Growth vs. Profitability? Choose Growth

T

The startup and venture funding environment is experiencing a dramatic shift. Especially in SaaS, public stocks are down 30-60% and private companies are struggling to raise capital.  As a result, we are all reading blogs with survival advice for entrepreneurs.   The advice boils down to the following: raise money if you can, preserve cash, reduce burn rate, let go of under-performing employees, and focus on profitability.  I think all of this is advice is rational and I am giving similar counsel to the companies I’m involved with.    

But, there is another piece of advice that I am not hearing enough.  And, that is: KEEP GROWING!  Once again, the debate between the merits of growth vs. profitability is underway.  My take: I don’t care what environment we are in, the startup and venture capital game is all about growth.   As others have said about startups in the past, if you aren’t growing, you are dying.  Of course, it is also wise to focus on unit economics, efficiency and to establish a “path to profitability”.  It is also okay to slow down growth (e.g. grow 60-70% with strong unit economics vs. 100% "at all costs").  But, keep growing.  And, regarding profitability, I believe that most early stage venture-backed startups are not able to grow rapidly AND be profitable until nearing IPO or soon after.  

The current public market is not rewarding high growth unprofitable companies.    As you can see in the chart below, it is the high growth unprofitable SaaS companies that have fallen the hardest.  In fact, if you look at the grey line (high growth unprofitable) and the dark blue line (low growth profitable), there is literally zero premium for being a high growth company without profits.  The premium comes for high growth profitable companies (the yellow line).   The yellow line is the desired state that all entrepreneurs should be striving for when public.   

I believe that the market for early stage, private companies is different.   As venture capitalists, our job is to back high growth companies that can eventually become profitable.  That’s what venture capital is for.  The role of venture capital is to fund a company to become the leader of a new category.  In the early years, growth is the primary goal, not profits.   But, by the time a company is nearing or newly public, profits AND growth are the key to a premium valuation.

So, my advice is to keep growing.  My bet is that by the time you are looking to exit or go public in a few years, the market will be rewarding growth again.      

The Pendulums of Venture Capital

The venture capital industry, like most investing asset classes, is subject to pendulums of sentiment and emotion.   As we are all witnessing, the pendulum of risk tolerance & valuation is swinging violently at the moment.  For the past 5 years, the pendulum has been pegged at the far end of the spectrum where investors discounted nearly all risk and, as a result, valuations were irrationally high across all stages.   In the past few weeks, that pendulum has swung wildly to the opposite end.   I believe that the public markets have over-corrected on tech valuations but that is a topic for another blog.   In this blog, I’d like to explore some other pendulums in venture capital that I believe are also in motion at this time.  Not surprisingly, these pendulums are all interconnected so it makes sense that they would move somewhat in unison.

Growth vs profitability

One pendulum that is clearly tied to the risk and valuation pendulum is the focus by investors on growth versus profitability.  For the past 5 years or so, investors have encouraged startups to invest aggressively to drive growth, often without concern for efficiency or unit economics.   And it has worked.   With cheap capital, we have all witnessed Hype Cycle Growth, where companies raise money, hire aggressively, grow revenue and then raise more money to repeat the cycle.   Interestingly, the very same venture capitalists who encouraged companies to grow at all costs are advising startups to cut burn rates and grow more efficiently.  This chart from the Wall Street Journal clearly shows how the pendulum of growth vs. profitability has manifested itself in the public markets for IPOs over the years. 

Young vs. Old

Another debate that has gone on for years, especially in Silicon Valley, has been the relative benefits of youth.  In the past 10 years, largely driven by the success of a few notable young founders, the pendulum in Silicon Valley has been pegged on the belief that youth is the key to success.  And, unfortunately, that older people cannot contribute.   There is even the belief that a 45-year-old can no longer practice venture capital.  To be sure, young people bring amazing new ideas, perspectives and risk tolerance to the table and have created incredible successes (and will continue to do so).   But, as this current hype cycle ends, I believe that the pendulum is swinging back (based on the success of many older members of the silicon valley community) to a more rational position where the contributions of older executives, entrepreneurs and VCs will be increasingly relevant, recognized and respected.  

