MarketX recently launched Radiate Ventures to invest in fintech, deep tech, and vertical SaaSRead more...
The firm invests mostly in B2B SaaS businesses, along with some consumer companies
Venture capital used to be a cottage industry, with very few investing in tomorrow's products and services. Oh, how times have changed! While there are more startups than ever, there's also more money chasing them.
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.
Dan Engel is Managing Partner and Founder at Santa Barbara Venture Partners.
Engel has been a B2B and B2C software entrepreneur since 1997, and has been a securities investor since 1991. Prior to Santa Barbara Venture Partners and being a venture capitalist at OCV Partners and NGEN Partners, Engel was CEO and co-founder of FastSpring, a SaaS company providing e-commerce store management for 3,000+ software vendors worldwide such as Adobe and TechSmith.
Prior to co-founding FastSpring, Engel was head of online customer acquisition at Google throughout its IPO phase, acquiring clients for AdWords and AdSense, Google’s primary revenue channels. Before Google, he was head of customer acquisition and marketing as part of the management team at Picasa, a digital photo consumer software company sold to Google. Picasa technology is now known as Google Photos. At Google, Engel introduced an analytics tool he was using at Picasa to track marketing campaigns which Google needed and subsequently acquired, creating what’s today known as Google Analytics.
At 24, Engel was an Entrepreneur-in-Residence (EIR) at Idealab, the original internet company incubator that had pioneered the dot com era starting in 1996. He had previously started a consumer e-commerce company while in college in 1997 which aimed to be the “Amazon for Magazine Subscriptions” yet failed when the dot com bubble burst. He has co-founded various other companies over the years, including Mobile1st, an Austin-based digital agency that increases mobile shopping conversion rate for e-commerce companies, CPC Search, a pay-per-click search digital agency, and Morpheus Software, makers of the popular Morpheus digital picture animation and manipulation software product line. While at Morpheus, Engel co-developed a series of animation videos showcasing Morpheus’ morphing technology that received over 50 million views on YouTube.
Prior to being a VC and a software entrepreneur, Dan’s passion was investment asset management. Starting in high school with Smith Barney (today Morgan Stanley), he held a variety of financial internships. He worked with Sanford C. Bernstein (today AllianceBernstein), creating their first website in 1996. During college, Engel interned at Merrill Lynch, working for four years alongside a veteran value investor who became his investment mentor. Later, at Fidelity Investments‘ FMR Division, he worked alongside the industry’s top fund managers and investment legends such as Will Danoff, Peter Lynch, and Ned Johnson. At 19, Engel sought out and learned from legendary value investor Philip Carret, a role model to Warren Buffett who helped pioneer value investing in 1927.
Engel serves on various boards, including non-profit boards such as New Beginnings, a non-profit that provides counseling services to military veteran, low income and homeless individuals, Partners in Housing Solutions, a non-profit that helps place homeless people from Santa Barbara County into permanent housing, and the Board of the Santa Barbara/Santa Maria Continuum of Care (CoC), the regional planning body that coordinates the community’s policies, strategies, and activities toward preventing and ending homelessness. He graduated Tulane University in 1998 majoring in Finance. He has appeared in various publications, including Entrepreneur Magazine, Forbes and The Wall Street Journal.
VatorNews: Tell me about Santa Barbara Venture Partners, how you like to invest and how you view yourself in the venture ecosystem.
Dan Engel: We're a little different: we don't really do much early stage, we do later stage, generally when revenue, preferably recurring subscription revenue, is at least $3 million; it could be $100 million, but it's got to be generally at least $3 million. The reason why is we are big believers that until you have market validation, until you have product market fit worked out, the risks are just really big. Having built a lot of different companies myself and seeing how long they took to succeed, a number of them are big successes like Picasa and FastSpring but, in each case, it took years and years to get the product market fit timing right. While you're going through it, you never know whether it's ever going to happen, so I wanted to skip over that.
