On the podcast: Venture’s gravity check

What looked like a recession at the onset of the pandemic turned out to be anything but: valuations inflated, funds grew and capital poured into the private markets. But, it couldn’t last forever. In this week’s episode of the “In Visible Capital” podcast, SignalFire founder and CEO Chris Farmer discusses why the venture capital balloon burst. Farmer also touches on how SignalFire leverages data to find and support entrepreneurs, why the firm turned to seed deals as a means of countering unsustainable valuations, corporate M&A and much more. Plus, PitchBook senior analyst Kyle Stanford joins to discuss key takeaways from the Q3 2022 US VC Valuations report.

In this episode of Sapphire Ventures‘ series “GameChangers,” Sapphire partner and Head of Revenue Excellence Karan Singh speaks with former MuleSoft CMO and SVP of Corporate Strategy Mahau Ma, now Sapphire operating partner, about the transformation from a tactical product-led sale to a strategic vision-led sale and the differentiating factors necessary to stand out in a heavily competitive category.

Listen to all of Season 6, presented by Sapphire Ventures, and subscribe to get future episodes of “In Visible Capital” on Apple Podcasts, Spotify, Google Podcasts or wherever you listen. For inquiries, please contact us at podcast@pitchbook.com.

Transcript

Marina Temkin: Thank you, Chris, for taking the time to meet with us today. For those who don’t know your firm, please tell us a little bit about SignalFire and how you do investments.

Chris Farmer: Thanks, Marina. I really appreciate you having me. It’s a pleasure to be on. SignalFire is the first venture firm designed from the ground up like a tech company. Our vision has been to apply the same opportunities and principles that the startup community has been applying to reinvent their industry to our own world of venture capital. That means using network, software, collaboration [and] AI to help bring a higher level of service to our entrepreneurs and more efficiency and structural advantage to making the best investment decisions as a firm as well.

We try to use technology and data to see the best opportunities, to make sure that we’re picking well to help us have an edge in winning over those entrepreneurs, and ultimately, most importantly, in supporting them at the highest levels over the lifecycle of a company, using that technology and data to help scale with our portfolios.

Marina: How has the model for your data analysis changed over the years? Now [that] we’re in a downturn, are you looking at different types of data points right now? Are you looking for different signals?

Chris: I think at the end of the day, company building is relatively constant, I would say. There’s some big differences in what sectors we focus on and how that evolves over time. You have to add new data sets when you start to focus on healthtech or Web3, or whatever it may be, in order to track where the best talent goes and where the companies are getting the best traction and whatnot. I do think that we do need to recalibrate for the efficiency of scaling in this type of market versus looking for growth at all costs, which we felt was unsustainable before and is even more so today in this environment, where there’s less certainty of capital going forward.

You would’ve seen a lot of companies lay off, which may have in the upmarket been a real sign of distress and in this market, unfortunately, it may be a sign of prudence and just management teams that are really focused on efficient growth and recalibrating to the new market environment.

Marina: I also understand that you’ve changed your approach to investing even prior to the downturn, you were anticipating this coming. How have you changed it then and how are you changing it more now, if you are?

Chris: Yes, we were getting very concerned about valuations. One of the beauties of having the data is we can do much more benchmarking. Often it’s hard to understand where you are situationally if you don’t have that data to ground yourself with. Over the last several years, we just felt that valuations were getting to unsustainable levels. We actually shifted down significantly. Our entry valuation to companies got lower over the last three years, whereas our peers were paying two to three times typically the price of entry into the same companies, and we did that by shifting risk, frankly, from valuation risk to execution and business model risk.

We did more pre-seed, we loaded more heavily at seed. Our Series B fund, our breakout fund that was typically focused on companies that had just more scale and velocity behind them, shifted earlier to take more company risk in exchange for taking less valuation risk. We were able to keep our cost basis lower during a period where the market was very risk-on and that was willing to pay huge premiums for companies that we felt were likely, given historical trends, to be end of cycle and unsustainable. Now that the market is correcting, we may shift back up again, where we will have the luxury of companies growing more efficiently and farther between financing rounds and be more efficient with the capital.

With our later-stage breakout fund, we may have the opportunity to invest in more mature companies at still reasonable prices that I think would’ve been very difficult over the last few years before the correction. Our goal is to always support entrepreneurs over the entire lifecycle, but we also are assessing risk and reward at any given point of entry into a partnership with an entrepreneur. We have an opportunity to get creative and support companies that are a little bit farther along as well with our capital.

Marina: From what I understand, you were investing more in seed and pre-seed over the last few years; now, you’re going to go maybe a little bit later. Are you still looking at the seed market? Because what I’m really interested in is how it has changed since last year.

Last year, things were getting so competitive. We saw some big-name firms getting into seed: Andreessen Horowitz announced a new fund, Sequoia, Greylock. Things were getting really competitive, valuations were getting really, really high.

Now, obviously, things have come down, but at the same time, seed is the most insulated stage, as they say, it’s the furthest from the stock market. What are you seeing happen in seed? Are there still investments? Have their valuations held up better than in later stages?

Chris: Yes, I think it’s hard to paint everything with a single brush. The other thing we did beyond shifting earlier over the last several years is, candidly, we focused on sectors that tend to be more resilient and business models that are more resilient that were more likely to be able to weather the storm. We overweight things like healthtech and cybersecurity, SaaS, data infrastructure [and] DevOps. There were very core areas, and we underweight areas that were more likely to be affected if there was an economic correction, like capital-intensive companies in say the hardware sector, or where there wasn’t a clear path to revenue. There was a large-scale R&D, like maybe autonomous driving.

