There has been a big debate over the last few years over whether the Series A crunch is real or not.
What everyone can agree on, though, is that there are definitely more seed and early stage funds now than ever before, and more people willing to give money to young companies looking to make it big.
But just who are these funds and venture capitalists that run them? What kinds of investments do they like making, and how do they see themselves in the VC landscape?
We're highlighting key members of the community to find out.
Jim Andelman is co-founder and Managing Partner of Rincon Venture Partners.
Before founding Rincon, Andelman led software investing at Broadview Capital Partners. Before BCP, he was at Alex. Brown, managing equity private placements and IPOs for software companies. Andelman began his career at boutique strategy/technology consulting firm Symmetrix. He received his MBA (first in his class) from the Tuck School and his BS (magna cum laude) from Wharton.
Jim serves on the Boards of Directors of Campus Explorer, Conversion Logic, Keen IO, Mobcrush, Rentlytics, Rainforest QA, Steelhouse, TaxJar and Tradesy. He previously served on the Boards of Cadforce (acquired by Neilsoft), Packet Island (acquired by BroadSoft), Burstly (acquired by Apple), DataPop (acquired by Criteo), Shift (acquired by Brand Networks) and Divshot (acquired by Google).
VatorNews: What is your investment philosophy or methodology? What do you like to invest in? What are your categories of interest?
Jim Andelman: We are one of the most tightly focused VC firms you'll meet. We invest almost exclusively in B2B Internet software-based businesses. We look for offerings that are part of the way work gets done. The type where if you turn them off, key functions will come to a halt. This is key to higher retention and therefore faster and more predictable value creation.
We do SaaS (aka business productivity apps), but also transaction processing, Infrastructure-as-a-Service, Marketing Technologies, B2B marketplaces and on-demand services, etc. Basically any offering where there is a business buyer of a software-based product with high recurrence and retention.
On the one hand we are very focused, meaning there's a lot we don’t do. We are not investing in drones, or hardware or consumer or Bitcoin. But there's tremendous diversity under the umbrella of B2B.
We are hunting in really fertile territory, as we see unbounded opportunity over the next 10 years for software solutions for business buyers. We don't pretend to think we're smarter than the sum of the wisdom of the founders who are coming up with great ideas, so we’re open-minded when it comes to specific solutions end markets. The big population of smart founders we seek to serve will come up with better ideas than we will. So we want to talk to any great team that is doing something under this B2B software umbrella.
VN: What would you say are the top investments you have been a part of? What stood out about those investments in particular?
JA: That’s kind of like asking who your favorite kid is, but I’ll highlight a few. I’m in my 16th year as a VC, and my partner and I have been doing this together as Rincon for eight years. The longer one does this business, the more one cares about the team. A great team will adjust their product, market and value proposition if necessary, but it's painful to make changes to the founding team. We want to back founders who can stay in their seats for a long time. We don't want them to think they’re interviewing their jobs every time we get together. So we put a very heavy emphasis on the character and capabilities of the core team. In fact we look for “serial founding teams”, ones who have worked together before, and who are choosing to spend up to 10 more years together on their next company.
One good example of that is Burstly, where we led their first priced round. Burstly built a suite a tools for mobile app developers, including Testflight (the leading mobile app beta testing service) and Skyrocket (the leading ad management platform for mobile games). They were acquired by Apple last year, so they went from being the defacto standard to the official standard. It was a combination of team and market opportunity. The co-founders had previously worked together at Tagworld, a provider of social media software, which was acquired by Viacom. Before that that they built Traffic Marketplace, which was a top five ad network. There was clearly a big market opportunity there, and since it was early days for mobile apps, we knew there was going to be a dramatic increase in activity, dollars and interest.
Another great company in the portoflio is Invoca, which is in the marketing automating space. It's like Marketo or Hubspot but for phone calls. They had a serial founding team, who all worked together at Callwave (2005 IPO), where my partner was the EVP Marketing & Sales, so we knew the team well. There was a clear and understandable market opportunity, and a talented team to pursue the opportunity. Here we co-led their first priced round with Mark Suster at Upfront Ventures, and they most recently raised a round from Accel’s growth fund.
