How do growth equity firms really create alpha?

1. @scottsnews
Perspectives on
Growth Equity in 2015
Scott Maxwell / @scottsnews
OpenView Venture Partners
3/25/2015

2. @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?

3. @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)

4. @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.

5. @scottsnews
How do growth equity firms
really create alpha?
@scottsnews

6. @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

7. @scottsnews
Some Focus Dimensions
Industry Sector
Company Situation
Stage of Growth
Geography

8. @scottsnews
Focus – OpenView Example
B2B Software /
Internet
Expansion Stage
Organic Hyper-growthNorth American
Customers

9. @scottsnews
Access to the Best Deals
• Reputation Development
• Research and Contact Databases
• Outbound calling and network
development
• Relationship development

10. @scottsnews
Access to the Best Deals
• Reputation Development
• Research and Contact Databases
• Outbound calling and network
development
• Relationship development

11. @scottsnews
Little Outbound = Negative Alpha

12. @scottsnews
Great People Create the
Front End Alpha
@scottsnews

13. @scottsnews
Some Key Metrics*
*Compare by growth segment
1
FTEs engaged in accessing the best deals
Target Universe
2
FTEs engaged in accessing the best deals
Number of deals done each year
3
GP “Rainmakers”
Number of deals done each year

14. @scottsnews
What about Company
Building Alpha?
@scottsnews

15. @scottsnews
The Flow of Economic Value
Customers
Revenue
Gross Profit
Net Income/Cash Flow
Capital Structure
Balance Sheet

16. @scottsnews
The Flow of Economic Value
Customers
Revenue
Gross Profit
Net Income/Cash Flow
Capital Structure
Balance Sheet

17. @scottsnews
The Flow of Economic Value
Customers
Revenue
Gross Profit
Net Income/Cash Flow
Capital Structure
Balance Sheet
Early Growth

18. @scottsnews
The Flow of Economic Value
Customers
Revenue
Gross Profit
Net Income/Cash Flow
Capital Structure
Balance Sheet
Later
Stage
Growth

19. @scottsnews
The Flow of Economic Value
Customers
Revenue
Gross Profit
Net Income/Cash Flow
Capital Structure
Balance Sheet
Later
Stage
Growth

20. @scottsnews
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

21. @scottsnews
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

22. @scottsnews
Again…Great People
Create the Alpha
@scottsnews

23. @scottsnews
Key Metrics*
*Compare by growth segment
1
FTEs engaged in Company Building Activities
Total Number of Portfolio Companies
2
FTEs engaged in Company Building Activities
Number of deals done each year
Note: Alignment metrics are more difficult to generate

24. @scottsnews
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

25. @scottsnews
What keeps me up at
night in 2015?
@scottsnews

26. @scottsnews
The exciting
thoughts..
@scottsnews
Image by Hamad AL-Mohannna

27. @scottsnews
Over the last decade, a lot
has changed
2005 2015

28. @scottsnews
There have been amazing
opportunities for
disruption and innovation
@scottsnews

29. @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)

30. @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

31. @scottsnews
Over the last decade, a lot
has changed…
Cloud

32. @scottsnews
Over the last decade, a lot
has changed…
Mobile

33. @scottsnews
Over the last decade, a lot
has changed…
Social
Products
?

34. @scottsnews
Over the last decade, a lot
has changed…
Intelligence
?

35. @scottsnews@scottsnews
Lots of great portfolio companies
to think about!

36. @scottsnews
But, the new investment
environment is also
keeping me up at night.
@scottsnews

37. @scottsnews@scottsnews
Image by Freddie Pena
And the thoughts make me
nervous.

38. @scottsnews@scottsnews
Image by Freddie Pena
One word…

39. @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

40. @scottsnews
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)

41. @scottsnews
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!

42. @scottsnews
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

43. @scottsnews@scottsnews
Image by Philip Leara
Why are valuations getting so
high?

44. @scottsnews
Too much capital?
“There is a great deal of
capital in the venture
market, creating
competition.”
Wall Street Journal
March 18th 2015

45. @scottsnews
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)

46. @scottsnews
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)

47. @scottsnews@scottsnews
Image by Nick Ares
It must be the LPs fault. They are
investing too much capital in the
industry.

48. @scottsnews
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)

49. @scottsnews
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

50. @scottsnews@scottsnews
Image by Justin Kern
Is the answer
increasing fund size?

51. @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

52. @scottsnews
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

53. @scottsnews
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?)

54. @scottsnews
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.

55. @scottsnews
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.

56. @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 valuation
33% lower return for
the new investor
We are raising $10m from
a new investor and are
comfortable taking 20%
dilution ($40m pre).

57. @scottsnews@scottsnews
Similar conversations are
taking place more regularly
these days

58. @scottsnews
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.

59. @scottsnews
= 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)

60. @scottsnews
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)

61. @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”

62. @scottsnews@scottsnews
But, fund size doesn’t explain
everything…

63. @scottsnews
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

64. @scottsnews@scottsnews
Why the higher capital
deployment and what is the
implication?

65. @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.

66. @scottsnews
What am I doing to
sleep better?
@scottsnews

67. @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

68. @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
Investments are illiquid and multiples are
likely to regress to the mean
May be possible due to platform shift
and internet marketing

69. @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
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

70. @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
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.

71. @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

72. @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

73. @scottsnews
Two Example Investments

74. @scottsnews@scottsnews
While patiently waiting through
this winter so that we can be
ready for the spring

75. @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

76. @scottsnews
Perspectives on
Growth Equity in 2015
Scott Maxwell / @scottsnews
OpenView Venture Partners
3/25/2015