Ep. 13 - Sapphire Ventures - VC/CVC Hot Trends?

AI is really, artificial intelligence is really just a blanket technology term that encompasses generative AI and machine learning and computer vision and a whole bunch of natural language and a whole bunch of other things. But the point is, is that AI is likely gonna be embedded as an enabling and empowering technology into existing and new software applications, software infrastructure, right? And so if you think about it that way, there's going to be tons of investment over the next 5 years.

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Good morning from Silicon Valley again. Here is Marco Marinucci with Mind the Bridge, and now we're in Mind the Chat. Today we're going to talk VC, we're going to talk investments, and we have the pleasure to have with us Rajiv Dam, a partner at Sapphire Ventures. Rajiv, good morning.

Good morning, Marco. Great to be here.

Thanks for having me. Sure, it's a pleasure. And really, the topic of the day is getting a sense of where you see the market going in terms of the investment, you know, phases. In particular, also want to talk a little bit more on the details of how AI is impacting also your internal processes. So, so let's get started. I think a good way to start is also a little bit of your, of your background. You work for one of the major enterprise growth VCs here in San Francisco, but not only Sapphire Ventures. So give us a little sense of what is Sapphire Ventures and what is the current focus.

Sure. Yeah. And great to be here. On the personal end, I'm a partner with Sapphire Ventures. Been investing for about a dozen-plus years now across a few dozen companies, all across B2B and enterprise software infrastructure applications. Have had the good fortune of many of those reaching some, some good scale and having some good outcomes. And so it's been a fun journey. You know, Sapphire Ventures is an enterprise software-focused venture capital firm. We're global in nature. Managing over $10 billion of capital. All we do is B2B software, whether again it's infrastructure or cybersecurity to horizontal or vertical software applications and everything in between, including B2B financial technology and digital health applications as well. And we invest that at the post sort of product-market fit stage all the way to the pre-IPO levels as well. And our mantra Marco is to, to really partner with visionary teams building companies of consequence. So we're really looking for the next LinkedIn or DocuSign or MuleSoft or Monday.com companies that we've invested in for the next versions of that, companies that can be household names as far as software geeks go, at least. And so that's kind of what gets us excited to get up in the morning and do our job.

You guys are very international by nature, and the history of Sapphire itself, I think, is pretty, pretty interesting. You know, being around, I would say almost 30 years, correct me if I'm wrong, but I believe was started like in '95 or '96 within SAP and then spun out and then rebranded like in 2014 or something like that. So very interesting also path. And you joined at the You've been with them more than 10 years, right? So you joined—

Right. I've been with them for more than 10 years. And that's right, Marco. You know, we spun out as a separate legal entity from SAP in 2010. We changed the brand name a few years after, but they continue to be just an incredible partner for us in many ways. And it's been a great journey. Obviously, I joined in 2013, and And the firm and the ecosystem at large has just exploded since. Sometimes it's better to be lucky than right in terms of right place, right time in terms of venture capital as well as private software investing here over the last 10 years.

And then you have offices and, and physical presence, I believe, in Austin, San Francisco. Where are you based? Out of San Francisco or Menlo Park office?

I'm based, I'm based, uh, here in the Bay Area. I spend half my time in the Menlo Park office, half my time in San San Francisco. We do have a team and an office in London as well, and we're pretty active investors across Europe and Israel. Um, and we're, we're now approaching, actually, believe it or not, 100 employees. So it's a rather large organization. Yeah. Wow.

And, uh, how much of your portfolio is, uh, international, so outside of U.S.?

I don't have the exact figure, but if I would estimate, it would be roughly anywhere from 15 to 20%.

Got it, got it. So you still, you know, kind of, you know, focus is US development, but then with some extensions into other markets in general, right? Interesting in hearing a little bit more about your professional path because you started as a VC kind of pretty young in your career. Uh, I believe you were investment banking, then private equity. That's what eventually— what brought you to Sapphire? Why, why VC?

