DigitalOcean, a cloud infrastructure provider targeting smaller business and younger companies, announced today that it has secured $100 million in new debt from a group of investors, bringing its 2016-era debt raise to a total of around $300 million. The company’s nearly $200 million debt raise in 2016 was preceded by an $83 million Series B in 2015.
TechCrunch spoke with DigitalOcean’s CEO Yancey Spruill (hired in 2019, along with a new, IPO-experienced CFO; the company added a new CMO earlier this year) to get under the skin of the new funding, and better understand the company’s revenue scale, its financial health and its future IPO plans.
The firm intends to use the new funds to invest in partnerships, boost product investment and grow what its CEO called an “early-stage” inside sales capacity.
For readers of our regular $100 million ARR club series, consider this something of a sister post. We’ll induct DigitalOcean later on. Today, let’s focus on the company’s momentum, and its choice of selecting debt over equity-derived fundraising.
Contextual growth
DigitalOcean is a large private company in revenue terms, with the former startup reporting an annualized run rate of $200 million in 2018 and $250 million toward the end of 2019. According to Spruill, all the company’s revenue is recurring, so we can treat those figures as effective annual recurring revenue (ARR) results.
Sticking to the financial realm, DigitalOcean told TechCrunch that it has a mid-20s percentage growth rate, and the company claims that its EBITDA (an adjusted profit metric) are in the low 20s. Citing a “strategy over the next several years to continue to focus very specifically on the SMB and developer communities,” Spruill told TechCrunch that DigitalOcean will scale to $1 billion in revenue in the next five years, and it will become free cash flow profitable (something the CEO also referred to, loosely, as profitability) in the next two.
All that and the company expects to reach a $300 million annualized run rate inside the first half of 2020. How has it done all of that without raising new capital since it put roughly $200 million in debt onto its book back in 2016? A good question. Let’s talk about DigitalOcean’s economics.
Economic efficiency
DigitalOcean has a pretty efficient go-to-market motion, which in human terms means that it can attract new customers at relatively low costs. It does this, per the CEO, by attracting millions of folks (around four million, he said) to its website each month. Those turn into tens of thousands of new customers.
Because DigitalOcean is a self-serve SaaS business, folks can show up and get started without hand-holding from sales. Sales cycles are expensive and slow. But, while allowing small companies to sign up on their own sounds attractive, companies that often lean on this acquisition method struggle with churn. So, I asked Spruill about that, specifically digging into customer churn via graduation, the pace at which customers that joined DigitalOcean as small companies left it for other players like Azure and AWS as they themselves grew (quote slightly condensed for readability):
Like any self-serve, early-stage, or SMB-focused business, [the] first three to four months is critical for [customers]. But when you look at our customer base over time — we look at every cohort of the eight year history of our company — all of our cohorts have grown each year, and our churn, which is what [your graduation rate] question is, do customers leave our platform, is de minimis after customers have been on our platform for a year or more.
So it doesn’t appear that churn is a catastrophe at DigitalOcean, which gives it what I’d call pretty attractive economics: Customers come in at relatively low customer acquisition costs, and with churn slipping very low after an initial quarter or so, the company can extract gross margin from those customers for quite some time. What does it do with that cash? It reinvests it. Here’s how Spruill explained that process:
The high retention rates of the customers and the strong revenue growth enable cash flow to support the growth and investment of the business and paying and supporting the debt. And when you think about the dilution, when you think about a business at our size and scale — the roughly $400 million of capital raised is probably the right proxy, if you look at our peers and our size and stage of company development — most of them the vast majority of the capital is equity. In our case, only a quarter of the capital, a little over quarter the capital is equity. So we’re going to use the cash flow leverage of the business to drive enormous returns to the equity in terms of not taking on that significant dilution, and still being able to grow the business in a in a responsible and exciting way.
The chorus sound effect you are hearing in the background are the company’s early-stage investors rejoicing at DigitalOcean not selling more shares to grow, concentrating the value-upside to existing shares. Shares that they own a lot of.
So let’s sum quickly: DigitalOcean is working to carve out an SMB and developer-focused cloud infra niche, keeping its economics in a good place by using low-CAC, self-serve revenue generation. The margins from that are paying for the company’s development, and its overall economics are good enough to allow it to leverage debt to invest in itself instead of equity. Overall, not what I expected to hear this morning, but that’s the fun part of news.
What’s in the future? Probably not an IPO any time soon. The company just raised more debt, money that it probably intends to use before debuting. The CEO told TechCrunch that “the IPO option for DigitalOcean is on the table,” going on to cite his company’s growth, growth rate, operating margins, “soon-to-be free cash flow margins” and scale as allowing the upstart “to have the conversation that this is a company that could go public.”
Next, adding DigitalOcean to the $100 million ARR club, and then I fancy a few more revenue milestones until an eventual S-1.