perspective on growth equity in 2015
TRANSCRIPT
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Perspectives on Growth Equity in 2015
Scott Maxwell / @scottsnewsOpenView Venture Partners3/25/2015
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Discussion Topics
• Who am I?• How do growth equity firms really create
alpha?• What keeps me up at night in 2015?• What am I doing to sleep better?
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Who am I?• California native, B.S., M.S Mechanical Engineering, UC
Davis• Ph.D. Mechanical Engineering, S.M. Management, MIT• 80’s: Education, Robot Design Start-ups• 90’s: McKinsey, Lehman, Putnam• 2000-2006: Insight Venture Partners• 2006- Present: OpenView Venture Partners (Expansion
stage, B2B Software, North American product markets)• Wife (25 years), 3 kids (22, 20, 17)
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Disclaimer.
I have spent the last 15 years trying to perfect one segment of growth equity.
I have a strong view on growth equity based on this experience.
But, since growth equity is large and diverse, I may or may not be correctly characterizing all flavors of growth equity with my comments.
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How do growth equity firmsreally create alpha?
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How Do Growth GPs Create Alpha?
• Focus (aids in network development, reputation, selection, company building)
• Access to the best deals (database, outbound, reputation, development)
• Deal Selection• Company-building resources/activities
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Some Focus Dimensions
Industry Sector
Company Situation
Stage of Growth
Geography
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Focus – OpenView Example
B2B Software /Internet
Expansion Stage
Organic Hyper-growthNorth AmericanCustomers
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Access to the Best Deals
• Reputation Development• Research and Contact Databases• Outbound calling and network
development• Relationship development
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Access to the Best Deals
• Reputation Development• Research and Contact Databases• Outbound calling and network
development• Relationship development
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Little Outbound = Negative Alpha
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Great People Create the Front End Alpha
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Some Key Metrics*
*Compare by growth segment
1FTEs engaged in accessing the best deals
Target Universe
2FTEs engaged in accessing the best deals
Number of deals done each year
3GP “Rainmakers”
Number of deals done each year
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What about CompanyBuilding Alpha?
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The Flow of Economic Value
Customers
Revenue
Gross Profit
Net Income/Cash Flow
Capital Structure
Balance Sheet
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The Flow of Economic Value
Customers
Revenue
Gross Profit
Net Income/Cash Flow
Capital Structure
Balance Sheet
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The Flow of Economic Value
Customers
Revenue
Gross Profit
Net Income/Cash Flow
Capital Structure
Balance Sheet
Early Growth
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The Flow of Economic Value
Customers
Revenue
Gross Profit
Net Income/Cash Flow
Capital Structure
Balance Sheet
Later Stage Growth
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The Flow of Economic Value
Customers
Revenue
Gross Profit
Net Income/Cash Flow
Capital Structure
Balance Sheet
Later Stage Growth
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Opportunities for GPs to Create AlphaOpportunity Expansion Stage Mid-Stage
GrowthLater Growth
People, Strategy, and Execution
Customer Market Insights
Practice /Process Development (GTM, Whole Product)Management System Development
Corporate Development
Capital Markets Development
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Opportunities for GPs to Create AlphaOpportunity Expansion Stage Mid-Stage
GrowthLater Growth
People, Strategy, and Execution
Customer Market Insights
Practice /Process Development (GTM, Whole Product)Management System Development
Corporate Development
Capital Markets Development
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Again…Great People Create the Alpha
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Key Metrics*
*Compare by growth segment
1FTEs engaged in Company Building Activities
Total Number of Portfolio Companies
2FTEs engaged in Company Building Activities
Number of deals done each year
Note: Alignment metrics are more difficult to generate
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Looking into AlignmentOpportunity Light Help More Help Dedicated Help
Talent acquisition/development
“We have a good network to recruit from”
“We can point you to the best third party recruiters”
“We have X dedicated recruiters”
Strategy and Execution “We will introduce you to our CEO network”
“We can point you to the best third party experts”
“We have a dedicated group and process”
Customer Market Insights “We know the market well” “We can point you to the best market research firms”
“we have X dedicated researchers”
Practice /Process Development (GTM, Whole Product)
“We can point you to other XYZ in the portfolio”
“We can point you to great experts who can help”
“we have X dedicated process experts for process XYZ”
Management System Development
“We can point you to other XYZ in the portfolio”
“We can point your to great experts who can help”
“we have X dedicated management system experts who can help”
Corporate Development “We know the market” “Our deal-finding engine can help”
“you will have a dedicated expert that will help”
Capital Markets Development
“We can introduce you to good bankers”
“Our partners have a lot of experience and will help”
“you will have a dedicated expert that will help
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What keeps me up atnight in 2015?
