Perspective on Growth Equity in 2015

@scottsnews

Perspectives on Growth Equity in 2015

Scott Maxwell / @scottsnewsOpenView Venture Partners3/25/2015

@scottsnews

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?

@scottsnews

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)

@scottsnews

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.

@scottsnews

How do growth equity firmsreally create alpha?

@scottsnews

@scottsnews

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

@scottsnews

Some Focus Dimensions

Industry Sector

Company Situation

Stage of Growth

Geography

@scottsnews

Focus – OpenView Example

B2B Software /Internet

Expansion Stage

Organic Hyper-growthNorth AmericanCustomers

@scottsnews

Access to the Best Deals

• Reputation Development• Research and Contact Databases• Outbound calling and network

development• Relationship development

@scottsnews

Little Outbound = Negative Alpha

@scottsnews

Great People Create the Front End Alpha

@scottsnews

@scottsnews

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”


@scottsnews

What about CompanyBuilding Alpha?

@scottsnews

@scottsnews

The Flow of Economic Value

Customers

Revenue

Gross Profit

Net Income/Cash Flow

Capital Structure

Balance Sheet

@scottsnews


Customers

Revenue

Gross Profit


Capital Structure

Balance Sheet

Early Growth

@scottsnews


Customers

Revenue

Gross Profit


Capital Structure

Balance Sheet

Later Stage Growth

@scottsnews

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

@scottsnews

Again…Great People Create the Alpha

@scottsnews

@scottsnews

Key Metrics*

*Compare by growth segment

1FTEs engaged in Company Building Activities

Total Number of Portfolio Companies

2FTEs engaged in Company Building Activities


Note: Alignment metrics are more difficult to generate

@scottsnews

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

@scottsnews

What keeps me up atnight in 2015?

@scottsnews

@scottsnews

The exciting thoughts..

@scottsnews

Image by Hamad AL-Mohannna

@scottsnews

Over the last decade, a lot has changed

2005 2015

@scottsnews

There have been amazing opportunities for disruption and innovation

@scottsnews

@scottsnews

The Software industry has found a much better economic model (SAAS instead of Perpetual License)

@scottsnews

Image from BrianVellmure.com

@scottsnews

The Software industry has found a much better economic model

(SAAS instead of Perpetual License)

@scottsnews

The Software industry has found a much better economic model (SAAS instead of Perpetual License)

@scottsnews

Image by Alex Kislow

The infrastructure platform has shifted…everyone has to start

from scratch

@scottsnews

Over the last decade, a lot has changed…

Cloud

@scottsnews


Mobile

@scottsnews


SocialProduct

s?

@scottsnews


Intelligence?

@scottsnews@scottsnews

Lots of great portfolio companies to think about!

@scottsnews

But, the new investmentenvironment is also

keeping me up at night.

@scottsnews


Image by Freddie Pena

And the thoughts make me nervous.


Image by Freddie Pena

One word…

@scottsnews

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

@scottsnews

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)

@scottsnews

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!

@scottsnews

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


Image by Philip Leara

Why are valuations getting so high?

@scottsnews

Too much capital?

“There is a great deal of capital in the venture

market, creating competition.”

Wall Street Journal March 18th 2015

@scottsnews

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)

@scottsnews

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)


Image by Nick Ares

It must be the LPs fault. They are investing too much capital in the

industry.

@scottsnews

But… this doesn’t seem to be the case.


2005 2014$0.00

$5.00

$10.00

$15.00

$20.00

$25.00

$30.00

Total Capital Raised by Growth GPs

(billions, USD)

@scottsnews

And… LPs seem to be more selective


2005 2006 2007 2008 2009 2010 2011 2012 2013 20140

20

40

60

80

100

120

140

Funds Formed by Growth GPs


Image by Justin Kern

Is the answer increasing fund size?

@scottsnews

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

@scottsnews


Founder & CEO

We don’t need more than $10m, and I refuse to take more than 20% dilution.


GP

@scottsnews


Founder & CEO



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?)

@scottsnews


Founder & CEO GP


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?)


@scottsnews


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


I’m am building an enduring company and have no intention of cashing that much out now.

@scottsnews

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



Similar conversations are taking place more regularly

these days

@scottsnews

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)


@scottsnews

= Larger Fund Sizes


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)

@scottsnews

Larger Fund Sizes = Larger Investments


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)

@scottsnews

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”


But, fund size doesn’t explain everything…

@scottsnews

Deal Pace Increasing Among Branded GPs - +225% in 10 years


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


Why the higher capital deployment and what is the

implication?

@scottsnews

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.

@scottsnews

What am I doing to sleep better?

@scottsnews

@scottsnews

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

@scottsnews



2. Basis expansion: hope to grow companies faster and larger than historical norms


May be possible due to platform shift and internet marketing

@scottsnews




3. Hibernate: Wait for the market to correct



Lose touch and relationships in the market

@scottsnews





4. Style Drift: Move earlier in the food chain with the presumption of better deals




Slight shift fine. Would need to re-gear firm for larger shift… too much risk.

@scottsnews





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.




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

@scottsnews

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

@scottsnews

Two Example Investments


While patiently waiting through this winter so that we can be

ready for the spring

@scottsnews

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

@scottsnews

Perspectives on Growth Equity in 2015

Scott Maxwell / @scottsnewsOpenView Venture Partners3/25/2015

Perspective on Growth Equity in 2015

Investor Relations

Transcript of Perspective on Growth Equity in 2015