Quote Stock Sell has had a lengthy tech history, it was originally written in MS Access and has undergone a number of rewrites in SQL and is now fully rewritten as a web based SaaS product. It is targeted for small to mid sized businesses, in particular those who want to deploy systems that will allow them to scale over time. It is particularly suited for businesses that track serial numbers, batch numbers or expiry dates and hence is suitable not only for businesses in the hard product areas but also for FMCG, pharma and other product-based businesses.

Quote Stock Sell is realistic about the appetite of small businesses to actually dive into the analytics of their business. As founder Mark Lazarus:

Let’s be honest – how many owners of small businesses really want to log in to a software system and run reports to find out business information, most prefer to just check the P&L and balance sheet to see what is happening at a glance.  As such we try to reflect changes in Quote Stock Sell straight to the balance sheet – for instance if you mark inventory as faulty in Quote Stock Sell, we journal that value into “Faulty Inventory” on the balance sheet

Anyway back to the product. Quote Stock Sell has a wide breadth of inventory functionality. Some of the key areas covered by Quote Stock Sell are:

• Customer management
• Supplier management
• Quotes
• Orders
• Employees
• Products
• Inventory
• Warehousing
• Point of Sale
• Invoicing
• Supplier returns
• Reporting

That’s a very wide range of functional areas and ticks most of the boxes that the majority of small product companies will have. Quote Stock Sell is tightly integrated with Xero and I was keen to quiz Lazarus about this strategy and how much risk he sees of Xero encroaching onto their territory – Xero has already, after all, announced that it will be introducing some inventory functionality in the near future. In a logical response, he told me that

With regard to Xero stealing our lunch – that is always a thought in the back of every add-on developers mind.  We think Xero have a lot of other priorities before they can cover all the features of our system.  We’ve had many years of development go into our product.  Ultimately the answer is “Yes”, Xero could steal our lunch, but I think it’ll take them a while to come up with the same recipe (as they are busy with many other things), and maybe what we’re doing is not really something they would like to do.  We spent many years hoping Quickbooks would come up with a system to cover what we needed so we didn’t have to keep developing our inhouse system – but it never happened, maybe Xero will be different, but for now we have a window of opportunity, and we also have plans to eventually move into a wider market space and other verticals as well, diversification is key, but we have to start somewhere and this is where we chose, the Xero add-on space, we hope it will be fruitful for us.

It’s a point of view that makes sense, Xero is likely, at least in the short to medium term, to only skim the surface of what real product companies need to runt heir business, given their focus purely on this space, Quote Stock Sell should have no problem keeping ahead of them. The product looks really strong, I would suggest that the UI is perhaps one area that lets them down a little bit, it seems to show the products routes in a previous generation of software. but a pretty UI is simply lipstick, what really counts is what’s under the hood and by this measure what we have here is a very strong inventory product.

The free solutions saves business owners from having to manually enter receipts into their accounting package – it solves the horrible reality of shoeboxes full of receipts that is the bane of many SMB’s existence. Users can scan receipts and file them directly into their accounting application on the spot. But unlike other vendors who only take one step in this process (Xero, for example, allows images to be attached to invoices within the application) Wave is going further and files scanned information directly into the accounting application. Using optical character recognition (OCR) the relevant information is automatically pulled from the image of the receipt and streamed into the Wave platform where it creates an accounting record that is categorized and matched against existing transaction. The image itself is also stored in the system for later audit or cross-checking purposes. I quizzed Wave founder and CEO Kirk Simpson on the details of the app, he responded saying:

If a user takes a picture of a receipt or uploads it to through the web then we OCR it and populate as much data as possible including: vendor, date and total (more coming later relating to sub-total and sales taxes).  We also use Wave’s auto-categorization to add the expense account (where possible). If we are unable to pull out the data – or if we get it wrong (things like image quality etc…will affect this) then the user can make the adjustments and verify them. The OCR is a learning engine so the more we see the same receipt the better the engine will get.  With our almost 600,000 signed up users our engine will get very robust very quickly.

This sort of automation of SMB processes is incredibly enabling – I’ve spent time with a vast number of SMBs who used to use MYOB and have moved to Xero for example. When quizzing these businesses about what really provides the value compared to legacy applications, it is the ecosystem of integration and automations which really drive efficiencies. Whether it’s an integration with a CRM or the automatic categorization of transactions from bank statements – lubricating the day to day life of SMBs is super valuable.