Yeah, you know, it's interesting. So I started in investment banking at Goldman Sachs. It was actually a pretty formative experience. I was in the financial institutions group in investment banking during the 2007 to '09 timeframe. So as you can imagine, it was, it was tumult everywhere, but I learned a whole lot. It's amazing advising CEOs and management teams on strategic alternatives of all types as an investment banker early in your career. And a place like Goldman Sachs from a cultural perspective just teaches you so much about how to combine really performance orientation with teamwork and collaboration. It's very hard and people think they're always at odds. Somehow Goldman makes it work. But I realized that instead of advising companies on what to do and what to invest in, maybe I should do it myself. And that's when I moved over to Silver Lake. And I also realized that, hey, growing up in the Bay Area, I've always been exposed and passionate about technology. And Silver Lake did just that, being one of the actually pioneers really in private equity oriented solely on technology. So at Silver Lake, I focused on more middle market transactions, software, some hardware, tech-enabled services for a couple of years. Awesome experience. I always tell people I learned way more at Silver Lake than I did at Harvard for business school. That was the true business school experience in terms of understanding every facet of businesses and your diligence processes and beyond.

Did you do business school after private equity, or was it before?

I did after. After.

Okay, got it, got it. So it was private equity, business school, and then, and then VC.

That's right, that's right. There is a, there is a very big distinction between private equity and venture capital. Venture capital, you generally are going after growth markets, right? Um, they're either you're creating a new market or you're disrupting a current market, and you're looking for that category leader. Venture capital, more so than any other asset class, follows that power law where you need to get into that category-leading, as I mentioned, company of consequence in order to generate a really large return. And, and that idea of studying and going after growth markets as a way to generate the return and growth stories really resonated with me. Uh, and so as I was even exiting Silver Lake in my first year of business school, contemplating on what I wanted to do, I knew I loved technology, I knew I loved investing, but I felt like that growth stage investing of where Sapphire really focuses on, and software in particular, uh, was interesting to me, and that's how I ended up there.

Awesome. I mean, we, uh, we see a lot of young professionals coming through some of our activities programs, and one of the common questions, a denominator, uh, a lot of them want at some stage, you know, to become investors and VCs. And, and there's not a single, uh, professional route to get there, but what, what do you think the— what, what kind of professionals you think are the ones that thrive as, as a VC, VC investors?

Venture capital is such an interesting sport. Uh, I've seen it, you know, we oftentimes hire because we are later stage investors where financial analysis and all that tends to be pretty critical. We do hire from consultants, uh, consulting firms and investment banks, a pretty traditional sort of feeder system. But, you know, you can be a product manager, you could have worked at corporate development, uh, in, in an actual company and still thrive in being an incredible venture, venture capital investor. You look at some of the best venture capital investors of all time, they come from all walks of life, right? And so there's no real way. I mean, I think the key is, is the characteristics that you exhibit, whether it's in the interview process when trying to break into a venture capital firm, that's what's really going to resonate with the folks interviewing you in that particular firm to say, let's bring this person on.

Yeah.

Yeah.

So, you know, it's, it's also the intellectual curiosity eventually, right? That gets you at your stage. How much is important? How much is the evaluation of teams versus the balance of the business? I mean, you are, as you said, at the growth stage. So there is a lot of financial analysis that goes behind.

Team is always critical. It's always critical. Remember, in venture capital, unlike private equity, we don't own the business. We own 5% or 10% or 15% or 20% of the business.

If you're lucky, yes.

You're betting on that team. To figure it out. At the end of the day, even at a board meeting, I can provide my advice, but I always caveat it, especially if I disagree with a particular CEO. I say, I invested in you. Ultimately, it's your business. You know the business better than I do. But based on what I know from the dozen or so boards that I've sat on over the years, here's what I think, right? And so you really need to bet on that team and that CEO to kind of carry you throughout the investment and beyond. And so it's still, even at $10 or $20 or $30 million of revenue, when it's beyond an idea and a company already has commercial traction, you know there's going to be a ton of ups and downs, and you're really betting on that founder or that CEO to kind of manage you through those times.

Yeah, so it's still a key, a key element regardless of the, of the stage of development. I want to talk about the big wave of AI and how is today impacting the investment process in general, and then VC as, as a consequence of that. So maybe the first, the first question I have is, uh, you hear and hear in the Bay, in Silicon Valley, a lot, many are saying that probably also with this big, big wave of AI coming and surging, you probably, it's harder to deploy large amount of capital because there's so many foundational layers already being laid. And so what's your view? Is the size of funds really impacted by AI or Not really going forward.