Obviously, the valuations are higher at a later stage, but the risk profile, especially when you're dealing with recurring revenue, and if you have strong retention metrics, it's just a whole different ballgame. And so, we don't expect that any of our investments will go to zero so that we'll have to offset them by finding the next Facebook; we're happy doing 3x to 6x in our investments over a three to six year time span, and that is pretty realistic for the stage we're going in at. It's really hard for our companies to fail, given that they’re generally recurring subscription businesses with very little churn. We're different from a portfolio of, say, 25 investments where they know that X number are going to fail, so they have to offset that by getting a 10x or 100x or 1,000x or whatever. I just don't like the idea of being dependent on having to have such a home run, because I've had them in my career; I invested in Apeel Sciences and went from about $4 million to $2.3 billion, but those are hard to find. I haven't had two that had that appreciation in all these years. So, those are rare, and I don't want to be dependent on those in order to be successful. A lot of our investors, we have about 75 of them, appreciate that.
The thing that gets us access to deals, despite our checks not being huge, and our brand name not being big and well known, is that we can offer something that other VC funds don't, and it happens to be the thing that's just about the most important to CEOs: help with accelerating revenue growth through help with demand generation, marketing, lead generation, and customer acquisition. I have my own experience, I ran customer acquisition at Google for GoToMeeting, which became a $600 million SaaS business; for Picasa, which became Google Photos; and for my own company, FastSpring, that we sold to Accel-KKR, which is like a smaller version of Stripe. More important than me is the LPs that we specifically recruited who are marketing gurus covering all different areas and channels of customer acquisition.
If you were to look at our website, it would show you a couple things: one, all the areas that we help with increasing the growth rate of revenue and marketing in general, and then it would show a selection of the types of investors/advisors we have that work with our portfolio companies to help them with accelerating revenue growth. The cool thing is that we don't just talk about it, we do it, and we tend to over deliver, under promise, and we've got a portfolio of company heads of marketing and CEOs that are just very, very happy with the amount of help that they get from us because they're used to a lot of VC firms that, one, say they’re going to help but, and then, two, don't have this expertise. We're not experts in operations or HR, things like that, but when it comes to this area, this is what we're all about. And we've got a pretty strong team of LPs and advisors that provide value to the companies that they can’t get otherwise.
VN: You said you're doing later stage. What stage is that, like Series B, C, D?
DE: So far, A to D. Those letters are used a little differently than they used to be; they change a lot, so we'll see what happens now with the market doing what it's doing. But most of the time it's A to D, or sometimes it'll be a convertible note.
One thing that's a little different about us, because we're able to get into deals other firms often wouldn't, unless they had the financial or brand clout, when a CEO sees the help that we offer and realizes that they want it, they find a way to make it work. Sometimes that means we come in between rounds, sometimes notes are put together. Half the time we're actually buying shares from the CEO or from executives or from legacy shareholders. Basically, the CEO decides they want our help, and they figure out a way to get us in and on the cap table. Because of that, we get a lot of situations where pricing is maybe different than it might otherwise be; we're not always just joining us everybody else in doing what's market. That's part of why we've been so successful in the first year and a half in terms of our IRR and TVPI and whatnot is we've been able to get in at really good prices, despite buying parts of SaaS companies that, when they go to do their next round, it's 2x what we paid only six months later. That dynamic has been really helpful to us.
Also, being relatively small has been really helpful. Because our checks are like $1 million or $2 million, not $10 million, that means we're not really a threat to a lot of the other investors, we're not really competing against the big guys. For example, when we did the deal with Classy, which got sold to GoFundMe, which we’re happy about, that was a $150 million round led by Norwest, and we put $2 million into it. If we were trying to put $20 million into it, it would have been a different story but, because we're small, the CEO is able to get the board and the investors to say, “hey, we're all going to benefit from the help these guys provide in terms of revenue growth, can we please get them in even though their check’s not that big?” And, generally, the people on the board and the investors say, “Yeah,” because what are they going to say? “If you're telling me this is going to help us all, and you need this help, we don't want to get in the way." But it would be more of an issue if we were a much bigger fund .
VN: What are your categories of interest? Do you invest in consumer or B2B, and in what verticals?
DE: The majority of what we do is recurring revenue B2B, preferably SaaS, and maybe 20% is consumer. Consumer is more fun, we love it; it's where I learned things to begin with when I started a company years ago in the dot com era, selling magazine subscriptions to consumers, and then Picasa is also a very consumer business. So, I enjoy it a little bit more but, in terms of investment ROI, we're more comfortable doing the majority of our deals in B2B software, where you can really rely on long-term retention rates, and have a good degree of predictability that revenue will go a certain direction first, hopefully for a significant period of time.
