Recent Lessons for a VC

Ravi Viswanathan

By Ravi Viswanathan, PhD

At my firm, New Enterprise Associates (NEA), we think a lot about the ingredients to creating huge companies – disruption, great entrepreneurs, big markets.  The disruption aspect is interesting as this has evolved over the years – in the 80’s and 90’s, much of the disruption was really technology based (a new molecule, a new piece of code, a new piece of hardware).  Now, disruption comes in a lot of ways – business models, go-to-market, value chain, market evolutions, as well as pure technology.

One disruption that has happened is the new wave of enterprise technology companies that have hit the public markets over the past 18 months.  Each are innovators in their own sectors, but as a group, they are shaking up the public markets in a very positive way.

Over the past 18 months, there have been 10 IPOs launched in enterprise technology companies with market values in excess of $1bn.  These include companies such as ServiceNow, Splunk, Fusion-io, and Palo Alto Networks.  These elite companies took 7-10 years to get to the public markets, but it was certainly worth the wait for their investors.  Annual revenue growth rates range from 30-70%, with valuation multiples also quite high (5-10x 2013 revenues).  The median revenue for this elite class of companies was over $200mm (for CY2012).  The message that the markets are communicating is that hyper-growth companies where solid business models exist with good revenue visibility will get rewarded.

Here are some additional takeaways:

Investors (public market investors as well as VCs) are enthusiastically investing in enterprise-focused startups:

  • There have been many well-received IPOs with <$100M in revenue, such as Demandware, Eloqua, and Brightcove
  • However, enterprise revenue is very “high quality”, e.g. sticky enterprise customers, recurring revenue through SaaS business model
  • Additionally, these companies are solving critical problems in the enterprise, and are easy for investors to understand on that level
  • Recent enterprise IPOs actually have generally lower margins than recent consumer IPOs, but investors have accepted the importance of reinvesting/investing in the business (growth at the expense of near-term profits), in large part due to a sticky customer base and the strong economics associated with acquiring these customers

Innovative business models are being well-received in the enterprise:

  • Startups are freely experimenting with business models to find the right fit for each market, e.g. Splunk offers freemium software and Workday generates substantial revenue from professional services such as training
  • A broad range of sales models are also employed, including selling directly to knowledge workers without initially going through a CIO, such as for Jive and Box (of course this was also a tactic Salesforce used heavily)

Enterprise companies are being rewarded with premium valuations in the public and private markets:

  • Strong growth rates support these valuations, e.g. Workday has a forward revenue multiple ~3x higher than Facebook’s, but it is also expected to grow ~70% in 2013, versus ~30% for Facebook
  • EBITDA and earnings multiples are also extremely high as investors accept low earnings during periods of fast growth
  • Public market valuations reflect strong M&A activity, including the acquisitions of Taleo, SuccessFactors, Yammer, and Buddy Media.  (On the subject of M&A, there is a broad discussion to be had about a “cloud land grab” and how difficult it has been for incumbents such as ORCL to develop products internally)

As a venture investor, the biggest takeaway here is that these companies can take a very long time to mature and hit scale, but that they also had a very strong entrepreneurial culture pervasive through their organizations.  This was critical given the length of time needed for “success” as well as the fact that in many cases, each of these companies were facing tough entrenched competitors.  But, the rewards can more than compensate for the risks.

Bio:

Ravi is a member of the Wharton Entrepreneurial Advisory Board. At NEA, Ravi focuses on investments in information technology and energy technology. Prior to joining NEA, Ravi worked at Goldman, Sachs & Co. where he was co-head of the technology practice in their private equity group and led direct, fund, and secondary investments in the areas of information technology and life sciences. Prior to Goldman Sachs, Ravi worked for McKinsey & Company and advised clients in the software, communications, and pharmaceutical sectors on strategy, acquisitions and new business building. Ravi received a master’s degree in Business Administration from the Wharton School at the University of Pennsylvania and a PhD in Chemical Engineering from the University of California at Santa Barbara where he focused his research on materials science applications in molecular electronics, biomaterials, and nanotechnology. Prior to graduate school, Ravi received a BS in Bioengineering from the University of Pennsylvania.