Anyway – back to Wave – the receipts app is available either within the application or on a native iOS application, the company intends to release an Android version soon. Like all the other core Wave accounting products, Receipts is completely free – subsidized by the offers and deals that Wave offers business users – while some suggest that advertising within an application is a disincentive to adoption, Wave’s 600000 users tracking over $20B of SMB income and spending would seem to disagree. And with over $19M in funding, it seems the investors are also bullish about this model.

It is for this reason that when Xero launched in its home territory of New Zealand, the deal it had secured with a number of loal banks for auotmed bank feeds was just so game changing. Bank feeds are supremely useful, and by spending time negotiating the deal, Xero had given itself an awesome launching point. The global reality however is somewhat different, and it’s fair to say that Xero didn’t have the same success convincing banks outside of NZ to come on board, hence their decision a few years ago to use the Yodlee platform to run their bank feeds. this was a logical decision (Yodlee, now owned by Intuit, is a banking integration platform that already has thousands of banking institution integrated into it Clarification – Intuit’s DOES have a bank aggregation service through it’s acquisition of Mint but it’s not Yodlee).

However, we’re talking about money here and, as is always the case with dollars and cents, a higher degree of suspicion arose. This was especially so given the deftly overlooked fact that, by using Yodlee, a customer is potentially in breach of their banking terms and conditions. This is due to the fact that to use Yodlee, internet banking login details need to be given by the customer to the Yodlee platform – a fact which contravenes many internet banking Terms of Agreement.

But time moved on and, despite some concerns in the odd online forum, customers kept signing up, and enjoying the benefits that automated bank feeds can bring. Which gets us to the announcement from FreeAgent that they too are using Yodlee for their bank integration. It seems to me that, regardless of the reality of a situation, there is a point at which perception gets tipped by critical mass. Clearly using Yodlee is, by the letter of the law, a contravention of a customers internet banking terms and condition. But customers seems to be deciding (either because they are ignorant of the implications, or because they are realistic about the very low levels of risk involved) that it is worth it to achieve the benefits that integration can bring.

It’s completely sub-optimal of course. In any other industry we would be incredulous that a third party site needs to be given full sign on credentials imply to perform a data transfer – but it’s symptomatic of an archaic and compliance-heavy system that doesn’t exactly encourage innovation and open mindedness. It’s a sure bet that both Xero and FreeAgent would be over the moon if a more robust integration was possible on a broad scale, but all things being equal, for the time being they’re happy leveraging the industry default, Yodlee.

And what about the customers, should they be worried? Well I’d suggest that most customers who would balk at using Yodlee for bank feeds would also balk at entrusting their accounting data to a vendor who stores their information in the cloud. But for the vast majority, perception is actuality, and the fact that many vendors, and hundred of thousands of customers have grown comfortable with Yodlee has flipped their perception to one of safety. Let’s hope that a justified perspective.

The other day I was talking to a friend who told me that his retired father has suddenly discovered Xero on the bourse, and is considering investing. This is a reflection on the level of maturity of the New Zealand market and the investing public. It’s also, to be frank, a reflection on the fact that institutional investors and advisers have suddenly decided Xero is a sure bet, no doubt encouraged by the stellar share price growth. They’re buying the stock and advising their clients to do similarly. The day Xero entered the ranks as one of the top 50 market cap companies on the NZX they also suddenly gained visibility within the advisory community – the combination of a stock that isn’t heavily traded with this increased demand leads to an artificially high impact from low volume trades – this is great on the upside but painful on the downside. It’s actually very positive for the maturity of the company that they recently cross listed on the Australian exchange – it brings them a greater level of savvy investors that actually understand the dynamics of a potentially high-growth/high-risk investment. Drury has also signaled a possible future listing on the US exchange – this too would give both some stability and some liquidity to the share price – both positive things.