There's a tremendous opportunity today for API-based services, offering capabilities to developers that they would otherwise need to build and maintain themselves. One example in our portfolio is Keen IO, which offers analytics back-end as-a-service. You don't have to hire big data engineers, or maintain complex big data infrastucture. Instead developers hook Keen IO up to their production systems, and data is sent and stored optimally for analytics, visualization and extraction. We co-led their seed round, and their Series A was last year led by Sequoia.
The final one I’ll highlight is Rainforest QA, which does QA testing-as-a-service via API. They built an elegant software management player on top of a crowd of 50,000 global human testers, so they offer the best of automation and human intelligence together for QA. Compared to the incumbent alternatives (manual, outsourced, automation test suites), Rainforest is better, faster and cheaper. We co-led their seed round with Jason Lemkin of SaaStr fame, and they’ve grown 9x since we invested earlier this year.
VN: What do you look for in companies that you put money in? What are the most important qualities?
JA: First off, we are considered a seed investor and most of what we do is called Series Seed, but we are more often than not leading the second round of funding that a company receives. The first funding for a company is these days typically a convertible note, and then a year or two later we lead its first priced round.
There are four things we prioritize. The first is the character and completeness of team. Nothing is more important than this. This includes strong “founder-market fit”, which ought to be self-explanatory. Second, the customer value proposition. We want customers to love the product so much that they’d feel extreme loss if it ceased to exist, that we’d need to pry it out of their cold dead hands. We shy away if we hear that customers are lukewarm on the value prop or not sure if the product will have a long life at their company.
Third is the opportunity for customers to grow their usage over time, to the degree that it more than offsets customer attrition. Technically this is called “net negative monthly churn”. Ideally every customer cohort is more valuable with each passing month. That can be hard to identify at the seed stage, but we’ve gotten pretty good at it.
And finally fourth, startups need to be targeting a big opportunity. We need to be able to convince ourselves that the market they are targeting will support the business to $100mm in annual revenue and beyond.
VN: What kind of traction do you look for in your startups? And can you be specific? Are you looking for a number of customers or order volume?
JA: The majority of companies we invest in already have revenue and product, with paying customers that we can talk to. We almost always introduce the company to new customers. We don’t expect the whole sales cycle to complete before our investment. But it's usually a win-win because we get to hear how the pitch went, whether the value proposition resonates or not, and get great objective market insights. Meanwhile the company gets free introductions to new prospective customers, and hopefully incremental revenue. In one situation we made an intro that doubled the Company’s MRR even before we invested.
Empirically, companies have averaged about $40,000 in monthly recurring revenue when we made our initial investment. But there can be a trade off between traction and team. The more capable, complete and proven the team is, the more willing we are to go earlier. We just made an investment in a pre-revenue company, but they have an exceptional founding team with three big exits under their belts already. On the flip side, if a company has a young / first-time founding team, that doesn't mean we dogmatically won’t invest, but for us to get to “yes,” odds are they have to be further along with customers. In short founders must have proven their ability to execute, either in a prior setting or in this one. Back to the facts, we made six investments this year, one of which was pre-revenue, and the other five had revenue. The smallest in revenue was doing $12k in MRR when we committed to invest, and biggest was at $240k in MRR.
We don't look for a specific number of customers, since every market is different, with different price points, purchasing dynamics, etc.
VN: Given that these days a Seed round is yesterday's Series A, meaning today a company raises a $3M Seed and no one blinks. But 10 years ago, $3M was a Series A. So what are the attributes to get that Seed round? Since it's a "Seed" does it imply that a company doesn't have to be that far along?
JA: The great news is that it's never been cheaper for Internet startups to get going. Back in 1999, the only game in town was selling expensive on-premise systems to IT within big enterprises. It took years of development to get the product ready to sell, so Seed and Series A were usually pre-revenue. Now if you're founding team has strong technical capability, you can launch with sweat equity and a credit card. That's a fundamental change.
The bad news on the other side of that same coin is that as starting up gets easier, more companies do it and it becomes much more competitive for VC dollars. The average convertible note round seems to be getting larger and less frequent, but still high volume. Generally a prerequisite for that is a core team and a good network, with the amount of traction required being inversely proportional to team and network. There are certainly many who feel that having a product in-market is table stakes.
When it comes to the first priced round, companies need a lead like us to write a check of $1mm or more, and that's a much higher hurdle. The individual partner at a VC firm who only makes two or three investments requires a higher level of conviction on each. So VCs making these kinds of investments often need to see more progress and more market validation.
