Karbon: A Case Study in Control Points

Dave Yuan, Founder and General Partner of Tidemark, in conversation with Stuart McLeod, Co-Founder and CEO of Karbon. This article is part of a series from?Tidemark’s Vertical SaaS Knowledge Project.

Karbon is the leading platform for accountants and is exactly what we look for in a Vertical SaaS company. Its product occupies a key control point that helps its customers manage their most important assets: time and people. And in the professional service industry, time equals money. Karbon’s customers’ staff are in Karbon’s product every day, all day. Karbon is their system of record, their system of engagement, and most importantly, it is the control point.

Co-Founder Stuart McLeod is a two-time founder. He sold his first company—a payroll company—to Xero.? We’ve been fortunate to have known Stuart through my previous investment in Xero and are excited to work with him again at Karbon. Tidemark invested in Karbon in 2021, and I’m honored to serve on the company’s board of directors.?

The following interview is all about McLeod’s entrepreneurial journey and his vision for how Karbon, a Tidemark portfolio company, can empower its accountant customers and support the small business economy.

This interview took place on April 6, 2022. Lightly edited for brevity and clarity.

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Dave Yuan: Stuart, thanks for chatting with us.

Stuart McLeod: My pleasure, Dave. Thank you for having me.

Dave:? We are really excited to learn about your journey, particularly as it relates to the business you’re building now and how that aligns with our vertical SaaS knowledge project. To start, it’d be great to get a little bit more about your personal journey and background.

Stuart: Sure. My first job, back in ’98 or ’99, was actually at Oracle as a presales support consultant and a presales consultant. And that first job, in the days of pre-SaaS and selling on-prem, was a fascinating experience. I’d always been into technology, and I did an IT degree in Melbourne. Working for a company like Oracle out of Redwood Shores had always been a dream of mine.?

But I was a little bit silly in my youth, and I had a gap in my technology career. I invested in some property and stuffed that up extensively. In order to recover financially, I did some contracting in Canberra, which is sort of Australia's equivalent to Washington (except nowhere near as glamorous, but the government paid well). I packed up my truck and drove up to Canberra to earn a couple hundred dollars an hour and get myself back on my feet.

That was where I first met my now-co-founder, John Freeman. He gave me a job, even though I was a really bad coder; we ended up running a side hustle, essentially. I was running a payroll bureau. This was in 2006, 2007. If you recall, Salesforce was the preeminent founder of SaaS and the No Software movement. You remember the No Software logo?

Dave:? Software sucks, with the big “X”. I remember that.

Stuart: Software sucks, exactly. The Xeros and the Zendesks, these types of companies, were the first-generation SaaS companies. I was running this payroll bureau on MYOB, which was a desktop software—I don’t think they even had an online product at that stage. They were very slow, so I said to John, “Running this payroll bureau on desktop software is really frustrating. What do you think about building an online payroll solution?” And he said okay.

We built what became PayCycle in his middle son’s bedroom in 2009. It was the traditional side hustle, and we bootstrapped it. There was no VC money in Australia at all; I remember going to these angel meetings. It was just another world back then.?

Dave:? When I started visiting Australia around 2012, people would always reflect on all these great software companies with zero venture capital, pre-Blackbird.

Stuart: None whatsoever! It was all credit cards and cash flow from my payroll bureau company. That’s how we got going. A couple years later, when we sold to Xero, there were still only two of us on the shift. Our timing was pretty good. To give you an idea of the age of that software, we wrote PayCycle in Silverlight. A lot of our support calls were how to get the plug-in going. That was the era. Microsoft was touting it.?

Xero was coming to Australia in 2009 or 2010, and we had a lot of affinity. We’d worked out that selling into SMB was easiest via the accounting channel. We worked with a lot of accountants, and that worked pretty well. I still remember being one of the very few vendor partners for Xero in Australia and going to the first road show in Adelaide. There were more Xero people and partner people than there were clients there! There were nine of us and three customers; now, Xero goes on road shows and there’s 3,000 people.?

Rod Drury rang and asked if we wanted to keep doing this by ourselves, or to sell to them. What it came down to for us was whether we were going to create more value by ourselves or by joining Xero. We made the right decision—we sold in 2011, and had payroll integrated into the Xero General Ledger for Australia in May 2012. You can see the Xero numbers accelerate dramatically. It was already a rocket ship, and having payroll integrated into the General Ledger made it even stronger.

It doesn’t work the same in the US as it does in Australia. MYOB taught everybody that payroll and general ledger were the same thing; you never separated them. Whereas in the US, with the complications of payroll and benefits, you don’t need it in the general ledger. It’s a big business to be had. Just ask Zenefits and Gusto.