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The exciting thoughts..
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Image by Hamad AL-Mohannna
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Over the last decade, a lot has changed
2005 2015
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There have been amazing opportunities for disruption and innovation
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The Software industry has found a much better economic model (SAAS instead of Perpetual License)
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Image from BrianVellmure.com
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The Software industry has found a much better economic model
(SAAS instead of Perpetual License)
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The Software industry has found a much better economic model (SAAS instead of Perpetual License)
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Image by Alex Kislow
The infrastructure platform has shifted…everyone has to start
from scratch
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Over the last decade, a lot has changed…
Cloud
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Over the last decade, a lot has changed…
Mobile
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Over the last decade, a lot has changed…
SocialProduct
s?
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Over the last decade, a lot has changed…
Intelligence?
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Lots of great portfolio companies to think about!
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But, the new investmentenvironment is also
keeping me up at night.
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Image by Freddie Pena
And the thoughts make me nervous.
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Image by Freddie Pena
One word…
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Valuations
“On the private side, multiples are probably
the frothiest they’ve been in my 15 years in
venture capital.” Neeraj Agrawal
General Partner, Battery Ventures March 2015
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Valuations
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014$0.0
$10.0
$20.0
$30.0
$40.0
$50.0
$60.0
$70.0
$80.0
$90.0
$100.0
Median Pre-Money Valuation of Growth GP Deals
(millions, USD)
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Valuations
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014$0.0
$10.0
$20.0
$30.0
$40.0
$50.0
$60.0
$70.0
$80.0
$90.0
$100.0
Median Pre-Money Valuation of Growth GP Deals
(millions, USD)
Up 2.2x over the last 10 years!
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But exit multiples are constant
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 20150x
2x
4x
6x
8x
10x
12x
14x
Total EV/Revenue (TTM) for Public SaaS Companies
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Image by Philip Leara
Why are valuations getting so high?
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Too much capital?
“There is a great deal of capital in the venture
market, creating competition.”
Wall Street Journal March 18th 2015
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Capital Invested by Growth GPs
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014$0.00
$5.00
$10.00
$15.00
$20.00
$25.00
$30.00
$35.00
$40.00
$45.00
(billions, USD)
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Driving up the average investment round
Source: PitchBook Data, Inc.
2005 2014$0.0
$5.0
$10.0
$15.0
$20.0
$25.0
Median Deal Size for Growth GPs
(millions, USD)
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Image by Nick Ares
It must be the LPs fault. They are investing too much capital in the
industry.
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But… this doesn’t seem to be the case.
Source: PitchBook Data, Inc.
2005 2014$0.00
$5.00
$10.00
$15.00
$20.00
$25.00
$30.00
Total Capital Raised by Growth GPs
(billions, USD)
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And… LPs seem to be more selective
Source: PitchBook Data, Inc.
2005 2006 2007 2008 2009 2010 2011 2012 2013 20140
20
40
60
80
100
120
140
Funds Formed by Growth GPs
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Image by Justin Kern
Is the answer increasing fund size?
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Larger investments in companies at the same stage leads to increased valuations.
Actual Negotiation Between an Anonymous GP and Founder, CEO:
We are raising $10m from a new investor and are comfortable taking 20% dilution ($40m pre).
Founder & CEO
We need to invest $20m to move the needle on our fund, but would really like to find a way to work with you.