However this greater scrutiny will challenge the company to find analogues for its business. Drury has regularly pointed out the fact that Microsoft acquired enterprise social networking company Yammer for $1.2B as justification for the sort of valuation Xero is hitting. That might work for new Zealand investors who don’t quite understand the nuances, but Yammer was a very different deal for a couple of reasons:

• It had an exceptionally effective viral user growth pattern that Microsoft needed to learn about as they try and morph their business into the internet age
• It was an answer to the growing attention that social networking within enterprise was garnering – Salesforce’s Chatter product and Tibco’s Tibbr were increasingly making Microsoft look late to the party

For these reasons, and given the massive war chest of cash that Microsoft holds, the Yammer deal made sense. it may end up being a failure as a business division of Microsoft, but as a learning, marketing and corporate culture tool it makes sense.

Others rightly suggest that Intuit, the US’s biggest vendor of SMB financial products, is a potential suitor for Xero (some even going on to suggest that it is Intuit behind the buying that is sending the share price upwards – a theory I discounted). People point to the fact that Intuit acquired the personal financial management product Mint a few years ago and has an appetite for acquisitions that shoehorn itself into this new world. The Mint acquisition was, in my view, a very different deal, in a couple of important ways:

• Mint had delivered an interesting mix of behind the scenes business intelligence. It was mining aggregate data to deliver insights to customers and hence had some very useful technology that could be back doored into other Intuit products
• Mint, like Yammer, had worked out the viral uptake model and, at the time of acquisition, boasted over a million users

While Xero is doing very well from a user numbers perspective, for Intuit to acquire the company, it would have to be showing stellar growth in the only market that really matters – the US. Xero has really ramped up its US presence, the company has shifted into its own space and has ramped up the team significantly, but it’s coming from a relatively small customer base. While I recently reflected on the 100000 customer milestone and suggested that this indicated that Xero had reached escape velocity,  this statement becomes far more nuanced when we look at the joint factors of massive market capitalization and global market share dynamics. I believe that Xero, at its current market capitalization, is yet to become a compelling proposition for a US acquisition. Rather, what a company like Intuit is likely to do is one of two scenarios:

• Wait until someone enjoys meaningful customer success in the US and acquire them for a lofty sum, secure in the knowledge that they’ve gained a path to continuing market domination
• Acquire a company for a far more modest sum that has potential to become the breakout product in the space

The cloud accounting space isn’t a zero sum game however and this creates another difficulty for Xero, it is unlikely that we’ll see a repeat of the emergence of a small number of companies that dominate in the three big geographies (Intuit in the US, Sage in the UK and MYOB in Australasia). Xero is helped by the fact that in the US there is no vendor that has really captured market share – Outright (recently acquired by GoDaddy) and Wave (an interesting company with a free model) are the two best known domestic providers, but potentially more compelling is FreeAgent, a UK based vendor that has recently entered the US market and is a savvy operator.

Xero is executing well and their potential is massive. However potential only explains part of a business’ valuation, does Xero’s potential justify a $1.5B valuation? Not in my analysis – surely it may go higher as market frothiness and low liquidity combine to drive the economics, but eventually an equilibrium needs to be found, one that is based on customer numbers, market growth and eventual profit – we’re yet to see Xero deliver on that.

Wave is continuing that velocity with the announcement today of WaveApps, a combined portfolio of applications that now constitutes a single integrated solution covering invoicing, accounting, payroll, payments, receipt management and other financial application requirements SMBs have. Wave is pushing the story that this centralization and integration of the different applications makes it easier for SMBs to runt heir businesses. Now I’m all for integrated applications, but it has to be pointed out that the different functional areas that Wave is integrating (and calling revolutionary) are functional areas that most accounting products include within their single solution – payroll perhaps not but the others are generally offered within one product – so the lofty claim by Wave is perhaps a little disingenuous.

In messaging this release, founder of Wave Kirk Simpson is looking to differentiate himself from other cloud accounting vendors who serve slightly larger organizations, as he points out:

There is a world of difference between the needs of a five-person company and a 55-person company.When we say ‘made for small business,’ we mean Wave is really built to work the way a small business owner wants their tools to work. This includes the one-person shops and ‘solopreneurs’ that make up more than half of small businesses in North America

This would appear to assert the fact that for these smallest of businesses, a rich ecosystem of applications is less compelling than is a tightly integrated solution – even if it is, by nature, somewhat less broad than a pick of best-of-breed solutions. They’re also strongly differentiating themselves from the freemium versions of their paid competitors’ products – Wave has free online accounting and free invoicing and receipt management – regardless of the number of invoices/receipts a business may generate.