That was a really great journey. Then Rod said, “Do you want to go up to the UK or the US?”. If? you’ve ever done a winter in London, you’ll know why we chose San Francisco! That was December 8, 2012, and we’ve been in the US ever since. We left Xero after four years or so and founded Balance Labs, which became Practice IQ, which is now Karbon, in 2014. Now we’re living the life in Incline Village in Nevada with a Reno office and 128 staff. That’s our journey up until today.

Dave:? That’s awesome. Stuart, you could have been a bigwig at Xero, right? The US was super critical. Why go do something hard and start another business?

Stuart: [Laughs] Nuttiness. Stupidity. To be honest, I’m just not a very good employee. But Xero was a fantastic journey. We had six staff at PayCycle and when I left, there was something like 1,200 staff. I took a lot of those lessons and applied them to what we’re doing today.?

I think it was Tien Tzou at Zuora who broke up company journeys into ones and threes, with $0-1 million different from $3-10 million, which is different from $10-30 million, which is different from $30-100 million. And the best time we had at Xero was sort of that $10-30 million, where you’ve got all the resources and money and none of the bullshit of a massive amount of middle management. That’s not a criticism, it’s just what happens. I wanted to do something that was important. I love creating value from nothing. I think that’s one of the most exciting things that people can do.

Dave:? Absolutely. It’s a hell of a lot of work, but seeing a company improve week on week, there’s nothing like it. Tell me about the initial insight around Karbon. Was the idea always communication and task management for accountants? Or did you start somewhere else first?

Stuart: What we started with was the theory that tax was one of the most unsexy, boring things that you could do, and there’s a lot of money to be made in unsexy and boring. Right? It seems to stand to reason. Nobody goes into Y Combinator and says, “I’m going to build software for accounting.” Unless it’s got crypto or ML in it, they’re not interested.

For a year, we spent quite a bit of money and half our time researching and developing a prototype for tax preparation for accountants in US jurisdictions, but we learned pretty early on that people change their religion more readily than they change their tax software. It’s so fragmented. The predominant age of tax accountants is on the north side of 50, and that’s not going to change overnight.

This was about bringing to bear our experience with accountants. The team that we’ve assembled I think is one of the most experienced and qualified teams to build software for accounting. So how can we bring those skills to bear in the accounting industry and make sure that we give ourselves the best chance of success? Tax is one of those angles, but that wasn’t a quick and easy way to build a company. The other thing about tax is, you need all 5,000 tax forms available before a firm will consider you because they’re not going to run two tax softwares side by side.

For all those reasons, we kind of gave up on that. Instead, we looked at our capacity to use our experience and bring in the workflow aspect of software like CCH, Thomson, IRIS, and Sage. All these software systems were aging and really not delivering any value, so we started all the way at the other end of the workflow. We worked out that email was the most predominant method of communication. Nobody had built that into the workflow and integrated it into their practice management, so we did that. That was the first “aha” moment we had. We built an email client. It was a bit of a silly thing to do, but it turns out that people come for the workflow and stay for the email. It’s where we started, and now we just get to expand on all of that and build it out.

Dave:? So what you do for your clients today is really the workflow, and how you communicate with clients. In this vertical SaaS framework that we’re putting together, we talk about control points. If you think about Karbon and what you do for your accounting clients, how do you think about Karbon as a control point? What are the aspects of the product that give you an unfair right to serve your accounts, in terms of offering new products or new services?

Stuart: We definitely put the customer first, and therefore the client first. We feel like we have a responsibility to improve accountants’ lives and keep the morale of accounting firms as high as we possibly can. We take advantage of that opportunity, in terms of getting Karbon into the hands of as many accountants as we possibly can.

Having this system of record, at the center of all the interactions that go on between the accountant and their client is the most important thing in a professional services organization. An accountant helps their client on their journey to become successful. At the end of the day, that’s as simple and as complex as it gets. If we can enable that journey, and provide a frictionless way of enabling that relationship, that’s the most amazing thing we can do. That enables accountants to help more people, be more effective, provide more value, grow their client base, improve their clients’ businesses, further the economy, and enjoy doing it. It’s actually a beautiful thing.?

The thing that gives us that right is, Karbon becomes the system of record, the control point, that the accountant cannot possibly do without in their practice. We do that through workflow. Like in a McDonald’s store, where you need the right people at the right place at the right time with the right skills in order to deliver the right amount of value—Karbon gives you that who, what, where, why, and how, and has the right person with all the right tools and the right documentation in order to effectively do their job. To the extent that you can, you automate all that.