We were underweight crypto, which hurt us on the way up and has helped us a fair amount as the market corrects. To answer the question directly, seed is a core of what we do. We’ve never stopped doing seeds. We’ve just had the changing dynamic where there’s more time between rounds and, in many cases, the time between a seed and a post-seed or a Series A was a matter of months. Now, it’s more likely to be elongated where companies are growing organically and efficiently on that capital. We’re still continuing to have a lens, assuming there’s going to be a high cost of capital for the foreseeable future, we’re still focused on those defensive sectors that are more resilient in economic volatility and where we have the strong thesis that there’s massive opportunity through the next decade.

We still enter at the seed stage in the vast majority of our companies, but our later-stage fund may shift up a little bit later into the lifecycle of a company where we had compressed it back-to-back. We’re a bit more likely to go back more to a barbell strategy that also has room for strong partners in this.

It’s very funny, I’ve gotten more referrals from top VC funds that see us as a strong value-added partner in the last six months than I probably did in the last five years. Because they recognize that getting aligned partners that can be with a company for the long haul is the best thing for the entrepreneur and frankly, for them. Whereas in the last part of the cycle, they had to grab everything they could in that stage because they knew the next round was going to be so much more expensive that it would be difficult to maintain or buy up ownership and keep a reasonable cost basis in those investments.

I think it’s a little bit less of a sharp elbow and a little bit more of a collaborative environment, where people recognize that having strong partners for the long haul is to everyone’s benefit. There’s a number of changing dynamics in this market.

Marina: What about valuations of the seed stage?

Chris: They’ve started to come down, they took a while, and it’s still a bit more all over the map. I think the late stage has corrected pretty significantly, and across the board, [there] tend to be fewer funds that have the scale to invest at that stage. Whereas at the seed stage, there are many alternatives because the absolute amount of capital is lower and there’s thousands of seed funds and angels and family offices and all sorts of cast of characters in the market. I think prices have come down, but maybe not as much on a percentage basis as some of the later-stage rounds.

It depends on the sector, and some entrepreneurs are more focused on [the] quality of their investor than they are in the valuation and their staying power over the long haul. Certain sectors like crypto seem to have corrected less so far at the seed stage, even though the late stage seems to be correcting pretty severely. I think these things will find their reasonable level over time, but it’s still a work in progress as we figure out where the bottom is and where a reasonable price is so that you can have a reasonable cadence of up rounds between each stage of a company’s growth.

Eventually, gravity will set in for all of these stages and hopefully end up in a balanced way. I’m not expecting a huge crash, but I do think there needs to be some balance in sobriety where things don’t overcorrect. People recognize that at some point you will– as I think it’s Warren Buffett that put it: In the short-term, the stock market is a popularity contest, in the long run, it’s a scale. I think at the end of the day, these companies have to produce cash flows and profits, and you have to scaffold to that through each stage and build up in a consistent way, which is the best for the employees, it’s best for the founders, and everything else along the way. If we can do it in a more capital-efficient way, I think everyone has a chance to win in the long run.

Marina: Which stage of development would you say is the most challenge? Which companies are having the hardest time raising in terms of stages?

Chris: I think it’s less of a stage issue than the circumstance. If you have raised at a price that is way beyond where the current market would price it, it’s very difficult without adding a lot of structure, which can be toxic in its own way to raise capital without doing a big down round, which a lot of founders and VCs are resistant to doing for obvious reasons. Then certain sectors that are more capital intensive and have less clear line of sight to profitability, or profitable margins, unit economics, those are the ones that are having a tougher time. That would include direct-to-consumer where you’ve got a lot of capital consumption from [Google] AdWords, or Facebook ads, or whatever it is in order to acquire customers.

It’s less clear what the lifetime value of a customer is, whereas on the enterprise’ SaaS side, if you have an 80%, 90% margin business and you have large enterprise recurring customers that aren’t going to go out of business in the near term or in the foreseeable future, I think that’s going to be less severely affected on a comparative basis.

Marina: So far in this downturn, we’re hearing about very few down rounds. Are they not happening or are people gravitating toward doing some sort of a structure ground where the terms are not as good as they used to be and they’re much more investor-friendly?

Chris: There’s definitely a lot of structure happening quietly at the later stages. People obviously don’t announce that proactively if they can avoid it for obvious reasons. You’re seeing interest rates attached to rounds going up. Unfortunately, sometimes preferences multiplying. I think that can be pretty dangerous and pretty toxic. Unless you have a very clear path to profitability, you know it’s your last capital.

But, I’m a believer that in general, you need to take your medicine and recalibrate to the right price so that employees on their 409As and their stock options are receiving fair value for the work and blood, sweat and tears that they’re putting into the company. Because, otherwise, you start to run into employee retention issues and satisfaction issues.

[At] the earlier stage, obviously, you see more flat rounds, small up rounds where you can grow into it. It’s the later stage that’s probably most severely impacted, but it typically takes 9 to 12 months from the economic correction. We’re not quite there yet for this to really set in because most companies raise money for 18 months and maybe they do a top-up round or they add some venture debt or they reduce their projected burn rate by not hiring as aggressively, or they, unfortunately, cut back a bit on headcount to reduce costs and to stretch the time period before they perhaps have to take their medicine.