We're pretty industry agnostic. If you looked at our portfolio, you see all different types of industries, from specification management software to telehealth software. On the consumer side we have Bark, which is the only way to track your teen’s online digital activity and have AI alert you if your child is doing something that you think you might need to know about, like talking about guns, talking about killing themselves, talking about killing others, having a sexual predator conversation on one of many apps. They track, through the logins, all these different apps and programs, like Gmail and WhatsApp, and then alert the parents and or school if there's something seriously problematic. The other consumer play we have is a company called Jackpocket, and they are the only way to play the lotto on your cell phone. So, 91% of people who play the lotto still go to physical stores; we don't think it’s always going to be that way and these guys are, by far, the leader. There's a lot of regulation in the space, so they have a very big moat and it's hard for anybody to really come after them. They even struggle through all the regulations, they don't always get it right, sometimes they have to redo it, but because it's so hard, that's why they're so far ahead and mostly the only game in town in most states for people who want to play the lotto on a mobile device.
One of the most exciting companies on the B2B side that’s just kicking ass in terms of results is something we came into relatively early, but it's very quickly getting very big. These guys have cracked the nut on how to use AI for radiology, making improvements in radiology results. A big problem in radiology is burnout, so the first product saves radiologists an hour a day out of a nine hour shift by automating using AI on some of the reporting. The second product deals with a problem a lot of people don't even know about which is, up to 60% of the time, follow-up and continually is not done properly, which means a lot of people don't end up finding out what they should, or getting all the right tests, it just falls through the cracks because of a lack pf communication between different doctors and the general practitioner and the radiation center. With that second product, we did a partnership with one of the big healthcare companies, so it hasn't been out that long, but we've already got millions in revenue, we’ve reported five cases of cancer that we found through using this AI process to ensure that people do the follow-up that sometimes falls through.
The Holy Grail is the third product, which is not out yet, which is about the fact that, unfortunately, a large percentage of the time, two radiologists look at the same imagery and come up with two different conclusions. And AI can really address that by saying, “Hey, you know that conclusion you came up with? We've looked at this 10,000 times, let me tell you why you might want to take another look.” Effectively, that's the concept. What's cool is these guys have more data than just about anybody else in radiology software, because they don't work with the hospitals, they work with the radiology groups and when you work at the hospitals, you can't get the data. They have like 10 or 15 times as much data as anybody else in the space and so they get a lot of attention from big players like Microsoft and Nuance, who are trying to figure out how they're doing it, how they're getting the data, can they get access to the data to use their own products, things like that. It's an amazing story: the guy who started it is the youngest radiologist ever in the United States. He did that for 11 years and he's also the second youngest doctor ever. So, quite a smart guy and we're really happy to be part of that.
VN: That's Jeff Chang from Rad AI, right? We did a podcast with him a few weeks ago.
DE: I didn't see that but he's amazing and these guys finally nailed it. So much money and VC and whatnot has gone into trying to crack this nut and, at the end of the day, for most of the solutions, the radiologists are like, “yeah, it's a little helpful, it's not helpful enough.” But with this, they're blowing the cover off the ball. They grew 130% just in the last seven months since we invested and every week they get another big client. Now they have eight of the 10 top radiology groups, so it's catching on big time and what's great is you get into one of these radiology groups and you get like 15 radiologists using it but the expansion capability can easily go to 200 or 2,000, depending on the group. So, there’s a lot of potential for ARR expansion and we'll see what happens. But, at the moment, it's one of our most exciting ones.
All of ours are doing really well; we have one that is doing well on the fundraising side, they raised more money at twice what we paid, six or seven months later, which is nice, but a big deal for them didn't come through and so their revenue is not growing the way that they expected. But everything else is kicking butt and we're very happy about it and we've got, at the moment, an estimated gross IRR of 75% and an estimated TVPI of 1.72. And we've only held our investments for an average of 10 months, so we're getting a lot of action and it's going well. I don't think it's going to keep up; our IRR will not be 75% as more time goes on, but that's okay, there's plenty of room to still have a wonderful return. We're fortunate that one of our companies just got acquired, a second one almost got acquired, which would have been about 4x in about 14 months, but the one that got acquired, Classy, they basically doubled our money in six months. Classy is the number two SaaS for nonprofits to do digital campaigns for raising money, so a company with many tens of millions of ARR. The company and the board decided not to take cash, even though they could have, and instead to merge into GoFundMe, and then the two entities combined together to have a very large footprint and a very large amount of revenue, enough to potentially have a very successful IPO. We'll see what happens with the market, but we expect to have a lot more success being part of GoFundMe than just having taken cash out.