The size of venture capital funds?

Yes. Yeah, deciding, you know, like, you know, do I have— can I deploy a billion dollars today if I have to start today, right? Or, or is, is today, with all the tools that are out there, we just need a fraction of that, uh, to be, to be effective?

I think so. I mean, listen, Marco, I— it's, it's interesting. There's— it's a kind of a yes and no answer, which I know are the worst, but In terms of the longer-term horizon, 3, 5, 7 years, we think there's an enormous opportunity to deploy not just a billion, and we think it's going to be tens of billions, hundreds of billions of dollars. AI is really— artificial intelligence is really just a blanket technology term that encompasses generative AI and machine learning and computer vision and a whole bunch of natural language and a whole bunch of other things. That's, by the way, been around for a while, and Sapphire's been investing in those companies for a while. Of course, now there's advancements, but the point is, is that AI is likely going to be embedded as an enabling and empowering technology into existing and new software applications, software infrastructure, right? And so if you think about it that way, there's going to be tons of investment over the next 5 years. Now, as you think about 2023, Marco, you're right in that I feel like there's been a, you know, an explosion, frankly, of investment out of the gate. And I think it's critical to still view these AI businesses through the same lens that Sapphire's always viewed these businesses. Is it a great team? Is it a great product that's defensible and that's solving a very specific customer and enterprise business value? right? Is it a big market opportunity? Are the financial metrics there? If you view it through that, uh, that's going to be critical to have a measured view in terms of the companies you invest in. In every single shift, platform, technological shift, it's not like all the best businesses are formed in the first 6 months. It could take 6 years, 7, 10, 12 years until the Google of generative AI is really formed, right? Now OpenAI clearly is a behemoth in the space, and I expect it will have incredible lasting power. But I expect there will be dozens, if not more, like I said, hundreds of companies that are going to be built over the next 10 years. And so we're really long-term bullish. I, I don't know if you saw the announcement, but Sapphire recently committed to investing a billion dollars, uh, just in backing sort of AI-oriented companies and founders and enterprises as a result. But again, we're taking a very measured pace and making sure we don't invest that first pull $1 billion just in the next 6 months.

Yeah. So, so is your investment thesis changed at all, or you're still using the same, same kind of fundamental pillars?

We're still using the same rubrics and the same philosophies to invest in these companies. The one thing that I will say is the pace of innovation is a lot quicker. And one of the things we're rethinking is if a company, let's say a company is an AI company but also using AI internally, in a really optimized fashion, which was still, by the way, very much at the early innings of seeing, then that company is actually— headcount may look a little bit different. So we're seeing actually like smaller companies, uh, um, being able to produce more ARR and more velocity of ARR, uh, annual recurring revenue, at a much faster clip. And so that's kind of a new rubric we're trying to get around. But no, our fundamental philosophy around having a product that is defensible, that is providing customer value, is still critical. Just because you have AI in your URL or your name does not necessarily mean you will be a wildly successful company because other companies that can do exactly what you're doing. And so we always look for that defensibility that gives you enduring growth.

Yeah. Is the— I wonder, everybody, all different companies today, different sizes, are embedding and testing new tools to be more effective. No matter the industry, I think the expectation of being better performing using tools is for everybody. I wonder, are you guys testing and embedding some of the AI tools in your day-by-day processes?

You know, we're trying. I think a couple of us do it from a sourcing mechanism, for example. You can kind of upload your LinkedIn contacts and and, and, and wed that with all of your partners and then use ChatGPT and kind of query and look through exactly who's who and where do they work and almost create a knowledge graph by yourself. That's very easy. So there's these small, you know, email, email generation and writing an email that you could send over to a prospect. If I'm trying to email a CEO, there are these pieces of our workflow that even at Sapphire we're hacking around with. I would say within my companies it's even more significant. Around things like customer support tickets, right? And being able to respond pretty immediately with an intelligible answer that's trained on a specific company's dataset of customer support. So it's not super generic. That's a huge area amongst many others. So no, we are seeing it. But I will say, Marco, that true enterprise in-production uses of AI is still very nascent. It's still a lot of people trying to figure out how do we use this? How do we make sure it doesn't hallucinate? How do we make sure it's relevant for our— especially if it's customer-facing communication, that's critical stuff, right? And so that is still very nascent, but we fully expect that over time, you know, we're gonna figure it out. That's why you see so many people kind of working away at this right now.

