It is not every day that a venture capital firm announces nearly $1 billion of new funds in one go. But that’s what has just happened.
Battery Ventures, one of the oldest and most established venture capital firms, announced on Tuesday that it has launched two new funds worth $950 million in total financing. The eleventh funds of the firm, Battery Ventures XI ($650 million) and Battery Ventures XI Side Fund ($300 million) will invest in a wide range of startups from the seed stage all the way to private equity deals.
This 33-year-old VC firm, which has four offices globally (San Francisco; Herzliya, Israel; Boston, and the newest addition Menlo Park), has seen six portfolio startups go public and 15 get acquired in the last three years alone. To understand more about how they have gotten to where they are, we had the opportunity to chat with General Partners Scott Tobin and Itzik Parnafes.
Interview with General Partners Scott Tobin and Itzik Parnafes
Scott Tobin: We have kind of a unique structure in terms of how we structure our funds.
Yaniv Feldman: Can you explain a little bit more?
Scott: So we’re a little bit of an odd duck in a way because we have a very broad investment mandate. Literally hundreds of thousands of dollars into seed projects into buying compete companies. That’s a little bit unique to people coming out of the tech venture world. We do it out of one pool of capital out of four different offices from around the world … Four offices, 10 time zones, there’s nine general partners in the fund. And we manage those assets irregardless of geography so we all have projects that we work on, we all have the same mandates in all the offices, whether to invest in seed companies, or in control transactions, in unique companies that will be able to drive potentially good returns for our investors. That’s what we do.
Our business has cycles and our cycles are dramatic. Think of it the way people here talk about the holidays are either early or late (in Israel): They’re never on time — you’re either in a boom or a bubble or on your face.
One of the challenges is this notion you’re almost swimming against stream because it’s very transactional in nature. There are two elements of the business that keep the business going: entrepreneurs and investors who put the capital in. We’re in the middle! Our investors wanna know that they have people managing their assets that aren’t going to be a deer in headlights when cycles change.
Expecting the bubble to burst
Scott: There will be tremendous amounts of headwinds coming into this industry and you’ve got a lot of people in this industry that have never seen a bear market. I haven’t done the survey, but actually we should do it, how many general partners in all the funds …
Itzik Parnafes: Have been here since ‘08, so for eight years they’ve seen nothing but bull markets …
Scott: And that means there’s gonna be a bloodbath because that means they’re coaching their entrepreneurs, ‘Hey, it is awesome! It is blue skies and green lights forever! And it’s great!’
You always wanna be the venture guy who shows up at the board meeting and everything’s good and never wanna be the venture guy who shows up at the board meeting and be like, ‘Hey, we gotta be careful. Because you know what, Things are gonna change.’ But things change, your kids grow up and all of the sudden they grow up [and] they get pimples. It sucks. But that’s what our industry is. It’s a dynamic industry.
Yaniv: I know a lot of general partners in Israel and the Valley who haven’t experienced the ’08 cycle or ’01 cycle but who are feeding from rumors and talks 8-12 months ago [where people] started saying the party’s over and things are coming to an end. There’s going to be another Michael Moritz ‘RIP good times’ presentation.
We’re probably at the end of a cycle. We don’t really know, no one really knows, but as we’ve seen from previous years, the seven good years are probably going to end soon and looking at what’s happening in the past seven years and back in the days of 2008, what do you think is going to happen right now?
Obviously there are a few things that we can definitely point at as making the market go unstable, like the high end later stage evaluations. I’m not talking about macroeconomics stuff like China and growth but my question is what do you think will happen? Will it be the same as in 2001 and 2008 with everything going bursting all over the place and take a year or two to build up back again?
There is another thesis saying that things are inflated and will deflate to a certain level but not the entire market will be affected, just the later stage companies that will probably have to either go down round, close up shop, or whatever. There are plenty of theses about what’s coming up, so leaving aside the time frame, what’s going to happen at this point?
Scott: I think the laws of Darwin will just take hold. Many of the greatest companies over the last 30 years have been born out of times where there are down cycles so it’s not like the world is going to come to an end. It’s not like the year 2000 where ATMs will stop working and planes will fall out of the sky, but I think the crux of it is, is what happens if funding cycles stop? That’s the big issue.
Yaniv: Who do you think will have a hard time raising money?
Scott: Look, valuations are still high. Even in terms if you look across what’s happening in the last quarter in the public markets, valuations are still high on a relative basis to historical norms. So you’ll have valuation resets. The challenge that private companies have is that there’s really no historical norm for determining what a valuation is.