With this release Wave is also announcing an upcoming mobile receipt scanning application that automatically converts scanned receipts into digital transactions within the accounting platform – this product will be free, but will come with a paid option for those who want manual checking of the digitization.

One of the paid services that Wave includes is payroll – for $5 per employee per month, Wave provides full payroll functionality, including direct deposit services. This is a strong differentiator from the front runner in the cloud accounting space, Xero, who only has US payroll via an integration with ADP – a service that works fine, but doesn’t have the design aesthetic of more modern products. it looks fairly probably that Xero will extend payroll to the US via it’s recently acquisition of Australian payroll vendor PayCycle but in the meant time, this is one drum that Wave will continue to beat. A mobile app for Wave Payroll will also be available early in 2013.

Wave is also introducing an interesting credit card payment facility that should simplify the acceptance of credit cards, along with clarifying the fee structure, for SMBs. Wave customers have a “pay now” option on their invoices which will let customer pay by major credit card. As expected a payment will be automatically reflected in the accounts receivable section of the ledger.

Finally Wave is delivering on the reality for most SMBs of a blurred distinction between business and personal finance. They are integrating personal financial tools that can be used as a budgeting and reporting aid on both personal and business accounts.

All these different product changes called for a rethink of UI and Wave is rolling out its new UI today as well – the UI looks really good and, I have to say, is very reminiscent of the Xero experience. No one denies that Xero really leads the space in terms of a friendly and intuitive UI, in taking guidance from Xero, Wave have done the logical thing.

Wave is a really interesting company – while some question the willingness of SMBs to use a free product and potentially let themselves in for advertising spam, the reality is that a significant part of the SMB community will be attracted to a product that is free. While other cloud accounting products might be beautiful, that beauty comes at a not-negligible cost for businesses. Wave is right to bank on a significant proportion of SMBs out there being willing to put up with a bit of advertising in return for getting free software.

For those who haven’t seen the details of the deal, Matrix Capital Management is investing NZ$58 million and Valar Ventures NZ$24 million into the company. Their total investment of NZ$82 million includes a purchase of NZ$22 million of shares from Xero’s three largest shareholders. All the transactions are priced at the 20-day volume-weighted average price at the time the deal was negotiated – NZ$6.00 per share. An interesting aspect of this is the fact that two of the founders, and MYOB founder (and large Xero shareholder) Craig Winkler are cashing out. Over on BoxFreeIT, Sholto has pointed out that:

Matrix Capital Management is investing NZ$58 million and Valar Ventures NZ$24 million. Their total investment of NZ$82 million includes a purchase of NZ$22 million of shares from Xero’s three largest shareholders. All the transactions are priced at the 20-day volume-weighted average price at the time the deal was negotiated – NZ$6.00 per share.

Cashing out is always a difficult subject. In the past few months we have seen both sides of the debate. Early Groupon investors were eviscerated when the company’s IPO was seen as largely an opportunity for them to cash out at significant gain. The performance of the deal deals company post-IPO seems to have justified this criticism, it seems the founders were aware of the temporary nature of the business and enjoyed the opportunity to take the money and run. On the other hand, Evernote recently raised USD85, in part to provide some liquidity to early investors, this move was largely supported, in part because of the very up-front nature CEO Phil Libin explained it.

In explaining the justification for cashing out, Xero CEO Rod Drury said that:

The investors made the offer to buy shares from the three largest Xero shareholders in order to minimise dilution to existing shareholders. As a result of the new share issue and transactions, Matrix Capital Management’s shareholding will increase from 1.8% to 9.8% and Valar Ventures will increase from 3.9% to 7.0%. Director Craig Winkler’s shareholding will reduce from 19.5% to 15.7%, Chief Executive Rod Drury’s shareholding will reduce from 21.0% to 18.5% and co-founder Hamish Edward’s shareholding will reduce from 5.7% to 4.9%.

As with all of these things, the real discussion that occurred around the deal is hidden from public view – but the fact that the share price has increased since the funding, despite the fact that existing shareholders have in fact been diluted somewhat by the round, indicates ongoing support for the company – it seemingly can do no wrong, at least in the minds of it shareholders who, outside from the handful of large funds, are both small scale, and long term. The impact on the market cap of Xero can be seen below, this round has pushed the company past the NZD900M mark, this despite it, as yet, being unprofitable.

