Jerry Chen & Jason Risch | VC Funding for the Cloud

Hi everyone. Welcome to Grey Matter, the podcast from Greylock, where we share stories from company builders and business leaders. I'm Heather Mack, head of Editorial at Greylock. Today we're bringing an update to our Castles in the Cloud project, which we launched last year to map the cloud technology landscape and find opportunities for startups to compete with the big three cloud providers of aws, Google Cloud and Microsoft Azure. We've compiled and analyzed data for 2021 and the beginning of 2022. These figures include the number of companies in the sector, the number of sub markets, and the amount of venture capital dollars invested in startups. Today's episode is the audio version of our analysis of venture capital funding into cloud startups. Greylock investors Jerry Chin and Jason Reich wrote the essay, which you can find in the analysis section of the Castles in the Cloud project website@greylock.com castles. Jason reads the essay. You can find all Gray Matter content on the blog section of greylock.com, and you can subscribe to Grey Matter podcasts on SoundCloud, Spotify, YouTube or wherever you get your podcasts.

VC funding for the Cloud Top 5 Markets for Startups by Jerry Chen and Jason Risch as the world continues to move into the cloud, the value of companies facilitating that Transition skyrocketed throughout 2021. From incredible growth in the market cap of each of the big three cloud providers to the volume of venture capital financing into the newest startups in the sector, it was another banner year for cloud technology. Additionally, the first quarter of 2022 continued the upward trajectory, showing the cloud transition still has plenty of Runway. While the recent public market contraction has had an undeniable cooling effect on the startup ecosystem, we firmly believe the need for reliable tools that advance and protect the capabilities of cloud will continue to present opportunities for startups to thrive. The long term trend of building cloud native applications will continue to provide attractive startup opportunities for founders. We've compiled and analyzed new data on the sector as part of our Castles in the Cloud project, mapping the activity in the venture capital funded startup ecosystem with that of the big three cloud providers, AWS, Azure and GCP. Total VC funding into the entire cloud sector hit $50.3 billion among tracked companies, up from 15.3 billion in 2020. We discuss four markets drawing the most funding as well as one market edge. We project to have more room to grow in the next section. These markets are Security, aiml, Management and Governance, Dev Tools and Edge in context. The big three cloud providers have each expanded tremendously within the $212 billion market. AWS remains the market leader with a 33% share, followed by Microsoft Azure with 22% and Google with 10%. Individually, each company grew significantly with a 37% increase for AWS, 46% for Azure and 44% for GCP. Such growth rates are remarkable for a market of that size, demonstrating the cloud transition has not decelerated even as businesses move back to in person operations. Some analysts believe AWS could soon reasonably be considered a trillion dollar company if valued independently from the rest of Amazon. Taken together, we believe the tandem growth in private and public cloud companies demonstrate that there are still many opportunities for startups both competing with and and collaborating with the major public companies in the sector. Top Markets Per our most recent data set, these four markets received the most VC funding. We believe there will be significant opportunities for startups in these subsectors going forward. 1. Security increasing attacks draw increasing investment While the cloud provides amazing benefits, it can also present increased security risk. Not only is the potential surface area for techs larger, it is also outside the safety of controlled on PREM systems and thus often poorly understood by traditional security teams and vendors. The number of cyber attacks per week on Corporate networks increased 50% in 2021 compared to 2020, peaking at an all time high in December due to the high profile log4j vulnerability. Investment and security companies mirrored this frenzy of activity. Security now has the second highest number of tracked unicorns in our database, with new unicorns raising across areas from cripple log analysis, Axonius Asset Management, Panther and Bigid data classification. As we noted last year, security had one of the biggest jumps between 2019 and 2020 in aggregate funding. That trend continued this year, only more so. Security startups received $7.5 billion from VC investors in 2021, compared with 2.1 billion in 2020. Within security, the leading subcategories were 3.03 billion for threat detection and 2.05 billion for vulnerability management, including Monster Rounds by Wiz, $500 million raised, Orca $700 million raised and Lace Work $1.83 billion raised. Identity and Access Management, a related market to security, also saw an additional $1.3 billion in funding. Security startup trends for 2022 strong valuations will persist for security startups even in rocky market conditions. The tailwinds behind security are such that both public and private companies remain strong in spite of today's economic volatility. Many public security companies have fared comparatively better than their software counterparts in the recent contraction of tech Co. Mult for example, as of May 17, 2022, the Nasdaq Tech 100 is down 29% year to date, while the Nasdaq CTA Cybersecurity Index is down about 50% less. At down 20% year to date, cybersecurity is often viewed as less discretionary than other categories of software spend. Regardless of market conditions for private companies operating in security, we expect financing to remain healthy. We saw multiple security companies raise strong rounds at higher valuations before the recent downturn. Abnormal Security, which was incubated at greylock, just raised 210 million and is now valued at $4 billion. Opportunity and specialization Moreover, we expect opportunities for startups will abound. Generally speaking, the big cloud providers lack the security background and holistic view across a customer's entire