Some companies will grow through it and a lot of companies won’t. Then they’ll run out of options of the inside round and the structures and the debt and all the things that they are able to do. Then they have to come to reality and recalibrate because they don’t really have any options left or levers to pull before they perhaps reset the valuation to something that’s more in line with where the market is at that point.

Marina: From what I understand, quite a few startups and probably the majority of startups have quite a bit of runway left. It depends how you look at it. Maybe it’s a year, maybe it’s two years, which means that we’re not going to see those down rounds for quite some time. We’re not going to see companies going out of business for quite some time. How does this downturn compare to the last two previous downturns, the big ones, the great financial crisis, and that dot-com bubble bust? Because I understand you were an investor during those times as well. Did we see the ramifications of the downturn much faster then than we do now because everyone is so well-capitalized?

Chris: I think we’ve had three different types of corrections in the last 20-plus years. In the dot-com bust, it was still a very nascent speculative market. A lot of these business models were unproven, it was unclear what the unit economics were and a lot of the experiments in the short run proved not to be viable. Some of those business models came back later as the internet had grown, people had greater amounts of broadband, they had mobile phone connectivity and a lot of those ideas and services actually flourished in the last cycle, maybe a decade later than they were originally contemplated.

As a result of that, most companies in that dot-com bust didn’t survive because there just wasn’t enough venture capital infrastructure. There wasn’t enough scale to the internet and whatnot to achieve the vision that they had set out for, but a handful of companies obviously flourished and became giants from that era. The great financial correction wasn’t as severe in tech, it was actually more of a credit crisis. It didn’t affect tech as much as perhaps the dot-com bust did. Obviously, if you were a fintech company and were tied to the credit crunch in some way, you could have been obliterated.

But most companies that were SaaS, long-term recurring, the market had scaled, that type of thing went through hard times for a period, but it wasn’t as fatal and catastrophic for the majority of the market. Then finally, in COVID-19, we obviously had a severe V-shaped dip in the stock market, but it ended up being because of the amount of stimulus and a migration to risk assets, and a very quick shift in the way people worked and behaved and saw doctors, etc. I think there was a very rapid tectonic shift to the adoption of all sorts of types of technology from ecommerce to telemedicine to video conferencing and the like. That actually looked like a recession for a second and turned into an accelerant.

What I think we’re seeing now is a sell-off of a lot of that speculative activity that happened as a result of, frankly, overstimulating the economy where interest rates were at such low levels that capital shifted out of fixed income and all sorts of other large categories including real estate, oil and gas, etc., into venture capital, which ballooned the amount of capital going into what’s a relatively small portion of the market, although a very prominent one.

That caused this overinflation as hedge funds, and corporates, and all sorts of new parties entered with unprecedented amounts of capital, in some cases funds that were small by public market perspectives but [that] were huge in the venture capital market.

As a result of that, I think what’s happening now is gravity is setting in and these companies ultimately are going to have to produce growth margins, profits, etc., in line with not necessarily terrible multiples and whatnot, but more in line with historical norms. They had gotten overinflated and now they’re coming back to reality. If you were being valued at 100 times revenue, that’s likely going to decompress by 5x or more over time and perhaps overcorrect in the short-term before they build back up and weed through which of the companies are not viable and which are the ones that are.

That’s been the shift in the market and it’s a pretty abrupt shift. The venture industry was very complicit in pushing companies to grow super quickly. The cost of capital was perceived as incredibly low and so people weren’t as worried about payback periods, and unit economics, and things as perhaps we should have been in a sustainable way. Now, it feels like a retrain to a lot of founders that we’re now pushing them for capital efficiency and everything else. That often requires substantial organizational changes and strategy changes and sometimes even business model changes in order to make that happen.

We all drunk too much of the Kool-Aid and now we’re going to have to get back to building and do it in the most efficient way possible because the cost of capital is much higher, the discount rates, you know, a dollar in 10 years in a high inflationary environment is going to be discounted much more heavily. It’s just not as highly valued as it was. Eventually, as we get inflation under control, hopefully, that will normalize. None of these extreme swings are good for company building or venture capital or anything else, but unfortunately, people love to stimulate on the bottom and not pump the brakes at the top. We tend to get more of a roller coaster than would be ideal with regard to company building.

Marina: I guess this is the first time the mature venture capital ecosystem is really getting tested. However, there is still a ton of dry powder. We’ve seen some of the crossover investors recede, but there’s a ton of dry powder. What are people doing? Investors mainly. Are they waiting to see for macroeconomic factors to be a little bit more clear? Are they waiting for the stock market volatility to subside? Because from what I understand, over the summer there was very little investing and maybe there’ll be more investing in the September, October, November time period, but it also depends. We just heard some really hawkish comments from the Fed chair, meaning that there we’re going to have more and more interest rate increases. Are VCs souring again, they’re going to be like, “We’re not going to invest as much as we thought we would when it was August timeframe.”

Chris: I don’t think that’s the case in the medium- to long-term. I think in the short-term, the priority has been to shore up your existing portfolio companies and your obligation is to the founders that you’ve already backed as opposed to looking at net new companies. Secondly, as I said, a lot of people found ways to stretch out before they raise so VCs have learned to wait for that progressive recalibration of where valuations are to find out what true value is because the first year is effectively the year of the falling knife. Catching falling knives is very dangerous.