Scott: And therefore it’s probably just a reset of expectations. Good companies will be able to continue to exist and hopefully the startup environment, I mean innovation, won’t slow down.
Will the bubble affect Israel in the same way?
Scott: If you look at the components of Israel, it’s almost a perfect storm of things happening in Israel in a positive way. There’s no shortage of entrepreneurs continuing to come into the ecosystem, right? There’s still a healthy number of firms that are investing capital. You have a continuous flow of successful entrepreneurs that have been abroad that are coming back to Israel that are bringing processes and bringing the fruits of their labor of success that they’ve gotten on an international level. Knowledge and experience, and they’re bringing all of that back.
You’ve finally got a generation of homegrown scaled companies, whether it’s Check Point or NICE, these companies have grown generations of real international managers that know how to manage companies that scale. All of those things together is like whoa!, that’s freaking awesome, right? There’s not a lot of places in the world that have that. Even in the States. You mentioned a lot of geographies, most of them don’t have that, right? So that’s a really powerful thing.
So my feeling is that there continues to be a great crop of new companies that will get funded. I think that probably the biggest challenge continues to be is in the reset when companies have raised money at such lofty valuations that need additional capital. They were born to grow and grow and grow, which are expensive infrastructures to maintain, and when they need to take on that additional capital, the valuation resets are going to be there and our business is full of the nonsense.
In Bnei Brak they call it the shtus of, “Oh you raised a down round, that’s terrible.” Who cares? So long as your company’s funded and you’re employing lots of people, and you’re creating value for your customers, that’s the most important thing. But you’ve got to get these companies to be profitable businesses.
Itzik: That’s the big difference from ’08 or ’01, is that the real economy does not undergo through a big recession right now. There might be a slowdown but even that’s debatable, right? The fact that the financial markets are going through a correction, for real companies that shouldn’t influence them all that much. If you have a company out there that’s only asset was its ability to keep raising more and more money, then they might be in trouble. But I think that it’s a good practice to actually not invest in such companies in the first place because you might get lucky or not. We’re trying to get the luck element out as much as we can.
Yaniv: But it’s not even in today’s economy. I’m looking 20 years back and the entire principle on which the VC industry is built is on growth companies.
Itzik: It’s not growth at any cost. We became a little smarter than that.
Yaniv: I don’t know about you two, but when it comes to the industry, that’s debatable.
(Scott and Itzik laugh.)
Will growth stage funding grind to a halt?
Yaniv: But you can see that there are companies that keep on raising more and more money even though they’re not profitable. Obviously the reason for that is because they can, but the question remains if something like the bubble bursting happens, do you think that the VC industry will still keep rewarding companies by putting more money on companies that require more growth, more Cs, Ds, and so forth. That’s one part of the question.
The second is what is happening at the end of the process? Eventually a company’s life process has four possible outcomes. They fail and shut down, they’re basically good and make money — it could be not enough and [they] need more but that’s another process — and the two others are M&A or IPO. Considering the fact that IPO is becoming less and less relevant in the last few years — the cycles and bureaucracy, the amount of money, the headache —we’ve been seeing less new money coming into public markets.
Scott: So let me play the counter to that. The industry has become enamored by the notion of not taking the company public because there’s been alternative capital sources. So this last generation of companies have raised more from private capital than in the history of the asset class. So instead of Fidelity and Price buying into an IPO, they give these companies money as a private company, so they did it.
Itzik: Yaniv, you might argue that Amazon, based on your criteria, shouldn’t have gone public. They kept losing money.
Yaniv: They are still losing money.
Itzik: Well, sometimes they make money. But fundamentally I think it’s a good company. I don’t think that being public affects their business negatively. I think they see them almost as a responsibility. They say that they are such a big company, that “we have to be public.” Obviously we have to be public. It almost like it’s not good for us to be hiding in the shadows.
What you are talking about is this twilight zone where a company might go public where they should maybe not be public where their business model is not robust enough to generate any kind of visibility. But if you’re talking about fundamentally strong companies, I would argue that there’s actually a fifth scenario. If there’s actually a fundamentally good company, at the end of the day they own their own destiny. They don’t have to go public or get acquired, they don’t have to do any of that and at the end of the day, we don’t like the exit scenario is not something that we ask ourselves all that often.
Yaniv: True. But you’re committed to your investors to give a return over a period of 7 to 10 to 12 years.
Scott: Every company that has gone public has had multiple opportunities to sell the company along the way. If you have a good company, you’re going to make money.