And this is actually for us, it's a shameless plug, but we do have a tool that a bunch of CVCs are using today to do, I mean, to support really the filtering of specific products based on well-defined semantics of, especially if you have a specific search, right? So that gives obviously a better flow of data already in the format that you want with executive summaries that you want with a focus on a subset of data that you want. So that's definitely helping. I don't think it's a revolution, but it's definitely providing providing, um, better tools. What do you think would be a tool that it could be really a game changer as, as a VC, right? What would make your life much easier, if any, right? Or maybe this is not something that can be— then could be translating into an AI.

I think so much of our job really is at— well, probably two areas. Um, one, at the sourcing angle, right? So much of our job is taking into account all the research that's out there on the internet, right? Um, and trying to find signal in it, and then automating a creation of a very contextually relevant email to the CEO, right? Based on all of that research that's out there. That's a lot of manual work. And yeah, you have some web scraping technologies and you could do it manually with some data scientists and other things, but even the generation, the last piece, I think that, that would be super interesting if you could somehow automate that with a human in the loop to make sure that the communication is, is ready for the CEO, uh, that you're trying to email, the company you're trying to email. I would say a second area is there's a ton of data that we have in our board presentations that we get from companies that pitch us. Um, right now what we do at Sapphire is we actually input all of that data manually for purposes of benchmarking to learn more about how SaaS companies are performing, what are the best-in-class metrics, what are the best-in-class headcount ratios for well-performing businesses. If that could be more automated, right, taking out all of those and making sense of the numbers and making sure there's no errors on that and inputting that and then generating narratives around that, not just charts, but actually written English narratives that are sensible. I think that would be really interesting as well. But I'll tell you, Marco, there's so many of these. I think the really native GenAI application businesses are still yet to be formed. I don't think we really all know what those huge businesses will be right now. There's a lot of businesses saying they're native AI businesses, but then you can point to Microsoft or some incumbent software provider and say, well, why don't they just engineering AI and do the same thing, right? So what are those businesses that need to be native from the start in leveraging and being born on this technology and will have a fundamental advantage to the incumbents? I think that's the thing at Sapphire we're really watching out for. We do see a lot more vertical applications. So someone that goes really deep in a legal vertical, in a healthcare vertical, where you have a lot of domain-specific data and knowledge that's a little bit more durable. And remember I mentioned moat and defensibility. We feel like that's a little bit more defensible than just a generic sort of AI for marketing sort of play.

I think that's a good segue where we stand and how is the today, the economical downturn kind of changing your pace of deployment? I mean, it's pretty clear 2023 is definitely Yeah, uh, you know, the, the time in the year where at least the, the speed of deployment has, uh, has, uh, has, has changed. I, I would start, uh, by asking you, you mentioned before you do have obviously some internal models, uh, working in a, in a, in a SaaS software. There's a lot of, I think, modeling that can, can, yeah, that can be built. Is your models when you're today evaluating companies kind of changed based on where we stand in terms of the economical downturn?

Yeah, you know, it's funny, the, the value of any company, very mathematically and just based on finance, is the present value of the future cash flow. So, so ability to generate profits has always been important. Of course, in a zero-interest environment, growth became critical even for Wall Street and public companies, and almost the only thing that mattered. Um, and, and I think now the VCs like us and others are really back to looking at the ability for any single company to be profitable in the long run. So even at $20 or $30 million of ARR, there are ways to kind of look at that. It's not just the unit economics of the sales efficiency of the business, but it's also the gross margin of the business, right? For a long time, people were like, gross margin doesn't matter, right? If it's 55% or 85%, it doesn't matter. That matters. And I hear a lot more people asking questions around gross margin, including us. Gross retention— people would focus a lot on net retention rates, um, and I now, I ask a lot of questions on gross retention rates because that means even in a downturn, if your gross retention is high, you still have a must-have product. Sure, people may not be buying more for you, but they're also not going to just completely rip you out. And so having gross retention rates that are well into the 90s percent is, is really critical as well. And then finally, an adjustment on growth. You know, let's be honest, the growth rates that we saw in 2020 and 2021 were artificial, artificially high. And so it's unfair for a VC to go to a $10 million ARR company and say, unless you're tripling, you're not a good business. At Sapphire, we're open. If you're not tripling, if you're doubling, if you're growing 70%, if you're growing whatever it is depending on the scale, we're open to that as long as the other facets and components of the financials make sense. Like I mentioned, the efficiency and the spend levels related to that growth. So we really try to take more of a holistic view around those metrics versus just growth only.