Even if it’s fallen quite a bit from where it was, you can still get cut and it’s maybe a 50-50 that you calculate correctly. When those knives have then fallen and they’re on the ground and you’re picking them up, it’s much, much less dangerous. After the bottom occurs, it’s not likely to be like a V-shape recovery very quickly. I think we’ve got a lot of adjustments we need to make and pay down a lot of the debt. It may be more taxes, cutting government spending, things that just like if you overspend on a credit card, it takes a fair amount of your monthly income to pay that down. It doesn’t happen overnight.

I think we saw spending on a global basis concurrently at a level unprecedented in modern economic history because it was a global pandemic simultaneously as opposed to a regional- or country-level economic correction. As a result of that, it had even more multiplied stimulus than we’ve seen historically. It’s going to be harder to get out of that and pay it down over time and then de-stimulate the economy, bring down inflation, all those types of things. As a result, even the capital that you have has less purchasing power because of inflation, especially on a forward-looking basis.

Also, the time had compressed between funds from typically two and a half or even three years to one year, sometimes even less than one year, between fund cycles. When you use more of that capital shore up, your existing portfolio companies don’t want to necessarily call capital on your LPs too aggressively, want to make sure that pricing adjusts, and then also need more time, frankly, before your next fundraise to show that you didn’t overpay for everything. These were in fact good companies that will grow through the valuations. It’s going to take more time for these companies to do it in an efficient way because they have lower multiples and they’re burning fuel less quickly.

As a result of that, the dry powder—while it was at unprecedented levels—it’s going to get stretched out over a much longer period of time. They have to use it more to support their existing portfolio. They’re going to wait longer before they raise their next fund. A lot of crossover capital from the public markets, corporates, sovereign wealth, etc., is pulling out and recalibrating to the public markets or whatever. So, yes, there’s a lot more capital and I think the good news is that’ll keep it from like absolutely cratering to the bottom, but it’s not as much as perhaps it appears if you spread it out over a longer period of time from a how much is invested on a monthly basis.

I think you’re starting to see the market come back and normalize a bit with back-to-school, people slowed down over the summer—not the entrepreneurs, but the VCs—waiting for the market to recalibrate. I think you’ll see it slowly come back in as opposed to be an avalanche or capital that comes back in a snap.

Marina: Are you hearing from your LPs, and maybe are other LPs discouraging investment now? Or is this all a part of a natural process that investors are waiting to put more money to work and it actually is helping some LPs because, from what I understand, they have something called the denominator effect issue where they’re over-invested into private markets compared to their public markets’ portfolios?

Chris: I think what happens is the public markets correct overnight. If a venture fund has a lot of public companies that have recently gone public, those companies will correct pretty quickly. The public side of an endowment’s portfolio, let’s say, will correct on a day-to-day basis. It may take nine months to a year for the venture markets to fully correct. Some of the public markets, maybe some of the crypto markets that are traded more liquidly will correct very quickly. I think a lot of LPs are going to refrain from re-upping for venture funds until they know where the private markets are and their portfolio is more in balance.

As a result of that, it’s less that they’re discouraging investment from their existing GPs as much as they’re warning them, “Don’t come back for money until we figure out and we rebalance our own portfolio because we’re way over proportion.” Because when the public portion of the pie and other asset categories compresses, but the private markets take a long time to compress, things are actually out of sync to their own reality, at least optically, in the portfolios. They’re not quite sure how much to correct it. Even the VCs are not sure how much to correct it.

It takes time for that to level out and become a little more stabilized and then they can reassess what they can afford to reinvest in the private markets. Then the other thing is the path to liquidity in the private markets, to recycle capital in order to reinvest it, becomes elongated. The public markets have almost frozen up completely and very few companies if any are going public. The return of capital for them to reinvest in the liquid funds is very difficult.

On that basis as well, so one is a denominator effect, but two is just a sure cash flow element in order for them to have the cash to reinvest in the private markets that has even longer duration because there’s not a lot of exits and liquidity at great prices today. They all are interrelated but compounding effects, that are causing LPs to be much more judicious in where they reinvest. That’s causing VCs to recognize that they’re going to have to really show a lot of proof points if they want to continue to be able to raise money.

Marina: Right. We’ve had just record fundraising, and a lot of new funds, I’m guessing that the new funds are going to be really, really struggling now because they have to show some really good returns and it’s really hard to show returns in this market. This year is also has been a record fundraising year, but I think that’s all from last year, things moved down into this year. What are your thoughts? What other ramifications [are there for] the whole VC ecosystem from this over-fundraising on dry capital?

Are we going to see very little fundraising over the next couple of years as funds work their way through the current dry powder and see how the market reacts to everything?

Chris: Yes. I think it’s going to be a combination of a bunch of different factors. I think some of the big hedge funds that cross over will really struggle I think to raise their next funds at anywhere near the scale, if at all. Because what happens when the public market side of the house on the hedge funds side corrects, it’s a very long path to getting back into profitability if you’ve taken a 50% hit in the public markets.

It can often destabilize these organizations and impact the private side of the house as well, particularly if it’s not a different team and everything else. Those are very likely to get heavily impacted. The corporate side of the house will want to do acquisitions as opposed to venture capital when prices are attractive or they’ll need that capital to shore up their own businesses. So, corporate capital tends to receive pretty strongly in these market corrections if the companies and categories are strongly affected by the recession.

Emerging managers at the other extreme, as the established funds got bigger and bigger and bigger, the emerging managers had a lot of success fundraising because people wanted to get in early on small fund sizes, etc. But, as you said, I think it’s going to be very hard for them to show proof points. There’s many funds that people have a side hustle or they’re doing it on their off time and have a day job. I think those ones, in particular, will be extremely difficult to fundraise if they have a high net worth LP base. That’s going to be extremely difficult to fundraise because those investors are much less reliable fund-on-fund. They’re not underwriting over a decade type of time horizon.