If you go to our website, and go to where it says “gain marketing advantage,” when you come to that page, and you scroll down, you'll see all these little colored bubbles that talk about all the different facets of marketing and demand generation that we help our companies and it's most all of them. The idea is, when you're a company, especially a startup, you've got some people in your marketing team, but they have decades of experience only in a few areas of marketing, so we try to fill in those gaps. Say you’re a consumer business and you want to run ads on the radio or TV. Well, how much experience do you have in that? And, if you have experience in that, you probably don't know that much about how to do search engine marketing, or you don't know that much about influencer marketing; it's not the same people. So, what we say is, “You want to do ads on the radio, you want to talk to some of our advisors. Talk to Bob Kraut who was the CMO of Papa John's, he's done national campaigns on the Super Bowl and things like that.” That's really useful for Jackpocket, for example, because they're doing these deals like sponsorships with the Jets, and they're doing a lot of TV ads, and so they're able to talk to someone like Bob and get his guidance and avoid making lots of mistakes and doing things much more efficiently and effectively. The person with the most marketing experience would probably be George Schweitzer, who ran all the global marketing for CBS for 30 years. He's very popular with our more consumer-oriented investments, but we try to really cover the gamut. Pretty much anything you want to do to acquire customers is our domain and we have expertise in it.
We have a few LPs that actually don't fit in with marketing and we just include them separately, like Michael Schaeman, who ran global sales at Apeel Sciences, and then Rusty Reed, the former CFO of Procore to help on the finance side. And then, in terms of recruiting, and the people culture category, we've got a couple of people; one of them works with the Google CEO doing the recruiting for executives there at Google. He's a Santa Barbara guy, he’s one of our investors, he loves talking to our CEOs, and he brings them a lot of candidates and he helps someone with their strategy. So, not everything is marketing, but most of what we do focuses on demand generation and growth marketing with the people that we have. They come from companies like Citrix, Sony, Papa John's, RingCentral, and J2 Global, which is a $4 billion SaaS conglomerate. Also, Commission Junction and Groupon who are doing affiliate marketing, and SailPoint & Dynatrace, which is doing strategic alliances. So, all these are areas that most of our companies need help in because they just don't have 20 people with 20 years experience each in a specific area. They leverage our network, and they get the help that they want.
VN: What's the macro trend you're betting on? How do you define that?
DE: Software and recurring revenue subscription businesses continue to be worthy of being valued differently from other businesses because of their structural advantages. For example, in the SaaS world, we're all like, “We don't need to make money right now because we should prioritize growth. We should get value-based in our revenue growth and if we wanted to be profitable, we could, it just doesn’t make sense since we want to grow as fast as we can.” Well, then the pandemic happened and it got tested. “Okay, SaaS companies, now's your chance, you're not going to be able to raise money, as far as we knew, for a few months. What are you going to do?” We saw, with pretty good success, that software companies were able to cut expenses to a very large extent, very quickly, in order to ensure their survival in trying to go through a pretty dark storm. So, it played out nicely and that was nice to see; it got tested and we passed the test.