Operating VC vs. Generalist VC

I admit that I bring some real bias to this particular debate (and, yes, the age debate as well).  Over the past few years, the belief has been increasingly accepted that only those with operating, technical or product experience can be successful venture capitalists.  For several years, VCs who were hiring would only consider (usually young and sometimes very junior) product executives coming out of Google, Facebook, Snapchat, etc.   Many of those hires will become fantastic venture capitalists, including a couple that I've been lucky enough to work with directly.  Of course, many will not.  I’ve seen many highly successful operating executives never make the transition to investor.  On the other hand, I’ve seen many venture capitalists who didn’t have operating experience rise to the top of the Midas list.  All you need to do is look at the backgrounds of Peter Fenton, Bill Gurley, Mike Moritz, Fred Wilson, and countless others to realize that successful venture capitalists can come from a variety of backgrounds.  I believe that the pendulum for this has rightly swung back to a point of equilibrium to take this into account.   

What other pendulums do you think are swinging right now?

My Next Chapter in Venture Capital

After 15 fulfilling years at InterWest, I am excited to share the news that I have joined Shasta Ventures.    

When I joined InterWest, I was 26 years old, the year was 2000 and the bubble was bursting.  Most young people who joined the venture business at that time did not make it.  I am grateful to my partners at InterWest for mentoring me, providing me with a strong platform and having the patience to help me build a track record.

In Shasta, I have found everything I was looking for in the next chapter of my venture career.   While there are many models for success in venture, I subscribe to the belief that this is not a scale business.  I wanted to join a firm where all the partners can sit around a small table and make quick and efficient decisions.   And, I wanted a fund size where a single fantastic investment can return all or most of a fund.  Strategically, I sought to join a firm that is focused solely on Information Technology and that also has a strong software franchise.  Shasta has a fantastic enterprise software practice with investments like Anaplan, Apptio, Lithium, Steelbrick, Zenprise, Zuora and many others.  And, Shasta’s strategy to invest in Series A and in early Series B companies overlaps exactly with my experience.   Finally, and most importantly, I have found a firm with a strong cultural fit, shared values and a common philosophy that entrepreneurs are the core of our business.  Shasta has built a fantastic reputation among its entrepreneurs for being a valued and trusted partner.   

Today is also a day of mixed emotions.  After 10 years, yesterday was my last as a board member of Marketo.  I feel so fortunate to have been able to invest in Phil Fernandez, Jon Miller and Dave Morandi when they had an idea to revolutionize digital marketing.   I have learned so much about what it takes to build a category-leading public company from the founders and the entire team at Marketo.  Thank you to Phil, Jon, Dave, Fred, Bill, Steve, Jason, Sanjay, Nick, Margo, Joan and all of my fellow board members for allowing me to be a part of Marketo’s fantastic journey these past 10 years!  

I couldn't be more thrilled that the Shasta team chose me to join them as a partner.  I feel like I am starting the venture business again for the first time with all the same excitement and anticipation.  More than anything, I feel lucky to have the opportunity to be in this business.   Working with passionate and fearless entrepreneurs building ground-breaking companies is a true privilege.

My Journey with Flurry Analytics

Every investment is a journey and I thought I’d share a few perspectives from my involvement with Flurry.  Fortunately, in this case, the journey was very successful with Yahoo acquiring Flurry.  There were many learnings from this investment, but here are three key takeaways:

•  Private-to-private mergers can be a game-changer
• Venture capital is a team sport
• Startups can survive even the scariest near-death experiences

Private-to-private mergers can be a game-changer

One of the most commonly held beliefs in startups & venture capital is that private-to-private mergers are doomed to failure.  It is true that many are unsuccessful.  But, in the case of Flurry, their merger with Pinch Media in 2009 was a true game-changer.  Prior to the merger, IW was speaking with both Flurry and Pinch Media about a potential investment but were having trouble deciding which to invest in as they were both at a similar size.  Then, Flurry CEO Simon Khalaf called me to ask if I’d be interested in investing in the merger of Flurry and Pinch Media.  I was immediately intrigued and after a bit more diligence, IW led the merger financing of the two companies.  What the merger did was solidify Flurry’s position not just as the leader in mobile analytics, but really as the “standard”.  Instead of continuing to compete with each other, the combination of Flurry & Pinch Media instantly created THE default analytics provider for mobile developers on iOS and Android and, as a result, Flurry grew alongside the exponential rise of the mobile app ecosystem.  

