I was excited to open up a new research report from Frontline Ventures on the topic of European expansion. 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. 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. For a typical IPO candidate in the SaaS space, this means 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. This way, they can facilitate their global expansion in a more precise and strategic way. Overall, when it comes to an IPO path, the European revenue range is not so critical as a quantitative value. Instead, the value matters due to what it says from a qualitative perspective about the company’s viability. The strength of its business fundamentals are what matter most.
When a SaaS company hits that “magic number” of 1/4 to 1/3 of global annual recurring revenue (ARR) from Europe, it clearly 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 in markets outside of your home country. 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 most tech companies do not embark on a European expansion initiative just for sales opportunity alone. This runs counter to the prevailing narrative. Often, the first story you’ll hear about with tech companies and new international offices is that they are hiring sales people. But most successful tech companies build both sales and engineering teams simultaneously. This starts from their earliest office opening.
Frontline looked at the composition of SaaS companies at the point in their European expansion when their local Europe-based offices had 15 employees. The graphic above from their report shows the breakdown. It 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
This is another very important finding from Frontline’s research. In the early days of expansion into a new country, the “founding team” behaves very much like a start-up. For an early-stage international office to succeed, Sales and Product teams must build a solid communication channel. 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 pursues European expansion, 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. This can create a natural hedging effect and limit exposure to risk. Planting employment seeds early in two of the largest teams at most SaaS companies can create a foundation. Companies want for those teams to grow bigger over time. Also, linking the cost basis directly 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 the chart below from the Frontline report with great interest. Many companies wrestle with the question of when to open their first European office. The researchers found that companies are better funded today when they start on their European expansion initiatives than they were about a decade ago. Frontline also found that businesses are waiting a bit longer than they did in the past. Most companies are waiting until they are beyond their Series B raise to begin European expansion. Lately, they 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.
How can you get the timing right? How do you know when to open up a European office? Or, should you just grow in Europe from outside of Europe? These can be a very difficult decisions to make. International growth in general is not for the faint of heart. Opening up new offices is a next-level undertaking. You’ll need to change up your operations considerably and introduce more complexity into your business. Companies must devote significant time, commitment, and resources to making any European expansion a success. Local growth usually comes at the expense of devoting attention to other things. For example, you might de-prioritize 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
Timing is key when entering new markets. European expansion becomes harder as you get bigger for many reasons. When you are well-funded and growing fast is precisely when you want to start looking at European expansion 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. When you’re in earlier phase of expansion, 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
Deciding when to expand with a European office can be tricky. Frontline offers five questions a CEO can ask as a European readiness test:
- 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, companies expand too late out of fear. They use the “growing US market” as a way to rationalize and procrastinate. Note especially question #5. The authors share an important observation. Google decided to prioritize international expansion even though their US business was booming, because it was a top personal priority for the CEO.
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 international expansion. It helps if the CEO has direct experience with international growth too. 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. Engineering talent availability is often a major factor in deciding where to set up a company’s international office. Frequently, it’s heavily weighted in the criteria used for an international office selection.
The current pandemic has highlighted the importance of remote work. But 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. Office decisions cannot be made just at the “Europe” level. The decision of where to put an office can depend not just on current tech talent availability. It also hinges on the country’s long-term commitments to 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 hiring advantages. Grow engineering teams in cities with lower levels of competition, and you can grow faster. US-based engineering leaders will have to deal with time zones. However, the pros usually outweigh the cons, especially as the company gets bigger.
Having engineering talent directly in your European offices matters for another reason. Put more Product team folks Europe, and they can influence important web application localization details. US-centric product design inhibits international expansion. The truth is, internationalization matters hugely to global success. To truly get your global product groove going, 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.” As they explain, 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 moving to 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. Companies expand internationally for many reasons. A founder or C-level connection leverages a connection in a given part of the world. A partner opens up opportunities in a new country. The CEO admires some other company that did well there. Many companies also react to demand or “market pull” by entering the market.
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. Companies below the US$500M revenue range are often figuring it out as they go along.
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, they 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. Knowing local realities would enable them to sell to them more quickly and easily.
Don’t fail do your homework in a rush to get started. You’ll grow at a less aggressive pace than if you go in with a well-informed growth strategy. A solid strategy tends to be more common at a bigger company that is more mature. Bigger companies 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. It can dictate how fast a company will cross the IPO finish line. An IPO 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. They may be sitting on the fence to begin with. These firms might fear their businesses are not yet ready. So, Brexit might give a wavering company additional reason for pause.
I asked Bristow for his most important takeaway from the research. He 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.”