In terms of trends in general, we're less about tagging along to a specific trend that we're buying into and trying to find investments along that trend; it's more about individual situations where we think that companies are particularly well poised, with a limited amount of risk, to grow very significantly in the market that they're in and they've got this long track record of being able to show how customers really don't leave. When I built FastSpring, we had 3,000 clients and our churn was 1.3% annually. So, I know what it does to ARR and your ability to grow at a really fast clip when you don't have much of a churn problem. These businesses just have an easy time growing really fast, relative to most other types of businesses that one can invest in. So, we pay a lot of attention to the retention rate and the customer satisfaction, the NPS scores. A lot of our companies won't have NPS of like 30, they'll have NPS like 50, 70, 90 even; Nice Healthcare, their NPS score is 94 at the moment, so that's how much they delight their customers. Again, it goes back to my own experience with FastSpring: we blew people away with our customer experience and customer service and that's really the biggest reason why we became successful, ultimately, because people were like, “I'm used to using services where the support is fine, or I'm using PayPal or Digital River or whatever and either the experience is bad or it's fine. These guys, it's absolutely a wow experience, and nobody can possibly beat it.” So, that's what we look for in our companies, where the customers are just so delighted and it has to show in the retention, both in terms of logo retention over time, as well as net revenue retention and expansion. When you see 130% net revenue retention, and 95% logo retention, and these customers have had the opportunity to cycle out or churn, it tells you a lot. So, we really listen to what the market says and what the customers are saying, more so than some other investors who are like, “Oh, I'm trying to find the greatest team, I don't really care that much about the product.” No, for us it really is, what is the market saying about the validation of this product and the traction and the lack of customers departing? That really drives it for us.
Then it’s trying to find reasonable deals; we're not Silicon Valley style, 28x multiple people. Our average multiple is about 8 times, which is pretty unusual. If you talk to SaaS VCs, most of the ones I deal with are dealing with 15 to 30 times ARR numbers, but we find pretty reasonable situations. It doesn't mean we don't make exceptions; we invested in the only software play in electric vehicles for optimizing batteries, which obviously is a big need, figuring out which batteries not to put into electric cars or into Amazon Alexa or Facebook Oculus, since those are all their clients. In that case, having the opportunity to invest in the EV future, and being tied to the volume of batteries in terms of how much revenue we produce, and being in EV without having to invest in a hardware company, that was pretty special. So, there we paid a higher multiple, maybe it was 18 or something, whereas other situations were typically like 7, 8, 9 times. But that's really a feature also of how fast are they growing. We invested in one of our consumer plays that I mentioned, and they've grown 400% for three years in a row. Well, odds are they're going to continue to grow pretty well, so that's worth paying extra for in terms of a multiple on the revenue.
VN: A lot of VCs will say the team is the most important thing but it sounds like you're saying that it's really not for you. So, that's an interesting contrast to what they usually say.
DE: They're generally wrong about that, based on my career, but you can also see it for yourself. Amazon comes out with the Amazon Fire, and Amazon's behind it with all their resources and everything, or Google with their Glasses, and they still become total flops. Why? It's just not the right timing, and the market timing fit isn't there. So, I don't care who you are; you could be Mark Zuckerberg, you can have the greatest team in the world, but if your product market timing fit is off, it really doesn't matter who you are. So, yes, you can say a great team can pivot and they can keep trying, they’ll figure it out and, yeah, there are some exceptions. There are some situations where you figure it out, but when I built FastSpring, we had an amazing team, we had four CEOs as co-founders, and I sat there and it's like, “dammit, the market is just not ready for the way we're doing this right now.” It didn't matter how experienced we were, it didn't matter how many customer relationships we really had in the industry, we knew it very well, we knew the people, but it didn't matter. So, going through that, it's like, “You know what? Nothing really matters if you don't have product market fit timing down.” I don't care who you are. And you just see that endlessly but, for whatever reason, most of these VCs, especially the early ones, are all about team, team, team. “I have to have an intuition about this entrepreneur.” Did you see the movie about Theranos, where she gets her money from that first investor based on her personality? He's all about choosing based on people. Well, obviously, that's an extreme example.
Also, if you're doing a later stage, SaaS recurring revenue, relatively low risk business investments, if you've got, say, $10 million in ARR, you don't have to worry that much about the team. They made it from nothing to here, so they know what they're doing and maybe they don't have 20 years experience in their particular vertical but they've been doing it for six years. They know enough and it's working. Again, it comes back to, what is the data saying? What are customers saying? So, yeah, I don't prioritize team the way others do. It doesn't mean we don’t have wonderful teams, but we prioritize product market timing fit and traction, and lack of churn way ahead of who the people are, in terms of their backgrounds, or our intuition about somebody. But, hey, if I was doing pre-revenue, I'd probably be doing it differently. Team would be a higher priority, and I'd be betting on people and ideas more than revenue and traction and customer response and market validation.