environment to compete meaningfully in this area. While the big providers are taking steps to provide more options for customers, adding more security services than any other new services in 2021, these tools typically function in a supportive capacity. For third party tools, this is where startups have the edge. One of the biggest challenges we hear from CISOs is the sharp rise in the noise and identified security risks and vulnerabilities in a cloud environment. Combined with the shortage of qualified security professionals out there. Security teams are overwhelmed and unable to correctly prioritize which ones to remediate first. Prioritization derived from business specific context on which assets are most critical can help address this challenge, as can the rise of automation and security engineering. We believe there is significant opportunity for these small hyper focused teams at startups to solve this problem. AIML Customization and Tying ML Models to Business Value as we wrote last year, the big three possess seemingly impenetrable moats, proprietary data sets combined with seamless interoperability and economies of scale. While these continue to be barriers, they have partially been offset by companies need to customize aiml to their specific businesses and use cases. This has led AIML to become the category with the most unicorns in our database 24 the second highest funding amount 6.4 billion in 2021 and the most tracked companies. 51 Many of these unicorns are in core areas such as model development and training data. In this case they are competing directly against the cloud providers end to end platforms like SageMaker, Azure ML and and Google AI Platform in model development. DataRobot has grown a large business by tying ML to business value and empowering technical analysts in addition to data scientists. Relative to the high number of tracked companies in the AIML category, other parts of mlops have developed more slowly. This is because just a handful of companies opt to purchase a best in breed ML stack rather than building their own or purchasing an all in one platform. However, we anticipate more companies will be swayed by the sophistication and usability of emerging tools such as those offered by base 10. The Applied ML company, which recently launched with 20 million in Series A funding led by Greylock, makes models easy to deploy by surrounding them with business logic and front end UI so businesses can quickly incorporate models into business critical processes and the workflows of domain experts. Other companies like Hugging Face which recently raised $100 million and weights and Biases have developed engaged communities which will ultimately compete against the Big three clouds on quality of ML practitioner workflow. Unicorns also continue to grow in domain specific areas. While the cloud providers can provide off the shelf APIs, many companies struggle with their flexibility and customizability to adapt them to their own data and use cases. Companies like Riskified and Fortur have built fraud detection algorithms and workflow in E commerce, while Instabase is a unicorn in document extraction with vertical solutions like medical claims processing and loan processing. ML trends in 2022 the rise of Large Language models Startups developing NLP tools are also among the Highest number of unicorns 5 of any segment in the last decade. Most of the acclaim and funding went to startups made possible by advances in vision technology and autonomous vehicles and X ray interpretation have dominated headlines recently. However, the rise of large language models like BERT from Google and GPT3 from OpenAI have driven increased funding and interest in NLP and companies that can be generated from it. GitHub Copilot is a prominent example. According to GitHub's internal benchmarks, 30% of new code is being suggested by Copilot and some programming languages. We're excited to see new vertical and horizontal businesses built on top of these large language models, which may be either developed by the company itself or built on top of providers like OpenAI. We're encouraged by the swift progress in the field we've seen in promising NLP startups like Adept, which just landed 65 million in Series A funding, and Anthropic, which recently announced its 580 million Series B acceleration of startup activity. It is likely more difficult to compete with the cloud providers in ML hardware and compute, but some startups are competing in related areas given the explosion of cost associated with training and deploying large models. Octoml building off of TBM and modular AI building off of MLIR are developing tools that leverage compilers and runtime to optimize deployment of hardware. MosaicML is applying best practices across training workflows, training algorithms and hardware runtimes to dramatically cut training costs. We see continued opportunity for startups to come in as third parties that can innovate down the ML infrastructure stack and move beyond the existing focus at the model Data and Application level. Management and Governance Giving businesses control and accountability tools that enable companies to extend control over their cloud drew considerable investor interest last year. Funding into the category reached 3.4 billion in 2021, a threefold increase from 2020. Such tools are in line with a few trends we foresee increasing in 2022. More sophisticated data Management and Protection as the risk and actual occurrence of cyber attacks has risen, cyber insurance providers such as Startup Unicorns Coalition and ABAY have become mandatory tools for businesses. However, the market is hardening as the sheer volume of attacks has led to an increase in premiums due to unexpectedly high losses. Ransomware attacks in particular are creating a spiral in which companies use their insurance policies to pay the hackers to recover their data, which increases the incentive for hackers in the first place. Companies like Rubrik, Cohesity and VM help to mitigate this risk in the first place by providing backup and disaster recovery, making assets recoverable without paying and depending on the hackers Rising ESG Expectations ESG has become a board level priority in the enterprise over the past few years, given predictions around increased government regulation, pressure