If you’re in the emerging manager bucket, it’s going to be more discretionary for a lot of the institutional LPs that they’re going to often continue to support their core managers where they have the longest standing relationships, the most track record, etc., and they’re not going to want to get shut out of the next fund cycle in those funds. Unfortunately, they’re going to disproportionately cut the next-generation managers that they had backed. I think it’s going to be very difficult for subscale funds and newer vintage funds to raise in this next cycle.

For the big established managers, if they stayed super disciplined on fund size and everything else, I think they’ll be in relatively strong shape if they have a strong track record. The ones that got super-sized into the billions and billions of fund cycles, what I expect is you’ll see some of the stronger teams spin out of those funds and raise independent funds or you’ll see fund size that shrink. A lot of the junior partners won’t have a clear glide path to get to general partner or whatever it is and will transition out to go do something else or try and start their own funds or whatever it is.

You’ll see some shrinking of those big funds to what may be more normalized norms and so it’ll be elongated period of time, but then you also see a fund contraction to back to basics because it’ll be hard to justify like, “Oh we need $5-plus billion in a fund cycle” just to maintain the ownership and the private markets for so long in these companies, because the companies will be using less capital because the cost capital is higher and maybe the outcomes won’t be as dramatic as they were at the end of the last cycle when these huge multiples were being applied to the value of these companies.

I think it’ll impact all of the markets but in different ways, in maybe a more binary way for the crossover funds and the emerging managers, and more on a rationing type of way for the established VC funds with multidecade or longer-term multifund track records that will just need to prove that they’re continuing to be good fiduciaries of LP capital.

Marina: You also mentioned corporates and corporate M&A. You and I talked about M&A earlier this summer; you said that some companies, even in your portfolio, are having a hard time extending their runway beyond a certain timeframe. I think it was about 12 months or so. You are suggesting that they consider maybe selling themselves. So far, it seems that the M&A market has been really, really slow.

What is happening? Are startups really in a good position that they’re not so desperate yet, or is it the corporates, the strategics, that are saying, “Well, would I want to buy it?” And by the same token, private equity firms, because they certainly have the drive power to do small acquisitions, not large ones, but small ones.

Chris: Let me handle those separately. I think on the corporate side, it takes time to develop those relationships. Often, you need to get business units selling or buying that there’re synergies. Often, it’s helpful to have a partnership of some kind, either from a technology or a channel standpoint. My advice to founders is if you don’t have certainty of capital and a lot of margin for error even in a very tough capital environment, that’s it’s wise to pre-thread other options and not wait till you’re down to weeks of capital and then be like, “Oh, I need to sell myself.” And then, corporates can’t possibly move quickly enough, and if they can, it’s going to be at extremely distressed prices in order to give them enough margin for error that they haven’t been able to make sure that the synergies are there or make sure that they were able to do their full diligence. The advice to founders is if you have 12 months of runway and you know you’re not default-fundable, as they say, where you have a high confidence that there may be some variation in valuation but that somebody will step up and lead your next round.

If you don’t have a near certainty of that, it’s just rational to make sure that you have alternatives and a soft landing or a good outcome from an M&A standpoint, and that just takes time to develop those relationships and make sure that you pre-thread that and don’t leave it to the last minute, because it takes longer to do anything with a corporate than it typically does with a financial investor. That’s just the advice just in a rationality in the interest of protecting your employees and protecting the founders themselves, that they always have a backup plan if they don’t have enough margin for error, either in runway and/or knowing their way above the bar for raising capital, even in a tougher environment.

Marina: A lot of companies, I would imagine, are not guaranteed their next round. Does this mean that quite a few of them have to consider developing relationships with corporates now, even if it’s just a backup option?

Chris: Yes. If you have a path to profitability, that’s a backup plan. That’s the best one, typically, but if you have a recurring revenue enterprise, customer base, super high margins, etc., and clear product-market fit and upsell, and all those kinds of things, great metrics, then you can almost certainly raise capital. The cost of that capital may change, but you’re in a relatively good shape. If it’s less clear what your payback period is on your capital, or there’s a lot of R&D risk at a company, or there’s not a clear path to revenue or profitability, or there’s a lot of capital intensity, or less experienced management team. All of the different factors, those just compound to give you less certainty.

Also, frankly, your existing investor base. This is where it really matters. If you have deep-pocketed, strong partners that you know are committed to supporting the business, you have more relative certainty of capital. Nobody has a certainty of anything, so it’s always good to have backup plans. But the private equity players also are building platform companies, and will use this as an opportunity to buy smaller companies to get to scale, but they need to wait for those valuations to come down to where it makes sense for a private equity firm, as opposed to what may be perceived as a very high multiple that assumes hypergrowth.

Because PE tends to be more focused on cost-cutting and getting these companies to cash flow more quickly or using some leverage and whatnot, consolidating management, etc., and overhead to get companies to a healthy state, as opposed to organically growing there at a very fast rate. Just different profiles of the kinds of companies that they’re pursuing.

Marina: Thanks, Chris. Maybe to wrap up my final question, what do you think is the most surprising to you about the market right now, and what are you most concerned about going forward?

