europe for What It Is: A Critical Lever for Top-Line Growth
I asked Jamie Bristow, the lead researcher for the report, to comment on what surprised him the most about the research. He and the Frontline X team have worked closely with companies expanding to Europe over the last 20 years, as both investors and operators. They found that their research mirrored a lot of their own direct observations over the years. “We were pleased to see a lot of the learnings and experience picked up on the ground validated in the analysis,” Bristow noted.
However, while they expected some reaction to Brexit, they were surprised by the degree to which it affected companies’ expansion plans and how much it caused them to miss out on market opportunity. “We had been working with companies that were hesitant about expanding following the vote. But the drop in expansions was more significant than we expected,” Bristow explained. “This is a huge missed opportunity for the companies that shied away, caused by perception of problems rather than reality on ground.”
European expansion can be a daunting proposition for US companies that are on the fence to begin with and might fear their businesses are not yet ready. So, for the ones already wavering, the distance from Europe and lack of familiarity with the local reality in the face of Brexit uncertainty might give them additional reason for pause.
When I asked him for his most important takeaway from the research on expanding into Europe, Bristow highlighted, “The size of the market is often underappreciated by CEOs considering expansion. Europe is typically the biggest growth lever that the company hasn’t started pulling.” He emphasized the difference a well-executed European expansion can make to a company’s top line, “Well-run B2B software companies derive c.30% of global revenue from Europe at IPO.”
There are many other gems for US-based tech companies in the Frontline report, too many for me to cover in a single blog post. I found myself reading with interest and nodding in agreement throughout as I walked through their analysis. The research discusses Brexit, COVID-19 impact, where exactly (which cities) to put an office in Europe, types of early hires to make, and many other important considerations that too many companies end up learning the hard way.
For that reason, I encourage you to check out the full report, but especially if you’re a tech company executive with international expansion on your radar, or your SaaS company plans to pursue an IPO path someday. It’s far easier to accomplish these milestones if you learn from these findings and follow the lead of the best SaaS companies that have already “been there, done that.”