Venture capital is a team sport

A misconception is that venture capital firms are a collection of individual partners operating largely on their own.  IW’s experience with Flurry demonstrates that nothing could be further from the truth.  Based on a relationship with CEO Simon Khalaf, my partner Khaled Nasr sourced the investment opportunity.   And, because of my focus on mobile, Khaled passed the potential investment to me and I conducted the due diligence, advocated the investment and initially sat on the board of directors of Flurry on behalf of IW.  However, when IW’s portfolio company Offerpal purchased Tapjoy and became competitive with Flurry, I had to make the very difficult decision to step off the board of Flurry and pass the seat to my partner Bruce Cleveland.  In 2011, IW brought on Keval Desai as a partner.  Keval had previously helped build Adwords at Google and we knew that he would be the perfect board member for Flurry.  Ultimately, Keval carried IW’s investment in Flurry to the finish line.  So, in the end, four different partners at InterWest played a role in our investment in Flurry and I think/hope that the Flurry management team would speak positively of their experience with IW despite the changes along the way.      

Startups can survive even the scariest near-death experiences

There was a moment during our Flurry journey where it appeared that the company might be shut down.  The short version: As part of its content marketing strategy, Flurry often released interesting data about the mobile ecosystem.  In a completely non-malicious post, Flurry wrote about some new devices (i.e. tablets) that were being tested in Cupertino (whoops!).   When Apple learned about that blog post, Steve Jobs wanted to shut Flurry down for this mistake.  Fortunately, the team at Flurry had built a fantastic mobile developer community which helped convince Apple to give Flurry another shot at life.   It was a reminder that no matter the situation, tenacious executives keep their heads down and plow ahead.  There is almost always a way through a bad situation and the Flurry team found it.  As a result, I can now watch the video below with a smile and some very fond memories:

Thanks to Simon Khalaf, Sean Byrnes and the entire team at Flurry for building such a special and important company and for including InterWest in the journey!  We wish them the best of luck at Yahoo in their quest to innovate in Search, Ads and Apps on mobile.   

Totango: The Leading Customer Success Solution

I am very excited to announce my latest SaaS investment in Totango.  Similar to our thesis when we invested in SaaS leaders such as Marketo, Spredfast, Optimizely and Newscred, we believe Totango's team has built the best product in an explosive emerging category.

Over the past 10 years, much of the investment in front-office software has gone into applications that enable enterprises to achieve revenue growth by optimizing the marketing and sales functions.  More recently, there are a number of market developments that have created the need and opportunity to increase revenue (and reduce churn) from existing customers.  Must read: David Skok's excellent blog on the subject of customer success & churn.

NewsCred: The Future of Content Marketing

I’m excited to announce that I have invested in NewsCred, a provider of end-to-end content marketing software that includes the world’s largest marketplace of licensed content. 

InterWest has conducted extensive due diligence on the content marketing space for over two years, meeting with 25+ innovative companies before selecting NewsCred.  Our selection was based on the same fundamental investment thesis that led us to invest early in other category-leading SaaS companies like Marketo, Optimizely, and Spredfast.  Namely, a massive market that satisfies our “Why Now?” questions, the best product in the space and a visionary and product-oriented team committed to building a company for the long-term. 

NewsCred is the clear leader in the space today and we believe they have all the characteristics of a category-leading company.  We look forward to supporting their team and co-investors in building a successful and long-lasting company.

Here are four reasons why we chose to invest in NewsCred, and why I am excited to join their Board of Directors:

Interview in San Jose Mercury News

Thank you to Peter Delevett from the San Jose Mercury News for posting this interview.  http://www.siliconbeat.com/2013/12/23/elevator-pitch-interwests-doug-pepper-on-the-magic-of-serial-entrepreneurs/

Doug Pepper joined the venture capital business straight out of business school — in 2000, as the dot-com bubble was bursting. Not what they call auspicious timing.

But by focusing on consumer Internet, mobile and (more recently) Software-as-a-Service deals, the Stanford grad has earned a seat at hot companies like Marketo (whose IPO last spring raised $85 million) and Lombardi (acquired by IBM for an estimated $180 million) — as well as onetime high-flyers like Groupon competitor Bloomspot, which JP Morgan Chase bought for less than what its investors are believed to have put into it. Can’t win ‘em all, as many a VC will tell you. 

Still, Pepper, who plies his trade at Sand Hill Road’s InterWest Partners, has found that investing in serial entrepreneurs can boost that batting average. In this week’s Elevator Pitch, Pepper talks about that strategy and what else he’s seeing in the tech world.