The investors have obviously determined that Xero, despite coming from a relatively modest based of some 100000 customers worldwide, has the ability to scale into the millions – it’s going to have to if it wants to make its later investors a return. While Instagram, a company with no revenue, recently sold for close to $1B, it is in a very different space and enjoyed the benefit of being in a highly competitive market where a number of massive properties could all have been considered potential buyers – while Facebook snapped it up, it could easily have been Twitter or Google who did so. A different situation exists for Xero, despite Drury’s assertions that they’re building the company as a long term hold, the sort of investors they’re getting now are going to want to see a big return – there’s two ways this may occur:

• Finding someone with deep enough pockets, and a strong-enough stomach to buy Xero. The list of potential buyers gets shorter as the valuation goes up – clearly Intuit is a potential buyer, but there’s not a particularly good cultural fit there and it would be a marriage borne out of necessity rather than love
• A re-listing on the US markets which have a new-found passion for B2B stocks. The recent success of the Workday IPO indicates this could be a potential model for the company

MyPOV

Xero should be proud of the fact that such canny investors have got faith in their ability to execute. But with this investment comes a new and heightened level of scrutiny that might prove uncomfortable to the company that, until now, has enjoyed almost unwavering support from shareholders. It is always interesting to see how a company which is the darling of a market place, handles the increasing overview and potential criticism that comes from higher-caliber investors. Clearly Valar and Matrix see lots of potential here – but these funds have a short to medium term horizon on that benefit – they’re going to need to see Xero scale quickly to see those gains. And that’s where the money comes in – Drury has already flagged the possibility of investing in a US based call center (which on its own is somewhat interesting since he has previously been very critical of high touch, and hence high cost, customer support structures). I’m still a little unsure of how Xero is going to really accelerate growth outside its home markets of NZ and Australia – it’s doing OK in the US, but this level of funding means they have to do superlatively – that’s not a given.

Of late Xero has started to attract some investment analyst commentary and this has largely been cautious of Xero’s valuation and prospects. Notwithstanding the immediate share price benefit that this latest funding round has had on the company, these fundamentals haven’t changed and Xero is exceptionally highly prices given it’s low liquidity and financial performance – it’s all about potential gains which increases the risk of investing significantly.

Perhaps the most accurate, if somewhat coarse, analysis came from a friend of mine with a history of investment banking. When discussing the market cap and opportunity that lies ahead for Xero, he joked about the dubious nature of the business model but added:

All due respects though. Rod found a way into the US money machine and really, if they can keep customer acquisition up, they are bound to be taken out by some bozo, just by sheer dint of their size

It’s not an elegant approach – but in the thrust and parry of technology investing, this $80M stands as a real validation that Xero might just be able to achieve the lofty goals its founders and early investors have set it.

Founded in New Zealand, TradeGecko is now based in Singapore and part of JFDI, a member of the global accelerator network. TradeGecko borrows cues from more enterprise-focused SaaS applications and includes an activity stream in order to surface relevant information for different people dealing with a stock management process. My experience gives me first hand knowledge of the face that SMB inventory-management tools are generally cumbersome on-premise offerings that are expensive, inflexible and difficult to use – some new entrants are trying to solve that and TradeGecko covers some areas touched on by other companies such as Unleashed Software, BrightPearl and Magento. At the top end, and generally out of the range of SMBs, are the enterprise grade SaaS plays like Intacct, NetSuite and Salesforce.

TradeGecko is aimed at a wide range of businesses including importers, distributors, wholesalers, manufacturers and designer-makers. Co-founder Carl Thompson formerly ran a clothing label part of his frustration at the the amount of administration involved in managing traditional systems led to the founding of TradeGecko.

TradeGecko is currently in beta and is currently integrated with Shopify. Further integrations with Xero and VendHQ are in the pipeline.

An added part of the roll out however was the introduction of a link at the top of online invoices which takes customers to a customer portal where they can see their invoicing history and amounts outstanding. Again a super valuable addition to the product. Things got a little unstuck however due to Xero’s understandable desire to track an audit trail around who is opening these invoices. The “link to other invoices” button takes end customers (ie the customers of Xero users) to a page which allows them to either login to Xero (if they’re already a user) or set up a free Xero login that gives them access to their invoice history.