VN: What are the attributes of a company getting a Series A?
JA: That's a bar that seems like it’s going up and up and up. In our space, a year ago for a Series A, if a company had north of $80-100k MMR and were growing well month-over-month, the odds of a good series A were quite strong. I’m hearing and seeing Series A investors becoming much more demanding latterly, and my perception is that has almost doubled. Companies that are at $100,000 MRR now have to compete for funding with companies that are at $200,000 MRR. Growing 10% month-over-month equates to a 3x the run-rate year-over-year. In terms of revenue for the calendar year it’s around a 2x. That's great growth, but in this market it frankly might not be not enough to attract a high quality Series A investor.
If you are growing 20% month-over-month for 12 months straight, that's 9x year-over-year on a run rate basis. That's daunting from an operator’s perspective. But some companies are pulling it off, and they are winning those Series A dollars.
We’ve all had powerful computers in our pockets for the last five years now, and we’re all using SaaS without even realizing it, in the form of Evernote, Gmail, iCal, even Facebook. With the consumerization of IT,and the rise of mobile solutions, the increase in the number of software buyers, the opportunity exists to grow faster than ever before. That’s compounded by the instant global distribution system provided by the Internet, which reinforces that opportunity to grow faster than ever before. So I think more more companies in absolute terms are experience such impressive growth.
VN: Given all the money moving into the private sector, I believe there's more money going into late-stage deals in 2015 than there was during the heyday, back in 2000, do you think we're in a bubble?
JA: There's certainly some irrational behavior on a case-by-case basis, with some companies getting valuations that are higher than they deserve. Some companies receive massive amounts of capital to deploy, and that that can be problematic. For the investors providing that capital, sometimes it works and sometimes it doesn't. But it also creates externalities: one competitor raises a ton of money, and that presents a conundrum for other companies in that space. How do they respond to that? In days gone by it was easier to ignore competition, and to focus on your product and your team, your business. Increasingly it feels like B2B markets are seeing increased concentration of enterprise value (“winner take all” or “winners take most”), as has historically been the norm in consumer. Take Slack, which is an example of a SaaS business with strong network effects, where perhaps the value of the business increases geometrically as the user base increases linearly. It has raised so much money, it sucks all the air out of the room for its competitors.
It's absolutely true that some companies are getting over-funded. In the first eight months of this calendar year, the late-stage market was definitely overheated. Practically anything that had potential to be a rocketship got richly funded. Now the pendulum in my opinion has swung too far the other way. Whereas earlier this year the dominant fear was the fear of missing out, now the dominant fear is fear of loss. This means that many solid expansion- and growth-stage companies are actually having a hard time raising. The most common state of the market for VC investments is “over-reaction.”
VN: If we're in a bubble, how does that affect your investing?
JA: It's kind of distant from what we do. We're investing so early, we win if a company grows from a toddler to healthy self-sustaining young adult. We hope they become $100 million+ revenue businesses, but more often than not they exit before that scale is attained. We do work with founders to help them see the benefits of staying independent longer.
We need to believe a company can be a $100 million plus independent company. We absolutely think about that, but we don't think about how T Rowe Price or Fidelity is going to be looking at it and whether it will be prematurely anointed as a “unicorn.” We are focused on helping companies build a scalable, repeatable growth engine. Helping them get from $30k in MRR to $200k in MRR before the next round. And then on toward that $100mm+ revenue scale.
VN: Tell me a bit about your background. Where did you go to school? What led you to the venture capital world?
JA: I spent my first 30 years in the Northeast, then moved to San Francisco, and I now live in Southern California. I went to Penn for undergrad in Philadelphia, then went back to Boston to work for a strategy consulting firm, with one of the co-founders of Bain & Co. That firm focused on the application of technology to drive strategic advantage, so from my very first job out of college, I’ve been involved with B2B software.
I went to business school at Dartmouth in New Hampshire, where I graduated first in my class. I joined an investment bank, Alex Brown & Sons, which was one of the “four horsemen” that served emerging growth companies. I focused on equity private placements for software companies, where I helped VC-backed companies that were raising their last round of funding before going public. In 1999 I was recruited by Broadview Capital Partners. We had a $250 million fund, and I led software investing from 1999 to 2003.
