Perspective on Growth Equity in 2015

@scottsnews

Perspectives on

Growth Equity in 2015

Scott Maxwell / @scottsnews

OpenView Venture Partners

3/25/2015

@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?

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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 firms

really 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 American

Customers

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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 Company

Building 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 Alpha

Opportunity Expansion Stage Mid-Stage

Growth

Later 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 Alpha

Opportunity Expansion Stage Mid-Stage

Growth

Later 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 Alignment

Opportunity 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 at

night 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…

SocialProducts

?

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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 investment

environment 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

$0.0

$10.0

$20.0

$30.0

$40.0

$50.0

$60.0

$70.0

$80.0

$90.0

$100.0

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Median Pre-Money Valuation of Growth GP Deals

(millions, USD)

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Valuations

$0.0

$10.0

$20.0

$30.0

$40.0

$50.0

$60.0

$70.0

$80.0

$90.0

$100.0

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

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

0x

2x

4x

6x

8x

10x

12x

14x

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

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

$0.00

$5.00

$10.00

$15.00

$20.00

$25.00

$30.00

$35.00

$40.00

$45.00

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

(billions, USD)

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Driving up the average investment round

Source: PitchBook Data, Inc.

$0.0

$5.0

$10.0

$15.0

$20.0

$25.0

2005 2014

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.

$0.00

$5.00

$10.00

$15.00

$20.00

$25.00

$30.00

2005 2014

Total Capital Raised by Growth GPs

(billions, USD)

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And… LPs seem to be more selective

Source: PitchBook Data, Inc.

0

20

40

60

80

100

120

140

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

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 valuation

33% 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

0

20

40

60

80

100

120

140

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Funds Formed by Growth GPs

$0.00

$5.00

$10.00

$15.00

$20.00

$25.00

$30.00

2005 2014

Total Capital Raised by Growth

GPs

(billions, USD)

Source: PitchBook Data, Inc.

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= Larger Fund Sizes

Source: PitchBook Data, Inc.

$0.00

$50.00

$100.00

$150.00

$200.00

$250.00

$300.00

$350.00

$400.00

2005 2014

Average New Fund Size for Growth GPs

(millions, USD)

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Larger Fund Sizes = Larger Investments

Source: PitchBook Data, Inc.

$0.00

$50.00

$100.00

$150.00

$200.00

$250.00

$300.00

$350.00

$400.00

2005 2014

Average New Fund Size for Growth GPs

(millions, USD)

$0.0

$5.0

$10.0

$15.0

$20.0

$25.0

2005 2014

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.

0

50

100

150

200

250

300

350

400

450

500

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

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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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

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Growth GP Strategies in This Environment

1. Multiple expansion: hope for high

market multiples at exits

1. 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

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Growth GP Strategies in This Environment

1. Multiple expansion: hope for high

market multiples at exits

1. Basis expansion: hope to grow

companies faster and larger than

historical norms

2. 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

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Growth GP Strategies in This Environment

1. Multiple expansion: hope for high

market multiples at exits

1. Basis expansion: hope to grow

companies faster and larger than

historical norms

2. Hibernate: Wait for the market to

correct

3. 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.

@scottsnews

Growth GP Strategies in This Environment

1. Multiple expansion: hope for high

market multiples at exits

1. Basis expansion: hope to grow

companies faster and larger than

historical norms

2. Hibernate: Wait for the market to

correct

3. Style Drift: Move earlier in the food

chain with the presumption of better

deals

4. 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

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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

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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

@scottsnews

Perspectives on

Growth Equity in 2015

Scott Maxwell / @scottsnews

OpenView Venture Partners

3/25/2015