GP
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We are raising $10m from a new investor and are comfortable taking 20% dilution ($40m pre).
Founder & CEO
We don’t need more than $10m, and I refuse to take more than 20% dilution.
We need to invest $20m to move the needle on our fund, but would really like to find a way to work with you.
GP
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We are raising $10m from a new investor and are comfortable taking 20% dilution ($40m pre).
Founder & CEO
We don’t need more than $10m, and I refuse to take more than 20% dilution.
We need to invest $20m to move the needle on our fund, but would really like to find a way to work with you.
GP
How about we invest $20m, $10m in primary and $10m in secondary, for 20% dilution to the business ($40m pre, $10m in CEO’s pocket?)
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We are raising $10m from a new investor and are comfortable taking 20% dilution ($40m pre).
Founder & CEO GP
We don’t need more than $10m, and I refuse to take more than 20% dilution.
I’m am building an enduring company and have no intention of cashing that much out now.
How about we invest $20m, $10m in primary and $10m in secondary, for 20% dilution to the business ($40m pre, $10m in CEO’s pocket?)
We need to invest $20m to move the needle on our fund, but would really like to find a way to work with you.
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We are raising $10m from a new investor and are comfortable taking 20% dilution ($40m pre).
Founder & CEO
We can invest $20m, $15m in primary and $5m in secondary, for 20% dilution to the business. Final offer ($60m pre, $5m in CEO’s pocket).
GP
We don’t need more than $10m, and I refuse to take more than 20% dilution.
I’m am building an enduring company and have no intention of cashing that much out now.
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Okay. Issue me a term sheet.
Founder & CEO
We can invest $20m, $15m in primary and $5m in secondary, for 20% dilution to the business. Final offer ($60m pre, $5m in CEO’s pocket).
GP
50% higher valuation33% lower return for
the new investor
We are raising $10m from a new investor and are comfortable taking 20% dilution ($40m pre).
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Similar conversations are taking place more regularly
these days
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Constant Capital and Fewer Funds
2005 2006 2007 2008 2009 2010 2011 2012 2013 20140
20
40
60
80
100
120
140
Funds Formed by Growth GPs
2005 2014$0.00
$5.00
$10.00
$15.00
$20.00
$25.00
$30.00
Total Capital Raised by Growth
GPs
(billions, USD)
Source: PitchBook Data, Inc.
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= Larger Fund Sizes
Source: PitchBook Data, Inc.
2005 2014$0.00
$50.00
$100.00
$150.00
$200.00
$250.00
$300.00
$350.00
$400.00
Average New Fund Size for Growth GPs
(millions, USD)
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Larger Fund Sizes = Larger Investments
Source: PitchBook Data, Inc.
2005 2014$0.00
$50.00
$100.00
$150.00
$200.00
$250.00
$300.00
$350.00
$400.00
Average New Fund Size for Growth GPs
(millions, USD)
2005 2014$0.0
$5.0
$10.0
$15.0
$20.0
$25.0
Median Deal Size for Growth GPs
(millions, USD)
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Will Fund Sizes Continue to Get Larger?
• Higher Management Fees raise GP comp• GP staffing competition from higher cash comp
levels• Ability for Larger LPs to participate• Lower stated return expectations from LPs• More deal flexibility• Common LP statement: “I want you to limit your fund
size, but we would like to have a higher allocation”
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But, fund size doesn’t explain everything…
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Deal Pace Increasing Among Branded GPs - +225% in 10 years
Source: PitchBook Data, Inc.
2005 2006 2007 2008 2009 2010 2011 2012 2013 20140
50
100
150
200
250
300
350
400
450
500
Number of Growth Equity Deals for These 10 GPs
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Why the higher capital deployment and what is the
implication?
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My Working Hypotheses
1
2
3
GP exuberance that the current crop of companies is better than the last.
Perhaps, some desire/pressure to deploy capital?
Average growth returns for investments made during this period will be below par.
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What am I doing to sleep better?