Chris: I think none of it is too surprising, unfortunately. It was pretty clear that we were getting to this part of the party where there was a lot of Kool-Aid being drunk, and everything was being priced to perfection. The reality is, there’s always a roller coaster in even the great companies, and so if you price with no margin for error and price it to perfection, you’re almost certain to be disappointed. That wasn’t a huge surprise. I think the most concerning thing is the combination of all sorts of geopolitical risks around the world.

You see fractures with Russia and China and the West, and you see political fractures in the US, to a very arguably unhealthy level that we haven’t seen in the modern era. You have an inflationary environment. You have a lot of industries like commercial real estate that are holding out with empty buildings, hoping that prices won’t drop, and then everything will go back to normal. I think there’s been a structural shift in how people work because they’ve learned that travel isn’t always necessary to have a meeting or that an office space will be used differently in this next era.

For getting teams to collaborate and join together and to have meetings and conferences and whatnot. Not to sit in a cubicle by yourself where you’re commuting an hour each way to do that, paying gas, polluting the air, and wasting a tremendous amount of time when you can be just as productive at home without a lot of the commute overhead and expense. Unfortunately, you never hit the bottom of a recession until there’s some sort of declaration of bankruptcy in some sector of the economy and in some individual companies. I think we’ve seen a lot of pain, but unfortunately, we haven’t seen some of them be more terminal.

I do think there are, unfortunately, going to be categories inevitably that are more terminal, and I think if we are fortunate to have a soft landing, it’s going to be a long grind out, that looks probably more like stagflation than a quick recovery, because I think we have to pay down a lot of the excesses that were the most extreme of the modern era. As a result of that, I just don’t see the easy path out of this. I think the markets are going to reward execution, capital efficiency, and long-term profitable growth, over growth at all costs, or companies that aren’t growing because you need to grow in an inflationary environment as well.

I do think it’ll affect different parts of the economy differently than others, but at the end of the day, as my partner, Walter Kortschak, likes to say, “There’s never a recession in the innovation economy.” That, ultimately, there’s always opportunity across every cycle, and it may not be across the board, but innovation will continue to evolve, and any huge structural change in the world creates huge opportunity because it creates big cracks in the foundation of things. And it’s really great, entrepreneurs will be able to thrive in every market environment. You just need to be disciplined and pick well and align yourself to the economic realities, and hopefully, we eventually all win in the long run.

Marina: Right. Thank you so much. This was very informative.

Chris: All right. Thank you so much for having me Marina.

Marina: Thanks for your time.

In this episode

Prior to founding SignalFire, Chris was a venture partner with General Catalyst Partners (2010–13), where he played a significant role in establishing the California office. He led GC’s successful seed investment program including seed investments in Alation, ClassDojo, Coinbase, Discord, Fivetran, Game Closure/PlayCo, Getaround, Stripe, Venmo and Zapier.

Chris was previously a vice president with Bessemer Venture Partners (2005–09) where he led investments in digital media and mobile companies. Prior to Bessemer, Chris was a consultant with Bain & Company where he advised on technology buyouts.

Earlier in his career, Chris was a successful entrepreneur. Chris spearheaded the turnaround of Skybitz, a wireless-enabled SaaS company that was acquired by Telular Corporation. He led product management, recruited the executive team, and was responsible for finance and business development. Chris conceived, designed, and launched products and services that drove over $35 million in annual revenue and $5 million in profit.

Previously, Chris founded an investment advisory firm for angel investors and private equity funds. Chris began his career on Wall Street in the private equity group of Cowen & Company.

Chris received a bachelor’s degree from Tufts University, where he studied international relations and business at Tufts and the Fletcher School of Diplomacy as part of a personally designed program. He received High Honors for his thesis on the policy implications and competitive dynamics of Internet marketplaces. His extensive research on best practices in venture capital has been published in Harvard Business Review, Institutional Investor, The Journal of Private Equity, as well as other leading publications.

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Karan Singh: Welcome to our segment of the program that we’re calling “Game Changers,” where we’ll explore how the best revenue leaders have transformed their company’s growth trajectory. I’m your host, Karan Singh, partner and leader of the Revenue Excellence function at Sapphire Ventures.

I’m Karan Singh, partner at Sapphire Ventures running Revenue Excellence, and I am your host. Joining me today is Mahau Ma, operating partner at Sapphire, a colleague and an ex-CMO and SVP of corporate strategy at MuleSoft. Mahau, happy to have you joining us.

Mahau Ma: Great to be here. Thanks for having me.

Karan: Absolutely. So Mahau, I like to start with just letting our listeners learn a little bit more about you, and you’ve had such an incredible run at MuleSoft, I think it was 14 years, something along those lines.

Mahau: Absolutely, yeah. 14 years from 2007 till early this year, ’22.

Karan: That’s incredible. And I know now you’ve obviously joined us at Sapphire, we’re delighted to have you. But tell me a little bit about, and rather than just read out your baseball card, which again, very familiar with, corporate strategy marketing. I mean, what was that big aha moment for you? I mean, you’ve been doing this for a while. When did you realize, hey, what I do matters? It actually impacts the organization in a meaningful way. I’d love for you to share a little bit.

Mahau: Thanks for that question, by the way. And it’s an opportunity for me to reflect back on everything that’s happened over the years. I started life in the consulting world, very analytical. It was all about the data, all about bringing the logical conclusions. And what’s interesting is that I brought that to the marketing world and to approach it that way. I’m not sure that there was a single aha moment though that turned the light bulb on from a marketing perspective. Although I will say that there’s probably a thousand micro moments that happened over the years that really made me realize we’re dealing with human beings here as customers. And it’s not always just about the data. It’s not always just about the logical conclusion.