This is a seemingly innocuous step, and one which, after the small hurdle of registering, will drive some real efficiencies for businesses. The problem, as shown from the large number of comments on the Xero blog post is that this is the first time that the customers of Xero users have been presented with anything that specifies the origination of the invoice. Previously emailed or printed invoices came in a fairly generic format that could have come from any number of accounting solutions (or a word template for that matter).

A number of commenters then saw this move as an attempt by Xero to utilize their business (ie the business that is a Xero customer) as a business development and sales channel. The account setup requires end users to create a Xero account – in this day and age when customer loyalty and customer data is sacrosanct, a number of people balked at the suggestion that Xero would, in essence, have a direct relationship with the customer. Xero justified this step by saying that:

The reason we require a login to view outstanding invoices is to give you an audit trail of exactly who has viewed those invoices and when they were viewed.

I’m not completely convinced the audit requirement argument is valid, if full audit trail was required then Xero wouldn’t be happy to email an invoice which can be forwarded ad infinitum. As it is, invoices are insecure and I would be surprised at any concerns from Xero customer in the event that the link to invoice history didn’t require a login.

In hindsight (and isn’t it always a great thing?) Xero would probably have been wise to have the “link to all online invoices” and hence the invitation to setup an account with Xero deselected by default – as it is removing the link from all invoices is a fairly complex and convoluted process that is likely more than many Xero customers really want to contend with.

Kudos to Xero head of design Phil Fierlinger who quickly wrote a post that detailed some of the thinking behind the functionality. There’s an interesting thing to look at here though, Xero now has over 100000 customers but has ambitions to service millions of customers – as they look for new ways to grow, introducing these sorts of viral features becomes attractive. In fact this is the way that their competitor FreshBooks has grown to its massive size. The difference is that a huge number of FreshBooks customers are using a free service, they expect that FreshBooks will, to a degree, leverage their networks to grow. The technique sits uncomfortably with Xero’s customer who are paying for the service. As one commenter said:

We pay a monthly fee – so in my view it’s not reasonable to use us to advertise your service. I think the online invoice should be on an unbranded domain without Xero links unless I choose to add them.

The bottom line is that online invoicing is an immensely useful tool and will be seen as the default way to do things in the future. But introducing new functionality like this needs to be done with a lot of thought, and vendors should always err on the side of caution, especially when attempting to leverage their customer’s customers. I suspect Xero will look at this release and think about the way it approaches these sorts of changes in the future.

A video of the workflow is embedded below

Sales Invoices from Xero on Vimeo.

On my first ever trip to the Bay area, six or so years ago, I attended the, now defunct, Office 2.0 conference. At the event I moderated a panel looking at what Accounting 2.0 actually meant and the value it could drive. The panel was a who’s who of the space and included folks from bill.com, Mint, FreshBooks and Wesabi. As an aside it’s interesting to see where those companies are today – both Mint and FreshBooks are still around and growing well while remaining independent. Mint was famously acquired by Intuit while Wesabi has sadly departed.

During the panel, Mike McDerment, founder and CEO of FreshBooks eloquently articulated their rationale for remaining laser-focused on being purely about invoicing and not jumping into the full cloud accounting space. It is a strategy that I’ve been dubious about ever since FreshBooks launched – I believe invoicing is only on part of the broader financial system requirements of an SMB and to miss out the other integral elements (accounts payable, general ledger etc) was somewhat of a half baked concept.

I always figured that the company knew best and their rampant growth was an indication that they were right, and my ideas were flawed. Bear in mind that FreshBooks boasts of customers in 120 countries, has built a 90 person company and has more paying customers in the US than any other accounting/invoicing application apart from QuickBooks.

News from an open letter to the FreshBooks community from McDerment recently changed all that. In the letter, McDerment told of a fundamental change within the company, a move to changing the way they describe what they do from being Cloud Invoicing, to Cloud Accounting. McDerment notes that over the last few years the company has slowly introduced more non-invoicing specific functionality – expense tracking, profit and loss reporting etc. He reflects on the fact that many FreshBooks customers are using the product as their “accounting system” and hence the company is now articulating what they do as accounting software.