Got it. And I'm curious to understand, in a firm also of your size, this shift or changes internally as metrics that would make really the spot for considering investment, do you define on Monday meetings you share among partners, okay, that's what we should now be focusing on. That's how the shift happens. So do you agree on the Monday meetings about those?

No, I mean, I think it's a little more organic. You know, Marco, there's companies that are pitching us all the time. There's companies we're speaking to and excited about and learning about. And when we discuss in a debrief what we liked about the company, what maybe we're concerned by what we need to diligence. I think it sort of comes out, right, that certain partners and want to focus on certain areas more so, and that these areas are critical. And so we're not tone deaf to the environment, and I think those are the right areas to focus on, and eventually that's where the focus becomes. But it's not a hard shift for us. The ability to have— for companies, you know, having strong unit economics and showing cash flow in the long term was always important. I would say it's you know, there's more of a renewed focus on it versus a pivot for any single venture capital firm.

Yeah, so if anything, probably the previous 2 or 3 years were an exception, right? Because they were really fueled by, as you said, you know, zero, zero interest rates.

That's exactly right, Marco.

How do you, uh, how do you balance today the support with the existing companies of your portfolio that were still built on, on the previous model, right, on growth at all costs versus the, the be, you know, definition and, and of new opportunities and, you know, how to, to deploy more capital in the current model.

It is always a balancing act in our job, right? On one hand, we are paid from our limited partners to deploy and invest more capital over a reasonable time period. On the other hand, we also pay to generate returns, which means helping your existing portfolio companies. Um, I would say for me personally, my time today, let's say August 2023, I probably spent half of any given week with my portfolio companies, um, whether it's board meetings, interim meetings, reforecasting of certain plans, hiring initiatives, product updates, what have you. I would say if you would have asked me at this time, August 2021, maybe it would have been 20%.

Oh wow, so significantly different.

So it's doubled, it's doubled. And that's because, Marco, despite the exuberance around AI, which is great, and we have the same enthusiasm particularly over the long term. Companies in the private markets are, are, are struggling. It's a tough market. Q1 was really tough. Q2 was probably similar to Q1 for some businesses, a little better for some, a little worse. I'm hopeful that we're feeling the bottom, so to speak, as it relates to operating performance. I can kind of feel the bottom. Things aren't getting— there aren't massive negative surprises, right, anymore, as there were in Q4 last year and Q1 this year. Q2 kind feels like we're feeling the bottom, but that bottom is still a challenge. It still means a lot of retooling, a re-engineering of DNA for many companies, as you just mentioned, to transform themselves in this new sort of market. And so that takes a lot of time, a lot of guidance, and a lot of patience. We're all in it together at the end of the day. Yeah.

And obviously in that environment, I think the window to go public, which is the financial event that we're all waiting for as VCs, as investors, as somewhat closed. I mean, there are some, you know, small reopenings we see here and there, but for the most part, at least nothing compared to, uh, 2021, as you mentioned before. What, what, what key characteristics does your portfolio company need to have today, you know, in order to be on, on a path for, for a planned exit in a short, short—

well, it depends on what the exit is. I think if you're, if you're hitting, if you're, you're aiming for the public markets Yes, um, because of the deluge of public software companies already out there, and what I suspect— remember, there's, don't quote me on this, but I think 1,500 unicorn businesses, technology businesses, right? All of those 1,500 aren't going to survive. All those 1,500 are going to go public. But even if 10% of them do, 150, that's a lot of public offerings of software companies, let's say, over the next 5 years. At some point, there's only so much appetite for a Wall Street investor and someone covering those companies to figure out what to focus on. So what I've noticed is companies that have more scale can stand out. Um, so don't go public when you have $100 million of revenue. I think $300 million honestly is the new $150 million. Wow, really?