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![Page 67: Perspective on Growth Equity in 2015](https://reader031.vdocuments.site/reader031/viewer/2022030310/58f9bf92760da32f4b8b49e2/html5/thumbnails/67.jpg)
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Growth GP Strategies in This Environment
1. Multiple expansion: hope for high market multiples at exits
Investments are illiquid and multiples are likely to regress to the mean
![Page 68: Perspective on Growth Equity in 2015](https://reader031.vdocuments.site/reader031/viewer/2022030310/58f9bf92760da32f4b8b49e2/html5/thumbnails/68.jpg)
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Growth GP Strategies in This Environment
1. Multiple expansion: hope for high market multiples at exits
2. Basis expansion: hope to grow companies faster and larger than historical norms
Investments are illiquid and multiples are likely to regress to the mean
May be possible due to platform shift and internet marketing
![Page 69: Perspective on Growth Equity in 2015](https://reader031.vdocuments.site/reader031/viewer/2022030310/58f9bf92760da32f4b8b49e2/html5/thumbnails/69.jpg)
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Growth GP Strategies in This Environment
1. Multiple expansion: hope for high market multiples at exits
2. Basis expansion: hope to grow companies faster and larger than historical norms
3. Hibernate: Wait for the market to correct
Investments are illiquid and multiples are likely to regress to the mean
May be possible due to platform shift and internet marketing
Lose touch and relationships in the market
![Page 70: Perspective on Growth Equity in 2015](https://reader031.vdocuments.site/reader031/viewer/2022030310/58f9bf92760da32f4b8b49e2/html5/thumbnails/70.jpg)
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Growth GP Strategies in This Environment
1. Multiple expansion: hope for high market multiples at exits
2. Basis expansion: hope to grow companies faster and larger than historical norms
3. Hibernate: Wait for the market to correct
4. Style Drift: Move earlier in the food chain with the presumption of better deals
Investments are illiquid and multiples are likely to regress to the mean
May be possible due to platform shift and internet marketing
Lose touch and relationships in the market
Slight shift fine. Would need to re-gear firm for larger shift… too much risk.
![Page 71: Perspective on Growth Equity in 2015](https://reader031.vdocuments.site/reader031/viewer/2022030310/58f9bf92760da32f4b8b49e2/html5/thumbnails/71.jpg)
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Growth GP Strategies in This Environment
1. Multiple expansion: hope for high market multiples at exits
2. Basis expansion: hope to grow companies faster and larger than historical norms
3. Hibernate: Wait for the market to correct
4. Style Drift: Move earlier in the food chain with the presumption of better deals
5. Raise the bar on selection: Select only the best of the best.
Investments are illiquid and multiples are likely to regress to the mean
May be possible due to platform shift and internet marketing
Lose touch and relationships in the market
Slight shift fine. Would need to re-gear firm for larger shift… too much risk.
Would allow for continued market coverage and reputation development, while making a few good investments
![Page 72: Perspective on Growth Equity in 2015](https://reader031.vdocuments.site/reader031/viewer/2022030310/58f9bf92760da32f4b8b49e2/html5/thumbnails/72.jpg)
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Overall OpenView Strategy in 2015
1. Focus on our current portfolio’s growth and exits
2. Selectively invest in platform opportunities being created by the macro trends in technology
• Stretches out the return curve
• Longer and higher tail to the return curve, compressed elsewhere
• Same expected return with higher expected portfolio variance
• Number of investments will be what they will be
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Two Example Investments
![Page 74: Perspective on Growth Equity in 2015](https://reader031.vdocuments.site/reader031/viewer/2022030310/58f9bf92760da32f4b8b49e2/html5/thumbnails/74.jpg)
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While patiently waiting through this winter so that we can be
ready for the spring
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Summary
• The more great people per X at a GP, the more true alpha creation
• The more aligned the great people are with the growth segment opportunities, the more true alpha creation
• If you are going to invest in 2015, be extremely selective…at least that’s our strategy
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Perspectives on Growth Equity in 2015
Scott Maxwell / @scottsnewsOpenView Venture Partners3/25/2015