When you turn up to your fry station, your fries are sitting there. The oil’s hot. The chip buckets are ready to go. We do that through workflow, through task management, through the time billing and fixed fee, enabling all of those aspects. Email is probably the part that enables all of this to happen as frictionlessly as possible. We get out of the way, but enable that system of record not only for the time, but also the communication. Then we move past email. We’re talking on Zoom today, but there’s all the other methods of communication that clients have with their accountant. We can enable that frictionlessly by ensuring that all the communication between client and firm is accessible, so you know where that relationship is, you can bill for it, and you can get paid for it.?

Dave:? We talked about workflow and data gravity, right? Workflow you guys obviously have in spades, as you pointed out. I think most accountants and their clients are on the task management capability. I think the other thing that’s interesting is that because everybody’s on that workflow, you essentially are managing people’s time. People’s time and their money are the most valuable resources. You have data, and you’re managing that piece, so you have this concept of data gravity as well.

The communication piece is something we see less frequently. Tell me about that. How common is it; how high is the usage? Is this the main method that your customers use to engage with their clients??

Stuart:? As I said, we didn’t really mean to go into building an email client. It’s pretty compelling, but it’s a bit silly just because it’s so big. And accountants, in particular, have been using Outlook for 125 years now, right? Trying to change that behavior is really difficult.

We introduced comments in emails. For email, IMAP and SMTP were added in the early to mid ’70s, and they really haven’t changed that much. I guess our innate understanding of how accountants work led to insights that we were able to bring to bear and put back into the product. Given the amount of time knowledge-workers spend in email, the amount of time they spend communicating with their clients in this fashion, and communicating internally, every tiny uplift you can give makes a massive difference.?

I never spare expense on beds or computers, because you spend so much time in both of them! For Karbon, it was the same thing. You spend so much time in email in a professional services organization that if we could improve that just a tiny bit, it’ll make a big difference. Our customers spend 7-plus hours a day in Karbon. We’re the left monitor. Improving that communication method, or the communication between customer and client, is a high priority. We try and keep working on it, but we didn’t set out to do it. It just came from our research and talking. We did something like 4000 hours of video and research before we kicked it off, so we had a pretty good idea that it was going to work.

Dave: We talked about having a sales control point. We talked about having data or workflow gravity, and we talked about multiparty communication. You have all three. That’s really powerful. I think that shows up in the engagement at 7 hours a day. That’s incredibly impressive.?

How do you think about expanding your offerings over time? You mentioned a little bit about billing. Where does the product go with the benefit of those control points?

Stuart: Yeah, great question. We’ve spent six, seven years building really only one-third of practice management. We’re going to build the remaining two-thirds in about nine months thanks to Tidemark and an inflow of cash and resources.

Practice management in itself is something that’s been around ever since the personal PC in the ’80s. The traditional vendors, the CCHs and the Thomsons, haven’t really changed their thinking in the way that practice management is delivered. I think there is an opportunity for improving that experience.? With Covid, accountants have had their whole business models upended. The days of mahogany partitions and having your whole staff in the office are basically dead. I think maybe 2% or 3% of our customer base is insisting on five days a week back in the offices. That’s just not going to happen, right?

Karbon enables that remote work. We also have many customers that were remote work from day one, so Covid was not an issue for them. The practice management experience, and what you’re after out of your practice management, has changed dramatically over the last five or six years. Particularly in the US, which was a little bit behind the technology curve compared to the southern hemisphere, and even the UK. I think Covid has helped the accounting industry catch up.

Dave:? Just for people who are less familiar with practice management, what’s missing right now?

Stuart: We’ve got two-thirds that are missing. We’ve done the workflow bit. And we’ve done a little bit of time. And now we’ve got to create an end-to-end experience. From lead, to proposal, to scheduling. to capacity planning, to task management, to workflow, to fixed-fee or time billing and invoice presentment—integrate that into the general ledger and receive payment for it, all in one spot. Manage all your communication and your client interaction through there. It’s just a really compelling offering.

But it’s probably only half of the story of the accountant. You can do all that, but you’ve got this other aspect going on. You’re working with your clients day-in and day-out; you’re in the general ledger; you’re in the software that is your client’s control point, whether that’s inventory management, or some kind of subscription billing, or billing and their bookings. The general ledger is becoming disintermediated. Particularly small businesses now have vertical SaaS software that they run their business on. Toast in restaurants, ServiceTitan in field service businesses.

When we survey our customers, we see that the accountant’s got 60 or 70 apps their firm uses day-in and day-out because their clients are using those softwares. And if we can bring that workflow into the whole accountant experience, and try and improve the whole way they interact with their clients, then we’re doing our job. I think it’s a fantastic opportunity.