from large shareholders like BlackRock and Consumer Expectations. Enterprises are working to measure, analyze and offset carbon emissions data to meet net neutrality objectives, and the cloud plays a significant role. AWS Carbon Footprint Tool, GCP Carbon Footprint and Microsoft Emissions Impact Dashboard all help customers explore the environmental impact of their cloud usage. Salesforce and Microsoft have each also launched sustainability cloud products aimed at helping customers analyze emissions data across their entire organization and competing with independent companies like Watershed and Persefoni. We believe this will continue to be an area of competition in 2022, both to serve these markets and to make cloud services as efficient as possible. Cost Management Cloud cost management was the number one ranked cloud initiative overall among responders to Flexera's 2022 State of the Cloud report. Respondents reported being an average of 12% over budget and self estimating 32% of overall cloud spend was wasted. FinOps teams are increasingly working with engineers to create better predictability as cost becomes one of the three key components of cloud management along with performance and security. Our database lists eight predominantly early stage companies providing products to help customers estimate and control cloud costs by properly sizing deployments. We believe bridging the gap between finance and development is key to enabling engineers to make accurate and informed decisions in real time. As companies see ballooning bills, we expect to see this concept spread into other areas. Cribble provides this service in the observability stack by filtering and transforming logs in front of downstream products like Splunk. Several stealth companies we have seen are looking to apply a similar concept in analytical databases Dev Tools extending engineering resources 2021 was a banner year for the emergence of large DevOps players as CircleCI, CloudBees, Harness and LaunchDarkly all become DevOps unicorns. While HashiCorp and GitLab went public, 2021 saw customers adopt third party DevOps platforms en masse. CICD is traditionally an area where engineers have been very opinionated and prefer to rely on open source software in order to have complete control over their stack, both from a customization standpoint as well as a reliability standpoint. However, the cloud has driven companies to become comfortable with the idea of abstracting away mission critical infrastructure even in areas like their build pipeline. Given expensive engineering resources and the talent crunch, many companies are also aiming to focus as much of their engineering talent as possible on building products instead of internal build processes. The convergence of these trends has created an opportunity for these DevOps companies to scale in an area that has been historically hard to monetize. DevTool trend for 2022 bundling and unbundling CircleCI harness and LaunchDarkly all started as different point solutions, CircleCI and continuous integration, harness and continuous deployment and LaunchDarkly and feature flagging. However, these and other DevOps companies have aimed to move up or down the stack to create an end to end solution. Many customers are increasingly open to adopting platforms in CI CD to ensure strong interoperability and simplicity. On the flip side, we also see the opportunity to unbundle some other parts of DevTools like GitHub, as will be the subject of a future essay. Edge the Next Cloud Frontier One smaller market in which we expect to see significant growth and innovation is in edge computing. Edge computing consists of storage and compute on the edge and is a powerful enabler for some of the other cloud markets we track, such as gaming and IoT. Gaming as a whole recently became the largest media category period and the demand for instance response times is huge in cloud gaming. The rise of AI models deployed on the edge in devices like cameras is also driving demand for edge computing. Another form of edge computing takes place in the browser, where technologies like Webassembly are bringing impressive capabilities. WASM allows compiled languages like C and Rust to be packaged into a binary and loaded into a browser. Companies like Figma have demonstrated the power of WASM over the past few years by significantly cutting load times and latency in their browser browser based applications. Leading companies like Shopify are also implementing WASM outside of the browser, and Cloudflare is investing heavily in WebAssembly on Cloudflare Workers. Leading companies like Shopify are also implementing WASM outside of the browser and Cloudflare is investing heavily in WebAssembly on Cloudflare workers. Despite the power of this technology, we have not seen an independent unicorn in the edge space yet. We predict that this will change in the next few years as companies are started that make WASM easier to use and others continue to harness WASM for applications. 2022 Preview Looking ahead, aggregate 2022 VC funding is showing some signs of slowing down as public market multiples contract, as data from carta shows a 25% decrease in average Series A valuations and a 42% decrease in Series C valuations. However, seed funding valuations remain strong and the best companies of all stages will continue to grow as opportunity abounds to compete against the cloud. Big three given the secular growth of the overall cloud market, COVID 19 and work from Home accelerated the cloud transition, and while many consumer and commerce stocks buoyed by COVID 19 have seen recent declines, there are no signs of the enterprise cloud transition reverting or decelerating. Many standout private cloud companies have the scale and predictability to go public and will do so once the public markets settle. We remain optimistic and are continuing to invest aggressively in the best founders building in the cloud opportunities above.

That concludes this episode of Grey Matter. You can find this essay and all Castles in the Cloud related content@greylock.com castles. You can find all other Grey Matter content under the blog section of greylock.com and you can subscribe to this podcast on SoundCloud, Spotify, YouTube, or wherever you get your podcasts. I'm Heather Mack. Thanks for listening.