After that I moved to Southern California, which is where my wife was raised and she wanted to settle down. I founded Rincon because I saw that Southern California was experiencing a big upswell in startup activity and good exits, and it was clear that there was a great opportunity for a new firm that supported those startups. We no longer invest only in SoCal, but its still big part of our story. Two-thirds of our portfolio is here, and most of the balance of the companies we’ve backed are in the Bay Area. It’s important for us to feel local to the companies, be able to actively support them, collaborate face-to-face. We can achieve that in the Bay Area and in Southern CA.
I have an alarming lack of operating experience, so I wanted a partner with impeccable operating chops. I was patient and finally coaxed John Greathouse to join me, who is a serial VC-backed executive. He’s helped build two companies that went public, and two that sold for over $150mm each. He helped build the GoTo franchise -- GotoMeeting, GotoMy PC, etc. – which is now one of the world’s largest SaaS businesses. He was the first business hire there and he ran marketing, sales, finance and services. Perfect experience for the sectors we're going after, and the stage at which we engage. I channel him when founders ask me for operational advice!
VN: What do you like best about being a VC? What makes you excited?
JA: There are three things.
One, I love being a doer. That sounds a little weird since some people think VCs aren’t doers. When I was a strategy consultant, I was good at it so I was promoted to team leader, which means I transitioned to managing other people and selling engagements. When I did Investment banking, I was good at it and I was rewarded by becoming a team leader, so I again transitioned to managing other people and selling engagements. Here as a VC, I get to be a doer my whole career. Like Benchmark and Foundry Group, we have no associates, so the partners do all the work. We run our hands through the dirt so to speak, and that’s gratifying to me personally.
Two, I love the opportunity for lifelong learning. If a startup team isn't doing something novel and new and interesting, I won't be spending time with them.
And three, my partner and I both have a strong service mentality. We like being helpful. The best day is when we know we helped a team out in ways that others wouldn’t or couldn’t.
VN: What is the size of your current fund?
JA: We’re investing out of our third fund, which has $40 million to invest. Our first was $25 million, and our second was $30 million.
VN: What is the investment range? How much do you put into each startup?
JA: Our initial investment into a company is typically $750,000 to $1.25 million. We have done as little as $100,000 and as much as $1.5 million. We are a lifecycle firm, so we reserve more than 100% of that initial investment for follow-on.
When things go as planned, we typically participate in our entry round plus the next two. Our model is, after those two rounds the company is either self-sustaining or we are priced out because the company is doing really well and raising money at a hefty valuation. In the latter case, our incremental (paltry) $500,000 isn’t needed, and is better deployed into the next startup earlier in its life.
Sometimes our first check is all a company ever needs. That frees up reserves for others, so it’s plausible that we invest $3 million or more over the lifetime of a specific portfolio company.
VN: Is there a typical percent that you want of a round? For instance, do you need to get 20% or 30% of a round?
JA: We are a low-volume, high-conviction, high-involvement firm. We limit the number of investments we make and the number of Board seats we take so we can be responsive and attentive when needed, and reserve the time to be proactive for the benefit of the companies we back. We do have a target ownership range, but it’s a lot lower than the typical Sandhill Road firm. When we are lead or co-lead, we look for 10-20%. We will infrequently write a smaller check as a co-investor, and then the target is more like 5%.
VN: Where is the firm currently in the investing cycle of its current fund?
JA: We have a new fund, which we started investing from at the beginning of this year. So we’ll be actively adding new companies to this portfolio for the next 3 years or so, before starting on Fund IV.
VN: What percentage of your fund is set aside for follow-on capital?
JA: About half.
VN: In a typical year how many startups do you invest in?
JA: We make five or six new investments each year, and usually make 7-10 follow-on investments each year into existing portfolio companies
VN: Is there anything else you think I should know about you or the firm?
JA: The big one is that most seed funds are high volume & low involvement, and we’re the opposite. We aspire to be the founders’ first call when they have questions or are wrestling with an issue. We strive to be present and responsive, invest in things where we know our stuff, where our counsel is valued. We want to be over-indexed on the earlier rounds of a company’s life, so our interests are tightly aligned with those of the founders. The majority of investments we’ve made have been referrals from founders we’re already working with, which we think is a pretty good barometer of how we’re doing.