Dave:? Okay, so if I were to play this back in simpler terms: you have these vertical SaaS applications that have a language and taxonomy appropriate for their end market. They know what a restaurant tip is versus other forms of wages; they know what lettuce is versus other forms of inventory. Right now, what a restaurant might do is take a vertical SaaS business system, integrate it into horizontal GL. The GL is a GL for every single industry, so you lose a lot of fidelity. Then the GL might report out information to the accountants.

Stuart: Yeah.

Dave:? So the accountants understand the end markets and the businesses, so why not connect, through Karbon, your accountant to the end client so they can serve their customer better in the language that they understand, the financial ratios that they understand, and maybe in real time as well. Just take steps out of the process to avoid all the patches that typically happen in how small businesses work where it counts. Is that the general idea?

Stuart: Exactly. If you look at our purpose, the way we can help our firms is by being that frictionless point of control so that you can manage your day and get things done quicker, easier, better. Know where things are up, so you can do things at volume without worrying about things falling through the cracks. Essentially what that means is we need to be integrated where the firm is meeting the client, which is in these vertical SaaS apps, in these general ledgers. If we can help with that process and be more integrated into the work, then the work about the work just keeps flowing. It’s better organized, it’s better prepared. The chip buckets are ready to go when the chips come out of the oil.

Dave:? I like the McDonald’s analogy. You know, what’s really interesting to me—because it’s a big part of what an accountant actually does—is data extraction. Data extraction should be software; it shouldn’t be manual receipts and such. It should be integration into point-of-sale systems and inventory systems.

Stuart: Yep. When we talk to our firms, when you really drill into it, accountants just want to help their clients. They get so much purpose and so much job satisfaction, so much life satisfaction, being on the journey with their clients. Accountants need to understand the data, but they don’t need to spend all day in it. They just want to be with their clients, adding value. I’ve been with one client for 20 years, and he literally started the business in the garage. Now he’s got 45 office buildings around Melbourne. It’s about enabling that and constantly improving the way that accountants are interacting with their clients. We’re pretty good at it. We’ve done a good job so far, and we’ve just got to keep at it.

Dave:? What I really like about this is that forward-looking vertical SaaS companies know that small businesses do better when they work with accountants. They’re looking to engage with accountants, but it’s hard to do that in scale. Right?

Stuart: Yes.

Dave: If you’re a single accountant trying to get electronic, API-driven, or integration-driven data extraction with a point of sale system (or any type of soft vertical SaaS system), forget about it. The nice part about Karbon is you’re doing this by function of the scale of the accountants. You’re doing more for your specific clients, and then their clients’ clients. That’s the power of the network that you’re building.

Stuart: Exactly.

Dave:? What other benefits do you get as you get bigger, as you get more accounts on the system? Are there benchmarking opportunities, or other analytics opportunities? Is there a way to take advantage of this great community of accountants that have a ton of data and knowledge, in a privacy-safe way?

Stuart: In terms of benchmarking and the like, yes, there’s that opportunity. Accountants have this funny attribute where they don’t really see each other as competitors; they’re more likely to engage with their peer group. They have a higher purpose—how can we improve the accounting industry as a whole? The war for talent, and tactics around retention, is absolutely top of mind, so a rising tide lifts all boats. Accountants would love to see more people coming into the industry. I think we’ve got an opportunity to help there.?

Benchmarking is interesting. Accountants love to know how they’re doing against the global standard. There’s no doubt about that. The one area where I think the industry has been underserved is by the larger traditional vendors—the CCHs, the Thomsons. Their data has never been available or accessible to them. It’s always been locked up in these modular desktop systems, and it’s in the best interests of these large software firms to keep that data locked up.?

I think there’s a big opportunity in enabling the accountants and their data—combining that with other systems to enable them to answer questions that they haven’t really been able to get easy answers to in the past, like reporting. As I said, the accessibility has been limited so it’s been hard to get answers to questions like, What are my most profitable clients? What are my most effective employees? Can I bring on more clients in four months, or six months, or eight months? Which employees have the best relationships with my clients? How can I promote them and lift them in their careers? That kind of thing. There’s enormous opportunity for us in making the accountants’ data accessible to them, in the format and the methodology in which they would like to access it.?

Dave:? You go from an operating system to a business management system.

Stuart: Yeah.?

Dave:? That’s a pretty cool transition. This is awesome, Stuart. Thank you for taking the time. We’re really excited to be an investor here, and hopefully get to ride along with you as you continue this journey.?

Stuart: Not at all. It’s fun.

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This article is part of a series from?Tidemark’s Vertical SaaS Knowledge Project.

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