One of my most influential mentors, important mentors in my life was my former boss, Greg Shot, CEO of MuleSoft for many years. And he would also always really challenge me on, from a marketing perspective, what are we selling here? Are we selling sushi or are we selling cold, dead fish? And I think that really captures the essence of what marketers really do. It’s really about positioning what you’re selling, capturing the imagination of your customer and really taking what is probably a great product and really wrapping it with something more aspirational. And I’ll just land on it is no different in something as corporate as enterprise software. Enterprise software is not just about selling the product that you have today, but it’s also about the product that’s coming. It’s about what your vision is for the customer and for the market.

Karan: That’s incredible. And I mean I think that’s a secret sauce for a great marketer, is thinking not just what is, but what will be. Because that’s what all of our customers are looking for, is understanding the full vision. So I get the feeling I know what that big game changer for you as Mahau, but I’m going to ask anyways. So given that experience and that background and a little bit of what you shared, give me a sense. So you were at MuleSoft again, for around 14 plus years and you were at various phases and stages of growth. What was that initiative that led you to say, hey, this is a business transformation activity we are doing. This is something that’s the hallmark of how MuleSoft is evolving.

Mahau: If I’m honest, this was probably not a single initiative in a point of time, but rather really a year’s long journey that we took as a company. And to really compress it in a soundbite, we took a company that started out as a highly technical adoption led model through various incarnations and evolutions all the way up to where it is today, frankly, which is a strategic vision-led platform based sale that hits from the C level all the way down to the developer, and really positions as the heart and lungs of a company’s operational infrastructure.

Karan: Let’s try to unpack that a little bit because I do think it’s a very relevant topic for a lot of our listeners and companies that I think we’ve both interacted with. Let’s start from the beginning if we can. What was the genesis of this? What was the why? What was the problem statement? What led you, and for that matter, MuleSoft, the organization to say, hey, we need, this?

Mahau: This takes us back to, picture of Sicily 1922, sort of thing. When the company was founded in 2006, this was an era where the open-source software business model was very hot at the time. It was off the back of the success of companies like Red Hat. Everyone wanted to leverage the popularity of the open source developer model and essentially disrupt existing incumbents in large categories like operating systems and management and so on and so forth, storage, et cetera.

And MuleSoft, it was called MuleSource at the time that reflected its open source heritage, what they really wanted to do, they started life as an open-source framework for connecting and running web services, essentially application integration software. There were larger companies, incumbents in the space like TIBCO software and webMethods, which was eventually acquired by Software AG and so on and so forth.

And the idea was that rather than having these heavy, proprietary platforms for doing integration, we were going to offer this very light, essentially free and open source framework for developers to pick up and use, adopt and use and just like many other open source models at the time, there was going to be this broad adoption of the software among developers, and then the commercial model would be to go in and monetize some portion of that adoption audience for the enterprise edition of the software. So that could be things like enterprise class capabilities, high availability, security features, management features. It was a very common model at the time. By the way, there have been other companies that have got successful on that model.

Karan: That groundswell. You build the mass adoption and then from there define that enterprise use case sort of thing.

Mahau: Precisely. So this works very well in places like a database. So MongoDB, great example of a company that got big on developer-led kind of adoption. And by the way, this was all before product-led growth, PLG was a thing. I mean people were in the early beginnings of this thing and we were experimenting with AB testing on the website to drive downloads and the color of the button was green versus blue and all that fun stuff. And we got very good at those sorts of things and we got very good at digital marketing and so on and so forth. But the long and the short of it, your question is what led us away from that model? And the answer to that is what we realized very quickly was that in our category, in the integration category, unlike in other categories like database and storage and other things like that, integration is not an individual adoption decision. A single developer typically can’t go and get successful on their own by downloading something like a MuleSoft.

Integration in fact is an organizational decision. It requires collaboration across multiple stakeholders, often across multiple teams to really drive any real value. And so we realized, geez, we’re going to run out of steam very quickly here if we continue to try this very technical, developer-oriented message and this very tactical volume driven sales play. And so we eventually started evolving the business, and by the way, this was baby steps. So the first step is, go from talking about the value of open source and about the value of commoditizing existing categories to actually starting to talk about the value of our product. We actually offer features and capabilities that have value to you as an organization. And so we went down this path of developing a more product-oriented, message-oriented sale, sales-led emotion. Let’s find the owner of an initiative of a project, articulate the value of the software and sell that project. And then as classic in SAS, start landing and expanding.

Karan: And expanding.

Mahau: So that’s step one. And what we realized there also was that, that was great, that we were getting some traction, but again, in integration, it’s a pretty complex set of technologies. It’s pretty hard to land, maybe four to six to eight month sales cycle. And we realized if we landed in just a single project, the juice was sometimes not worth the squeeze. We would spend all this time and effort with a complex sale talking about the product, but ending with a 50, 80, maybe 100 K deal, and the unit economics were not going to really scale for us.

So from there, and again, this is maybe over the course of a couple more years, we started really pushing on, geez, maybe this isn’t a product-oriented message. Maybe this should be a business outcome oriented message. How do we tap into the broader areas of budget that are driven by actual business led initiatives? And this is in the era where digital transformation started to be in the minds of folks. Things like customer experience, things like legacy modernization, things like a cloud migration. So we can start tapping into larger initiatives that then were driving toward tangible business outcomes. And in that era for us it was all about helping our field and helping our marketing functions really understand how to connect the dots between those business outcomes and what we offered from an underlying technology perspective.