You think so? You think it's that, that different, right? Like 3x?

I believe so. Um, and so you have to have significant scale. That's critical. I think number 2, and people don't talk about it enough, is predictability, forecastability. Even right now in Q2 of this year, for my businesses that are $100, $150, $200 of ARR, we're still not able to forecast the plan accurately. A lot of that's because of internal execution issues, but a lot of that's because the macro environment and the buying environment for most software is still volatile. It's still being figured out. Any company needs to make sure you can plan around a number and hit that number because if you don't in the public markets, you will be penalized for at least 18 or 24 months regardless of how good your performance is afterwards. The third thing I would say is a little more nuanced, is around obviously showing a path to profitability and, and actually almost being profitable from day one is critical. Measuring yourself around a rule of 40 metric is critical. But more important than that, I hear this from my, my friends who work at hedge funds and mutual funds and public market investors, is is there a platform story? Is this a next small software application, or is this a story that can be sort of a platform that can continue to have durable growth? You know, people oftentimes in venture capital land, they invest when they say, wow, the growth rate was 100%. But I always say growth persistence or growth durability is more important than any point-in-time growth. If 100% becomes 50% and becomes 20%, and 5%, that's a business that's not worth much after 4 years. But if you start at 30% and you just stay at 30%, like HubSpot is doing now, right, for 7 years, that growth durability persistence is a lot. The reason that that is, is because the market size is big, and now they're a platform, or they really execute well on a multi-product story. Those platform multi-product elements, it's a bit of a lost art Not many software companies do that well, and that's something I have an eye on for my existing companies as well as new companies I talk to.

Yeah, that's, that's very true. And I believe that everything you are saying here is leading to companies stay private longer, at least with today's view, right?

So because very much so, and a lot more exits to private equity firms and consolidation with other companies. And that's okay, by the way. Going public is not the end-all be-all. As a board member, as an investor, and I'm sure as founders, CEOs, it's about maximizing shareholder value. That's the fiduciary I have to companies. And if that means the path is a Salesforce or an SAP or Oracle has to acquire you, or a Vista Equity or Thoma Bravo, and that's the best path for the company to maximize current but also long-term shareholder value, That's okay as well. There's no shame in that, right? And I think you're going to see a lot more of that here over the next 5 years.

I wonder, I mean, is that fair to say with all, in all the boards that you're sitting these days that, you know, the view to an exit has definitely changed over the last couple of years? Are you adding 1 or 2 years to that event on average? Is that a, yeah, or more?

I mean, listen, Marco, there was a point in time in the middle of 2021 where I'm sure out of those 1,500 unicorns, half thought that they could exit in 2022, 2023. Yeah, we have a couple of those. So fast, right? And, and the market— I— the IPO market shut down. But what people don't realize is they always say, when, Rajiv, when will the IPO window open? Yeah, it's really less about this artificial window, it's more about when will the performance of businesses and the predictability, as I just said, of these businesses return. Once that returns, any company can go public. People will want to, you know, and, and now especially that interest rates have somewhat stabilized, I think we know where they're going to go, they can go public. So it's more about the performance of the businesses, and that is taking just 2, 3, 4 years longer for a lot of businesses.

Yeah, I mean, we would love to have this conversation a year from now, and the world would for sure be totally different, and we see a lot better. Yeah, a lot better. But I mean, I, I'm with you that it feels like we're bouncing from at the bottom. And clearly, at least where I think we have the tools today to plan for, you know, the new metrics and how to be successful even in these conditions. Rajiv, listen, thanks for your insights. Very, very appreciated. Very much appreciated. And we'll love to talk again.

Thanks, Marco. Appreciate it. Take care.

Take care.

You too. Bye-bye. Thank you for being with us today and see you in the next episode of Open Innovation Talks: Mind the Bridge, Chat with Industry Leaders.