VN: Do you vet the product? Is it the same thing where you feel like they've gotten to this point, they must know what they're doing or do you do due diligence on the product as well?
DE: We do a certain amount of due diligence on the product. In general, we don't lead, so we work with other VCs to do the due diligence. We're not the ones who invest the hundreds of thousands in due diligence, but we participate a lot. We'll sit in on a lot of the phone calls with customers and things like that and we'll get all our questions answered but, when it comes to product, we might pay a little less attention than some other VCs, relatively speaking, because we look more, again, at what does the product usage rate look like? How much is it being used? How long are people sticking with the same product? How quickly are new people signing up? What is the market saying about the product and how effective it is and how required and critical it is and how they can't go without it? What really matters is what the market is saying. We can look at a product all day long, and say how wonderful it is, it looks great, it's going to do great, but, at the end of the day, it's a lot of guesswork that we can’t rely on, and I've been through that many times. So, when you have somebody like Jeff from Rad AI behind things on the product side, we can't add that much value there. I have not been a radiologist for 11 years.
One of the tricky things is when you invest in software, it seems really fun, but the challenge is, you're not going to be expert in most of the industries that you get into and truly understand the product. We have a product right now, it's been our biggest struggle to really understand the pain point. We keep talking to customer after customer after customer because it's in cybersecurity and we brought in all these cybersecurity experts to try to help us but it's a niche thing and it's hard. Unless you're sitting there with the pain point understanding why you need to become a customer; I haven't been in cybersecurity myself on the operation side. So, sometimes we're challenged with that. We looked at another deal in the solar installer software space and we had to learn about it. So, sometimes that's part of what makes the job harder than maybe it might otherwise be. Even though we get to do software, and software is great and has all the great margins and everything else, and the least likely to fail, it is a little tricky to be industry agnostic and have to learn about a lot of different industries one by one, and bring in expertise. We do it before we make the investment, we have to get to a certain point, but it's a challenge. Something like Bark, where they're the leading provider of alerting parents and schools when there's a problem, that's pretty straightforward, but cybersecurity, and we're also looking at one right now that deals with doing backup of data from the cloud, like Google and Salesforce and Slack data. Why do you need to backup anything if it's already on the cloud? So, we've had to understand exactly why a lot of people in IT and security feel that they need to backup something, even if it's on AWS or it's on Office 365 or Azur. So, sometimes we have to bring in experts to learn as we go and sometimes it's harder than other times.
VN: Let's talk about valuations and how you see those trending. We've all seen them skyrocket the last few years, last couple of years, especially, but where do you see them going now? Do you see them continuing to go up? Are they starting to come down? What does that going to mean for companies going forward?
DE: Of course, nobody knows. The best predictor would be history: if you look at the history of SaaS, in times when the valuations of SaaS companies dropped big, like now, the history has been that they recovered very fast. It doesn't necessarily mean four weeks, but in general a number of months, and it usually doesn't mean 12 months. So, that's what has happened over and over again; if you look at the big drop in 2016, you can pull up the chart of it and see, it's like everything dropped at least 40% and then, three months later, almost all that had recovered. So, I would expect the same thing to happen again. I know that when things go bad everyone thinks the sky is falling and it's never going to be the same and, “this time it's different,” and all that. But, generally, you can rely on history and trends when it comes to things like valuations. What's good for us as venture capitalists is, the more these prices get knocked down, especially if it's temporary, the more we get lower pricing that then potentially recovers later and we benefit. Even if the company isn't doing well, we benefit just from the increase in valuations and multiples again, so it's a bonus.
What does it mean for the companies in our portfolio? Well, let's hope they don't have to raise money right at this moment. Most of them don’t, or there's going to be a lessened valuation than they might have gotten three months ago. At the same time, it's a mixed bag. I've talked to a lot of different VCs; the early stage guys are telling me a lot, “Oh, yeah, we're seeing big drops in multiples.” The later stage guys are often saying, “No, we're still competing with Sequoia and the other big ones like ourselves, and we need to get into these deals, we've got all this money to invest, and fine, so we're not paying 30, we're paying 25 or 26 but we're not paying 15 all of a sudden.”