Semantics or a Fundamental Shift?

While some might suggest that this is just marketing spin, designed to offset the increasing threat of full-blown SMB accounting solution Xero, I believe that there is more to this announcement than simply branding. FreshBooks has built out a very rich level of functionality for invoicing, but it has discovered, I believe, that SMBs want to tick off all the boxes of their accounting requirements from one vendor. While this is something of a departure from a company that has long been an advocate of the best of breed style of SMB software (FreshBooks is a foundation member of The Small Business Web, an affiliation of software vendors selling to SMBs who all adhere to a viewpoint about integrations and point solutions), it is a logical one. Businesses don’t want to have to invoice in one application but to go into another application to reconcile their bank accounts or provide their data to their accountant – they want to do all of that in one application, with one user interface and experience.

Reassessing the Accounting Landscape

Cloud accounting for SMBs is a largely untapped potential market, particularly in the US. While Xero is the biggest global vendor, with 100000 customers it is an important, but tiny player when compared to the desktop behemoths, MYOB, Sage and Intuit who together account for around six million business customers. No one has yet really got to scale in this space. Enter now FreshBooks who can boast that five million companies have used their product over the time of their existence. While FreshBooks has a massive free user base, and clearly a large number of those five million have dropped off, it’s fair to say that in terms of mindshare, FreshBooks beats Xero hands-down. What Xero does have, is a strong channel and partner strategy with accountants, and this is something that FreshBooks are starting to talk about now. In his letter McDerment stated that;

While FreshBooks will always be designed for you, the business owner, we are going to make it easy for you to work with your accountant, and make it easy for your accountant to work with FreshBooks. So while your FreshBooks account won’t have all the advanced features that accountants need at their fingertips, and it won’t be mired in accounting jargon that’s confusing and complicated for you, we’re going to build bridges between your FreshBooks account and the complex tools your accountant needs.

That’s an aspirational message, but a difficult one to deliver. Accountants are notoriously conservative and at the same time concerned about threats to their traditional revenue. This is something that Xero has battled over the years and generally managed to obviate through their very strong messaging about accountants being their route to market and trusted partners – indeed, while Xero surely has a direct sales strategy for part of its operation, this is somewhat understated and the accounting partners sit front and center.

Not so FreshBooks who haven’t needed strong ties into accounting practices – a move to full accounting changes this and FreshBooks will need to carefully balance their self-service, SMB-led uptake, with the concerns of accounting partners who are undeniably something of a gatekeeper when it comes to choosing software for SMBs.

Crystal Ball Gazing

The space just got a little more interesting. In the US Intuit has largely been asleep at the wheel and doesn’t have an overarching compelling cloud story. While the Intuit Partner Platform is interesting, it hasn’t seemed to set the world on fire. Xero on the other hand is still an unknown in the US. It has reached a global figure of 100000 customers which is impressive, but US growth and go-to-market is still largely unknown, especially so considering how fragmented the US market is and the fact that Xero follows a strong strategy of using accountants as a sales channel.

And now FreshBooks ponies up and seeks to translate its massive customer base (both paid and free) into something much bigger. So does intuit acquire FreshBooks in order to both gain a compelling Cloud solution and counter the threat from Xero? Perhaps – Intuit has, after all, shown a history of acquiring companies to further their product portfolio. Note though that FreshBooks is well funded and firmly entrenched. A land-and-expand strategy which sees them remain independent but leverage their footprint in the invoicing space to become the new uber-accounting vendor is also plausible.

And what does it mean for Xero? The fledgling in the US market? Well in many ways it is positive, FreshBooks now helps it to articulate the benefits of Cloud accounting and does so in a more direct-sales model which isn’t overly threatening to Xero’s channel strategy.

Time will tell – stay tuned for updates!

• Xero now has 100,000 paying customers – up from 45,000 at last year’s Annual Meeting
• Xero’s first 50,000 customers took 5 years to achieve, the second 50,000 was achieved in 10 months
• Annualised committed monthly revenue has risen to $34.5 million, up from $25.5 million at 31 March 2012
• 57% of Xero’s committed monthly revenue is from offshore markets, up from 51% at 31 March 2012

I’ve been critical of Xero myself in the past, and have had to suffer the displeasure of CEO Rod Drury, someone who doesn’t appreciate criticism, especially not from someone in his own country. As an aside, and having spent time talking with, and questioning other public and private technology CEOs, I would suggest that Xero needs to get a little more used to this side of public exposure – especially as it moves into the more critical US market. Anyway, that aside, the Xero numbers firmly put it into escape velocity, here follows my reasoning.

