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2008 Venture Capital Outlook - Software
It’s not a particular business model or technology that’ll get your company funded in 2008. The key is to solve a valuable business problem.
Bryan Stolle, Mohr Davidow Ventures and CIE Advisor
Over the last few years, no entrepreneur pitching a VC for funding would use the words “enterprise software” in their company description. Last year, no entrepreneur refrained from using the word “SaaS” to describe their business model.
Investment trends come and go but software has been the leading category of venture funding for many years. Nearly $5.3 billion was invested in 905 companies during 2007.
Right now, software VC activity is hot again. But what’s different these days is how VC firms are thinking about “software” investments and what entrepreneurs should focus on during their fundraising.
What’s Hot? Solving Business Problems
The most important factor in determining whether we will back a company is whether it solves a critical business problem. The problem must be serious, urgent and there must be significant value to the customers in solving it. The solution must be affordable, rational, and really solve the problem. Finally, solving that problem cost-effectively must allow the creation of a large market, or allow the company to take significant share in a large market.
To most VC firms today, there is no preference for how the problem is solved, as long as it makes sense for the market. It could be delivered as a software-as-a-service (SaaS) solution, an appliance, an open source download with premium add-on services, an ad-supported application (“freemium”) or as an outsourced business process. There is software-enablement somewhere in the process but it doesn’t matter whether the customer is exposed to it or not.
During the last several years, startups regularly pitched their companies saying, “It’s going to work because it is based on the SaaS model.” Thankfully, we’ve moved past that in the last year or so as the success of other models has becomes apparent, and entrepreneurs realize it takes more than the latest fad in business models to build a great company.
The majority of entrepreneurs seeking funding today are very conscious about their business model, and why it makes sense for their target market. They are very knowledgeable about their space and their customers, and have been thoughtful about what will work best─whether it’s most important to reduce friction in the sales process, accelerate adoption, facilitate growth and expansion (“land and expand,” as we say,) or some other benefit.
Software VC Climate is Favorable
It’s pretty amazing how many new software-related ideas are coming to the table these days. I think the main reason for the uptick is that for the previous seven-plus years, few software sectors were “hot” in terms of market activity (with the notable exceptions of compliance and security.) Most enterprises were still focused on getting their Oracle or SAP installations working or obtaining value from the massive investments they’d already made in their current systems. A few enterprises were working on new initiatives “around the edges” with function-specific solutions, like PBWiki for corporate wikis or Genius.com or Landslide for improving sales/customer interaction, or HelpStream for community-based and self-help customer support, but they were the exceptions for the most part.
However, the business world today is very different. If you mentally transport yourself back to the late 1990s, you can start to better appreciate the sea change that has roiled business IT. Back then, outsourcing was happening but not everywhere. We might have worked with a few firms to design, build and deliver our products, but not many and not always. We talked about being global, but most businesses really weren’t, especially below the Global 1000. Today, businesses in virtually every industry collaborate heavily (or entirely) with other firms to help deliver products to customers, and most of the partners are spread around the globe.
Not ten years ago, I remember having debates about whether it made sense to hire a VP of sales─or any other senior manager, for that matter - that wouldn’t be stationed at headquarters. Now, almost all the companies we see have a distributed workforce that includes members of the senior executive team who work remotely. A global, distributed team is involved in bringing most products to market today.
At the same time, enterprise IT is rapidly becoming “consumerized.” Rather than being controlled and led by the IT department and the CIO, users across a company can easily go online or to a store and get a product that they need to do their job better. Today’s worker doesn’t think twice about running out to Fry’s, buying a wireless router, and configuring it on their own, saying, “If IT can’t do it, I’ll just do it myself.”
These trends are critical to the future evolution of the software industry. Why? Think about how and when the major enterprise software vendors developed their products. They were all started many years ago and were designed to run companies with centralized operations. The business world is a very different place today and there is a huge opportunity for new software solutions to take the place of these older enterprise applications which have a very tough time delivering value to a distributed, user-driven organization.
Trends for Software VC in 2008
Advice for Entrepreneurs
Although the current investment climate remains strong (at least at the moment) for software startups, economic conditions mean entrepreneurs should consider the following tips regarding venture funding in 2008.
But if you look at the market activity over the last two-and-a-half years, you’ll see we’ve witnessed close to 100 software-related IPOs. That’s not “bubble” levels but it is a pretty active, vibrant IPO market for a single sector. Obviously, it depends on the company, but I think that leading venture capitalists are certainly not ruling out the potential for an IPO, and looking exclusively toward M&A exits for all their software deals.
The bottom line? Software entrepreneurs must aim to build the best possible company they can. Building for expediency and a quick acquisition will rarely deliver returns to anyone. We expect most exits will take place five to seven years after the initial investment─no one knows what the IPO market will look like at that time. The only way to ensure success is to build a great company─and build it to last. Whatever the exit opportunity, a successful software company built to last will always command a higher price.
Bryan Stolle is a general partner with Mohr Davidow Ventures (www.mdv.com). Article republished courtesy of Stolle and SandHill.com