In January, there were signs that venture capitalists were growing less bullish due to the now 10% drop in the NASDAQ since the end of last August.
But not every VC is feeling blue. Kevin Spain, general partner of Emergence Capital, sees a big opportunity in a market that’s largely untapped by venture capitalists.
Emergence has been quite successful investing in companies that sell cloud services to enterprises. It was an early investor in Salesforce, SuccessFactors, Box, and ServiceMax which GE acquired for $950 billion (and in December 2018 announced it would sell).
in a November 2017 interview with partner Jason Green, I learned that Emergence toted up the value it’s created at a cool $100 billion.
This brings to mind a controversial idea from my recently published fourteenth book, Scaling Your Startup: Mastering the Four Stages From Idea to $10 billion.
The idea is that once a company gets its first customers, it should reengineer its business processes — such as marketing, selling, and retaining customers — so that the cost of performing those activities declines as the company takes on more customers.
This idea of building a scalable business model is controversial because the majority of investors and entrepreneurs I interviewed for the book rejected this idea. Instead, they mostly believe that rapid growth is far more important than rapid growth with a clear path to profitability.
In fact, the idea of building a scalable business model is not always controversial. When venture capitalists change their outlook from fear of missing out to fear of losing everything, they abruptly demand that their companies get cash flow positive before they can get additional capital.
With the recent plunge in tech stocks– the same trend that sparked the VC freeze I wrote about in 2016, the number of seed deals has declined 41% from 1,500 in 2015 to 882 in the fourth quarter of 2018, I noted in a January 22 column.
Startups are lowering their valuations to raise capital. While electric-scooter startups Bird Rides and Lime were valued above $1 billion the last time they raised capital, both “recently lowered their valuation goals in fundraising efforts,” I wrote.
And they’re cutting staff. For example, Elon Musk’s rocket company, SpacEx is cutting about 600 jobs to “become a leaner company” with “extraordinarily difficult challenges ahead.” Musk’s cash-burning electric car company — Tesla — also announced 3,200 layoffs.
And then there’s San Francisco messaging startup Hustle which announced mass layoffs earlier this month after missing revenue goals for the quarter and the year. Its CEO Roddy Lindsay, a Stanford grad and early Facebook hire, took a 56% pay cut — from $125,000 to $55,000, according to the Journal, which reported that Lindsay is bringing in a consultant “who helped liquidate Pets.com during the dot-com bust.”
But Emergence has long believed that it should seek out companies with scalable business models. As Green told me in November 2017, “We look at the unit economics of a business — comparing the cost to acquire a customer with the customer’s lifetime value. Once you understand how that works you can achieve success over 10 to 15 years.”
Emergence sounds untroubled by the recent downturn in technology stocks and how it will affect its investing strategy. As Spain said on January 31,
[The direction of technology stocks] is always a hot topic. But we care about what it might mean for how declining technology stocks will affect fund raising and what it means for creating companies. For the past 15 years, we’ve been most successful when we invested in fundamentally great companies during a bad macroeconomic environment.
Since Emergence is a seed stage investor, it is less concerned about the IPO environment than a late stage investor.
When it comes to building a scalable business model, Spain agrees with Green. As Spain said, “There is a difference between smart growth and growth at all costs. We like smart growth in which unit costs decline as the company gets bigger. What’s more, public markets don’t reward companies if they’re not scalable.”
He also offered useful advice to entrepreneurs seeking to make their business models scalable. “First, companies should track the right metrics and make sure their unit economics make sense and are trending in the right direction. Second, have a plan for how to fix the metrics. Don’t wait until the end of the year. Every quarter you should have realistic targets and a plan [to get the metrics back on track if they deviate from the target]. Finally, you have to have investors who are aligned with the idea of scalable growth.”
Spain does not think that it’s clear whether VC is heading into a downturn. As he said, “Anecdotally, there is some evidence of pessimism but it’s anybody’s guess whether that will become more widespread. IF there is downturn in M&A and IPOs, it will lead to lower valuations.”
Spain seems most excited about a new category of business software he calls the deskless workforce — software for people whose work does not involve sitting in offices.
Emergence has at least three companies in its portfolio that fit in this category. One is Upkeep, mobile software that “helps plumbers, electricians, and maintenance workers keep track of work orders, assets, and also saves their employers time and money.” Another one is Openpath that lets people access their offices with their smartphone. Emergence is also an investor in videoconferencing service, Zoom.
Emergence sees a large untapped market. As Spain said, “Enterprises spend $300 billion on software for people working at their desks. But that accounts for only 20% of the workforce. The other 80% are deskless and they don’t have great software. Only 1% of the venture capital is going into this segment. And the knowledge on how to write such software is not all in Silicon Valley.”