I saw in TechCrunch, they did something where they used Carta data to show prices going down of Series C's and the Series C amount was going down as well, in terms of how much you raised. Part of what I've heard is it's taking longer to close transactions, so I'm dealing with that now with our tenth investment for our Fund I, where it's just dragging and dragging. And they're trying to make the case, “our revenue has been going up so you have to pay us more,” and we're like, “Hello, have you seen the NASDAQ? There’s a war, we don't know what that’s going to turn into.” In this case, actually, it's a company that has some vulnerability in Ukraine and they're still trying to say that they should be getting a good percentage higher than when we first started talking because their revenue keeps going up. “Yes, revenue goes up, and in a normal time that would help you; in this time it is, unfortunately, not offset by what's going on in prices, and the global dynamics at the moment and the fear factor.”
VN: Are you seeing companies starting to take down rounds? Or is that something you think is going to happen going forward?
DE: There's going to be an increase, for now, in the number of down rounds that occur. Companies will try to last longer before they have to open up to raising capital in this current climate and, hopefully, they have enough runway to wait until it's a better window. But, yeah, that's inevitable.
We had a company in Santa Barbara actually go bust recently that some VCs invested in it; they couldn't raise any more money. It was a hot thing that they had going, but just people didn't buy into it anymore. You weren't seeing that so much a year ago. We also get a lot of opportunities because there's this willingness now to have secondaries be a bigger part of the situation whereas, in the past, that was frowned upon, certainly 10 years ago it was, but all that changed. When a normal VC fund comes in and they're like, “hey, we want to invest, we're interested,” the company says, “Oh, well, we're not raising right now.” We come right back, and we say, “Oh, that's okay. If you want our help, we’ll buy secondary." And so about half our deals, we've done that and that gives us a much larger universe and a lot better timing on our opportunities than than other VCs can get.
Companies that are still growing at a great clip like they were before these problems started are going to continue to get pretty good respect in terms of their multiples. I don't expect them to have down rounds, maybe a 12 times multiple becomes 10 times or nine times or something like that, but it doesn't become three or four times. I mean, obviously, anything can happen, we can have a Great Depression, we can have another pandemic, there's always that, but in the normal course of things, people tend to overreact on the extremes on both sides, both in terms of over excitement when things are going well and over worry and fear and the sky is falling when things get a little scary. So, that's where we try to take advantage as investors, by not being so impacted by those kinds of things and thinking about the long run. We take a value investing approach, I guess, to venture capital, thinking really about the long run, the long term trends, getting in at reasonable prices. I've been called a value investor VC a few times by LPs, and they say, “I’ve never heard of that.” I say, “Well, I was a value investor ever since I was 15. I was doing investments pretty much every day in the public markets and I learned an awful lot. But my mentor was quite the value investor and so it's not probably a coincidence that I have this Warren Buffett approach to VC."
VN: Tell me about your LPs. What's your pitch to them?
DE: Once they see the value add and realize that companies can't get that same value add from other firms, and how important that customer acquisition is to companies, it's pretty straightforward. Because a lot of investors are looking for differentiation that makes sense, where the value add really is different, which is mostly BS. Every firm has to tell you how their angle is different or better and the reason they don't deliver is because they really aren't any different and their value add really isn't very special. It's not like that in our case: we can show companies and investors, “here are the areas where we help, here are the people we have helping, and, by the way, here's what we do for our companies.” For example, with Specright, we did 15 different things for them; like, we got them their PR firm, we connected them to talk about TV advertising with the person who did it nationally. We're very aggressive in helping because we're all about our reputation, we have to over deliver. Otherwise, we're not really authentic when we say we have this value add, and we're just like everybody else and won't be believed. So, we have the proof and we show it to our prospective CEOs and investors as well.
We write it out, we keep track of it, we know for every one of our portfolio companies all the different areas of value add we've provided in marketing, and sometimes in other areas, but mostly marketing. Usually, we've done 10 or 15 things per company. Sometimes there's a company that doesn't want help, they think they're going to want to help so they stick us on the shelf, but then they end up wanting to do things more internally. But, in terms of the value prop to the investors, number one, they see my track record as an angel investor for years where I had a 51% IRR over six years, before I got into VC. Then they see the work I did with other VC funds, but then they see, now that we have a Fund II that we're working toward, they see the results of Fund I: in 18 months, we've obtained the results that I mentioned to you earlier. So, they can look at the deals, they can see how appealing the companies are to them, and they can see what the results have been in such a short period of time. So, it becomes a bit of a no-brainer relative to some of the other stuff that they see. Often, we're recruiting people specifically that have that marketing expertise so they obviously appreciate this value addition more than somebody who doesn't have it. And then, at the same time, we're bringing them in as someone additional that can help our companies.