Karan: What’s interesting about that, as I reflect back to my time at Cloudera and Cloudera was data warehousing, same thing, open source centric, all that. I used to joke with my teams about it. There’s no demo to be had with a data warehouse. You can’t demo a data warehouse, right? It’s a concept. You’re putting a bunch of data in it and then therefore and thusly similar to MuleSoft, you had no choice but to think about it more use case centric and to think about it more vision centric.

What I did observe from my path lines, Mahau and I’m curious how this went for you. So I’ve seen a lot of companies make that transition from that feature sale, that individual featured demo centric sale to use case centric. Not a lot of companies make that next step to that, hey, here’s what the vision is, here’s the business transformation you’re going to be able to lead. So I’m curious, I mean you obviously had a competitive environment that you were working in as well within MuleSoft. I mean, did your competitors find that transition as well, or do you feel like this was a differentiating factor for you in the MuleSoft team? Share a little bit more there.

Mahau: What’s notable about the integration category is that it’s a very heavily competed category. You can find a whole bunch of players taking it from different angles. Many of our competitors at the time came at it from frankly a business user angle. They would say, hey, for less technical users, we can solve these connectivity challenges to support these underlying business processes. And that was their thing.

So I think part of it was yes, we had to respond to competitors who started from that angle, started from the solution in the business angle. I’ll also say though, that even though it was a super crowded space, no company before MuleSoft had actually really broken out and defined a category the way that MuleSoft did. Not to pat ourselves on the back, but if you look at the evidence in terms of just the scale that the company got to, I think MuleSoft did something really quite different. Really what it all adds up to at the tip of the pyramid, is this very fundamental belief for us as a company that our competitive customers of the future will be innovating, not by building new things, but rather by composing and combining existing IT assets to create new innovation. At the end of the day, what we were doing there was positioning ourselves not just as a technology vendor, but really trying to enable a real partnership with these executives who were looking for the reason to invest so heavily in digital transformation.

Karan: That’s great. Last question for you on this. Was there an organizational-wide decision based on the socialization you did, to say, hey, we’re going to make space for this, we’re going to make bandwidth for this? Or how did you actually get that time carved out to actually make this transformation happen?

Mahau: Yeah, I mean that is always the challenge in a startup environment, you’re changing the tires and repainting the plane while it’s in mid-air, in a way. That was no exception for us, particularly in times like this where resources are constrained, cash isn’t unlimited. Things like the company culture start playing into it. Do I have a culture where everyone is in their gut lined up to make this thing successful? Does everyone really believe in the mission? And frankly, are we willing to trade off some balance for some period of time to make that happen? And it’s a hard message, particularly in today’s world, but for us, that absolutely was a big part of it. We were notorious for not trading things off. It was like we had 15 first priorities and we had to make them all happen. So were we perfect? No, absolutely not. We failed on many things, but did we all believe deeply in that mission? I would say yes.

Karan: Mahau, I mean, this is incredible. You’re right, we could have talked for two hours, three hours on the topic. I’m glad we were able to distill a few key attributes of it out and maybe some good learnings for our listeners. So really grateful for that. If you’re open to it, I like to finish these conversations with a lightning round. Four questions, three questions, something like that. Don’t think too hard on them. One, two sentence answers. They should be a little fun, a little something. Again, I want to sandwich a little more learning of Mahau for the listeners as well. You game?

Mahau: Okay. I’m a little scared, but let’s see where it goes.

Karan: I wouldn’t be. Right on. Okay. First one, when you made the transition to leadership, what would you share as best practices on that journey?

Mahau: The biggest one for me as a leader was it took me a long time to figure out how to have the hard conversations sooner rather than later. I think a lot of early leaders, including myself, put a lot more emphasis on being liked or not rocking the boat or sometimes not losing a team member, and they undervalue the value of delivering real, candid feedback.

Karan: What’s the biggest misconception about your discipline, marketing?

Mahau: Both within marketing as well as people who are looking at it from the outside, they often get confused between activity and value. And so you get a lot of people saying, geez, I did a lot of stuff, or we’re doing a lot of stuff, how come nothing’s coming out the other end? And I think that shouldn’t be the case today with how instrumented we are and all of the good frameworks we have for measuring outcomes. But it still happens everywhere. I see it everywhere.

Karan: Yeah. Important mindset shift. All right. This last one’s my favorite one, then you’re free. If you weren’t doing what you’re doing, which is being a venture partner, marketing, corporate strategy, what would you be doing?

Mahau: Aha. I’ll tell you, one of my very close friends is a luxury travel advisor, essentially a high end travel agent to the stars. And boy, this guy’s life is very enviable. He’s always jetting off to one corner of the planet or another, reviewing amazing places and seems to be having a ball. I mean, I’m sure there’s parts of that job that are also a grind, but boy, that looks like a pretty good life to me.

Karan: Yeah, I’m sure he’s got a fantastic Instagram. Amazing. Thank you for the very, very compelling conversation. Really appreciated my friend.

Mahau: Absolutely. I loved being here and I love talking about what we do so, that’s great.

Karan: Amazing. Thanks a lot.

All opinions expressed by Sapphire and podcast guests are solely their own opinions and do not reflect the opinions or views of Sapphire Ventures LLC. This podcast is produced solely for informational purposes and should not be construed as investment recommendation or otherwise relied upon as the basis for investment decisions.