MyPOV

Many critical commenters point out that Xero has not yet reached profitability and continues to add expense to its business by way of staff hiring. This criticism is unsurprising given that Xero comes from a country which has little experience in high-growth software businesses. To understand the dynamic it is important to understand the accounting software industry where three vendors, MYOB, Sage and Intuit claim incumbency globally. Given this triumvirate, it soon becomes clear that anyone who wishes to break their hold on the market needs to scale quickly in terms of customer numbers – with 100k customers, Xero is now a recognized competitor and this leads it into the territory of the other big software trend, acquisition. This is not a “slow organic growth” opportunity – anyone wishing to challenge the incumbents (and contrary to public perception, Xero has a number of competitors in the space trying to do so – FreeAgent, KashFlow, Pearl, Zoho etc) needs to focus on rapid growth in order to both beat the other new upstarts, and gain the attention of the big boys.

When Xero was first formed, and perhaps in an attempt to appeal to parochial New Zealanders, there were many comments from the leadership about wanting to build a long term New Zealand business. This has softened recently with an admission in the past year from Drury that an acquisition would occur should the price be right (in that instance Drury suggested that his personal metric was a higher price than that garnered by TradeMe, a $700M acquisition). With the market capitalization hovering around the $600M mark now, a close to $1B takeover looks plausible. Obviously the number of potential acquirers reduces as the price goes up but both Intuit and Sage are no doubt putting a ruler across Xero as they realize their own cloud strategies are lacking. There are also a number of other vendors who sell to the SMB space who will be looking at the company – it’s worth noting that Xero competitor Outright was recently purchased by large US hosting company GoDaddy – it’s a natural fit for GoDaddy who has millions of SMB customers, so don’t look past other ISPs, general technology companies, banks or business service provision organizations taking a look at Xero. Given a very low level of liquidity for Xero (share turnover is incredibly slow and the vast majority of the stock is owned by 100 individuals) and the $1 per share initial purchase price at IPO, there could well be some pleased investors who could reap a 5x or more return in the event of an acquisition.

Xero has its share of detractors – many venting their spleens anonymously on New Zealand’s NBR website. Most of their criticism focuses on two distinct areas;

1. Criticism of immature investors who seem unwilling or unable to question the Xero strategy
2. Questions around profitability

The first criticism is probably fair. As I’ve said before most investors seem a little too eager to give Xero free realm to do as they see fit – it’s unusual for this to be the case with public companies and sometimes lulls them into a false sense of complacency which is dangerous when new markets are entered, as an aside it will be very interesting to see what happens if and when Xero lists on the Australian stock exchange where it has neither the home town advantage nor the lower maturity level of investors. I do note with interest that institutional investors are taking more of an interest in Xero now – this should improve the level of debate.

In terms of the second question about profitability – despite being a critic of growth-at-all-costs strategies – Xero is one example where the only option is to scale to size – and in doing so become a target for acquisition – this is clearly what is occurring and, given the fairly large cash reserves, and the positivity and deep-pocketedness of some of its backers (notable MYOB founder Craig Winkler, TradeMe founders Sam Morgan and Rowan Simpson and uber investor Peter Thiel), extra cash injections shouldn’t be hard to come by.

There’s no such thing as a sure bet, and I’ve had some people within the orbit of some of the incumbents in the space suggest that these players are finally going to counter Xero’s rise, in their words “the empire is about to strike back”. It’s hard however to see clearly how any of the incumbents could really do what is needed, which is to disrupt themselves before Xero (or more likely, Xero’s acquirer) does it for them. Xero looks set to make a handful of people a pretty impressive return.

Disclosure - I have consulted for MYOB and Xero and aman investor and director of Connect2Field which is 30 percent owned by Accounting software company Reckon. I am also co-founder of LiveMigrate which provides migration services from desktop accounting software to Xero. I advise many companies (either formally or informally) in the accounting software ecosystem.