VN: What are some of the lessons that you've learned as a VC over your career? Let's say if somebody else was saying, “I want to get into venture capital,” what are some of the lessons that you've learned that you would impart on to them?
DE: Like most people looking at starting a venture fund, they find it intimidating, and they probably think it's not really something they can pull off. So, it took some time for me to get comfortable and one of the ways I did that was by getting some experience working with other VCs as a venture partner. I did that for a few years, and I did that with a couple of different firms. So, I got that experience, I was part of the meetings, and I learned all these things that I didn't know much about and figured out if this was something that is appropriate for me and my background or not. Before I was a VC, I had all this experience building software companies and in angel investing, but not as a professional venture capital investor and all the things that go into building a fund. So, it’s not that expensive these days compared to what people expect because there's so many turnkey services that you can plug in, and there's no way to do all this fund administration and sidecar SPVs and all this stuff that we're able to use service providers for. Now, there's a lot of issues with the service providers, they're not always adequate, but you can get by. We just went through an audit, so I'm not in the best mood about service providers, but there are ways to do these things that are not that expensive and you can start a fund. If you talk to one lawyer, they'll tell you, “Oh, yeah, we’ll launch your fund, it’s $150 grand,” but if you talk to another lawyer, the right kind for a smaller VC fund, it's $25 or $35 grand. So, financially, there's ways to do it, that doesn't have to be cost prohibitive.
Also, one thing that turns a lot of Angel VCs off is they read the endless articles that they're not going to make any money for a long time. In my experience, that hasn't been the case. Sure, our fees don't add up to too much, I got very little money in salary last year, and that's fine, I'm tied to the upside. And that'll change in the future as we get bigger funds based on our success rate. In the beginning, when we were a smaller fund, we didn't know how much money we'd raise, we'd do a check like $500,000; now we do $2 million. How do we do that? Well, we do $1 million from our fund and then we go to our 75 LPs and say, “Hey, who wants to do an additional amount?" and we get 20-something folks to put in money on it, in addition, and then our check ends up being bigger. And so, for us, as general partners, it doubles what we otherwise would do. So, even though it's not that big of a fund, even though it's the first fund, as things go on we're doing well financially, even though I went into it assuming that that wasn't really a benefit. I mean, at some point, it might be. In my case, I wasn't really doing it for the money part so much, I was doing this work anyway, doing my own Angel deals, so the pandemic that happened and it got a little boring having to be at home all the time in isolation. And so I'm like, “I'm doing this anyway, might as well bring some other people along.” And now it's really fun. So, instead of just bragging to my wife, “oh, we just made all this money on a deal,” now I have 75 people along with me that are happy and enjoy it as well. So, it's a nice social thing, too.
VN: What's the part of being an investor being a VC, that you really love the most? What's the part that really motivates you?
DE: Finding a needle in a haystack. That's really hard to do and when you find it, that's a really special instance. We feel like all the investments we've made are very special, to that degree. I mean, we looked at 1,000 deals last year, and we did seven. They're really hard to find and it's partly about timing, it's partly about who you are and what you bring to the table, it's partly about how you assess situations in terms of risk and reward and upside. But, that's really satisfying.
Another thing I like is, having built all these software companies before I was a VC, this is so much more relaxing than being a serial entrepreneur. It doesn't mean being a VC and having a fund is relaxing; it means it is relative to being a CEO and founder and struggling for years before you get anywhere. Then, when you are successful, some new competitors shows up. All that stuff that you own just being fully immersed in one company with your net worth tied to one company, that's just an inferior life experience versus being on the outside as an investor trying to add value and not having to own all the headaches yourself for all the companies. I won't be going back to your serial entrepreneurship, most likely.
Support VatorNews by Donating
Read more from our "Meet the VC" series
Overwater Ventures recently announced it's $20M debut fund to invest in human and planet healthRead more...
Red Cell Partners is an incubation firm focused on national security and healthcareRead more...