Itzik: You don’t have to plan for that. If it’s a good company, you’ll see ample returns. You really don’t need to engineer for that. You actually need to get a little frightened if you start engineering for the good exit because that shows that something there fundamentally might be not as strong as you want.
How do you choose how to allocate your investments?
Scott: We’re pretty boring in terms of how we deploy our capital. About 40-45% of that goes into early stage venture. About 30% goes into growth stage companies, and about 30% goes into private equity where it’s controlled transactions.
Yaniv: So specifically for the early stage and growth stage, leaving the private equity aside, what’s of the most interest to you guys today?
Itzik: Obviously since we have such a wide mandate, there’s many different areas. In general we’re looking at the world as it is comprised of infrastructure, anything that has to do with deep technology and storage, computing and security. All of the things that you have to lay out in order to build on top of that, what we call software or applications where we deliver value. That could be value for businesses or services that the companies provide for consumers.
On the application side, we have a string of very successful companies dealing with sales and marketing operations. This can be one of the biggest expenses for any kind of big company. Anything you can do to help them measure the efficiency of their spend or actually increase the efficiency.
Yaniv: Of the sales or marketing?
Itzik: Yes. What do people do with their time, how effective they are, help the manager to keep track of the processes and identify bottlenecks there. Keep track of the entire sales funnel, all the way from when a lead comes in, through the nurturing process, reaching the data all around this lead, and taking it through the sales funnel.
There’s a really nice company here in Israel called Leadspace that works with this. They know when somebody comes in, they can give you a lot of context about why he’s coming in now, who is he exactly, who are the other people in the organization that you have to talk to, and how likely is this lead to actually buy something from you in the next few months. This can tell you as a sales organization if you need to focus on this particular opportunity or do you need to focus elsewhere.
Yaniv: From what you said, you’re mostly leaning towards the enterprise and B2B kind of operations.
Itzik: But that’s as a part of an 80/20 rule. If you select carefully, there’s a lot of consumer oriented innovation that is very interesting for us.
There’s a company here called 90min. They were founded around sports fans where they are contributing content and this content gets consumed by soccer fans all around the world. It’s built around the notion that you have a team that you want to follow and read all about it, and you want to sometimes contribute content for the benefit of everybody else. 90min is on its way to becoming one of the largest content sites in the world of sport worldwide.
That company was started in Israel and is very much an Israeli company with a lot of operations that are outside of the country. It’s been able to tap into the enthusiasm that sports fans have all around the world, from Western Europe to Malaysia and Mexico. Now they’re going to the U.S.
Yaniv: But what made you invest in them? What did you see in them that made you do something that’s not in your comfort zone?
Itzik: Actually Scott is an old time investor in both media and sports, and we had a lot of discussions around that. Scott invested in a company called the Tennis Channel many years ago, and we had a lot of discussion about how the world of sports consumption is actually migrating from what was broadcast television, to cable, and now is going digital. The Tennis Channel was a very successful investment for us with the move to cable.
We think about 90min almost as a next generation of the same theme about how sports consumption evolves over the years. The underlying theme is that sports is actually a very important aspect of people’s lives, and as the medium markets, sports is a very interesting market to be in. So we’re very happy to see this succession of companies and shaping them to the appropriate form to the current generation and technologies.
The missed opportunities
Yaniv: Do you feel that there is a company in Israel specifically that you looked at and decided not to invest in that you later said I wish I would have?
Itzik: We looked at Mobileye and I for one was skeptical because of the nature of the market there. In hindsight, I would have loved to have been an investor in Mobileye, but there’s no wisdom in that.
I think that if you look at the list of investors there, I don’t think that it’s surprising that there’s very few if any VCs there. The problem there is that it takes you a very long while to get into the market. To even understand that you have a product market fit takes you a long time and a lot of money just to get there.
The time by itself is not so much of an issue. The problem is that you have to keep supporting them, putting in a lot of money without getting feedback about if you actually have something that is viable. That was my problem when we looked at Mobileye and maybe I should have been more believing, but it is what it is.
We want to help build suns
Scott: And if people have suns (שמשות), we want to know them. We want to help build suns.
Yaniv: That’s a good catchy headline.
Scott: I have five boys at home and that could be misinterpreted. We need to have the conviction to want to build things, but you have to have it in your culture that it’s okay to take that risk in order to build the sun. It’s easier to be a moon.
We’re a small country. We act like we have to be beholden upon everybody else. The sun is where it starts from. Israel and a lot of centers around the world that we invest from, we’re investing in creating the light. That’s an important thing and I think that the whole innovation economy needs to internalize that because it’s a fantastic part of the economy.