Venture capital veterans Bill Malloy and Brian Nugent see themselves as both entrepreneurs and financiers, working to improve the fortunes of both the startups in their investment portfolio, as well as the limited partners invested in their firm.
In their former lives, Bill was a venture backed entrepreneur working in the digital music space in Silicon Valley during the 1990’s tech boom; while Brian was an executive at both public and privately-held enterprise software companies, including serving as COO at EdgeWave (EWVE); and CEO at Applied Identity. Following their entrepreneurial tenures, they went to work on the opposite side of the table, with Bill working with Draper Fisher Jurvetson, Zone Ventures, thereafter running the venture capital arm of his family office, Malloy & Company; and Brian became a partner at Torch Hill Investment Partners, a mid-market private equity firm focused on technology investments, before joining forces and forming Sway Ventures (formerly AITV) in 2013.
We recently sat down and talked with Bill Malloy and Brian Nugent, founding general partners with US-based venture capital firm Sway Ventures, about their assessment of the venture capital market and the trends in this sector, which is so vital to Silicon Valley’s economic health.
Q: What are your views on the venture capital market right now?
Bill Malloy: Right now, we are in a bit of a correction period. In economics terms, we’re increasing at a decreasing rate. It’s been a spectacular eight years of mostly up and to the right, it now looks like the growth trajectory is slowing. The most important thing to remember, however, is that when you invest across the lifecycle of a startup, you can ride most slowdowns, that’s where it comes down to investing in great companies led by smart teams. You can find those companies in any market environment. I still think that the best technology entrepreneurs focus on hiring the best engineers and build a culture around their engineering talent.
Q: What’s changed recently?
Bill Malloy: Just like with the public markets, the venture capital market has become a bit over-heated. People are cognizant of that, but sometimes it’s hard to stop. It comes to a point where people realize it’s gone too far, and they put on the brakes. Break out companies are still finding investors and doing rounds that are being priced up. I have also seen companies that raised capital in the summer of 2015 coming to market at the same valuation just to build cash on their balance sheet to prepare for a hard market to raise capital.
Q: How did the current slowdown start?
Brian Nugent: You saw it begin in the public markets towards the end of 2015 and more so since the beginning of 2016. That investor appetite trickles down until it gets reflected all the way back to the venture capital ecosystem.
Q: What factors cause VC’s to allow the market to overheat?
Bill Malloy: There is a lot of economic and psychological research pointing to the fact that, in general, people are continually unsatisfied. Individuals consume to excess, and then reverse course the other way just as aggressively. One just needs to look at the wild ride of the late 1990s; I was in Silicon Valley working in the digital music space at the time. It was a volatile time, to say the least, filled with excess and then massive austerity. Then you can also point to 2008; things got frothy followed by a crash. Now we’re seven or eight years out, and things are getting hotter and hotter, and there likely will be another correction, we’re seeing data pointing to that. The key thing to keep in mind is to look at where the money is coming from, in all the booms and then busts, you saw capital pouring in from sources that are not core technology investors. The public funds come in, and with them a tremendous amount of capital without the requisite ability to properly diligence and understand the underlying technology. You see that today as large funds are coming into later stage venture, driving valuations higher and higher.
Q: Why does that cycle keep repeating?
Brian Nugent: I think it’s human nature, we could talk at length about the behavioral science behind it, but I do think human psychology has a lot to do with it. On the other hand, technology also seems to develop in similar bursts. Investors see technology causing disruption on a massive scale across industries, and then people begin to throw capital behind it, to the point that where you over-fund things and see rich valuations. We saw it with the Internet in the 1990’s, with clean tech in the 2000’s, and now we see it across consumer apps, mobile and cloud computing.
Q: Is it an issue of too much capital in the system?
Bill Malloy: I think the easiest way to think about the venture capital market is to compare it to a real estate market. Imagine a neighborhood that has both good homes and bad homes. Now imagine that market becomes highly desirable, all of a sudden demand surges and people want to live in that neighborhood. Capital (purchase offers) is being thrown at both the good and bad houses. I’m the first to admit that there deserve to be some innovative companies receiving capital. These are the companies solving very hard problems in old-line industries like finance, healthcare, and government. On the other hand, there also simply too many companies chasing capital and not all of them are businesses that can survive a slowdown in venture funding. So do I think there’s too much capital in the system? Maybe. Do I think that there are too many companies with unjustified valuations? Absolutely. Not all of these companies deserve to be great. Some will die, some will get pruned, some will be acquired, and some will continue to thrive. That’s the cycle of technology and venture capital.
Q: How does the age or experience of current entrepreneurs feed into this?
Brian Nugent: For someone like myself, the Dot-Com crash is fresh in my mind. I was living in Silicon Valley in the late 90’s working in digital media. I saw the disruption and carnage firsthand. The Millennials I work with don’t remember the end of the dot-com bubble. Most of the entrepreneurs leading companies now are in their 20s. The costs structures have changed so dramatically since the late 90’s that you can do with under $20k what used to require $2M. The barriers to entry of launching a startup are so low, they just go ahead and do it. If you look objectively at the market, you’ll see the momentum slowly building and then accelerating to higher and higher valuations. In these frothy times, a lot of entrepreneurs take shortcuts when it comes to the product, or technology, or the business. Raising capital comes too easily, and as a result bad habits form. Again, it’s important to note that this certainly does not apply to all startups in this environment. There are gems to be found in any economic climate. At our firm, we look for startup CEO’s that are focused on both growth, as well as unit economics.
Q: What is a typical day like for you?
Bill Malloy: I’ve been doing this for nearly a decade, and no two days are alike. A typical day might look like the following scenario. I’ll have breakfast with a large public technology company (these firms have large balance sheets and are looking for M&A opportunities). This would be a company which we might be co-invested with and with which we have several investments related to this company’s five-year strategy. It’s in their interest, our interest, and the interest of our portfolio companies for conversations like these to happen. Then maybe I’ll have coffee with a fellow VC and talk about deal sharing, maybe I’m looking to invest in one of their portfolio companies or visa versa. Back at the office I might meet with a director of sales, someone I’m trying to recruit for one of our portfolio companies. Then maybe I’ll listen to a potential portfolio company pitch our group. Later I have meetings with my fellow general partners or operating partners. Finally, I like to use the hours after work as “office hours” so to speak. This is a time for me to take calls with the CEO’s of our portfolio companies. Maybe this particular day I’m speaking with a CEO and strategizing how he might be able to leverage our strategic limited partners to gain access to Europe. I have the opportunity to meet with a lot of different people all vital to the firm, our investment strategy, and the outcomes of our portfolio companies. I love the strategic aspect of it; it feels like a drawn out game of chess.
Q: What are some of the ways you provide value to a CEO of one of your investments?
Brian Nugent: It could be counseling or letting him vent. That’s part of the job. It really comes down to two key areas where a VC can add value for CEO’s. The first is helping them build out their leadership skills. This includes things that you learn over time and can glean from those who’ve walked in your shoes already. It may be things like managing executives, organizational design, or running sales and building marketing organizations. The second area is providing them with an ecosystem they can leverage. What I’m talking about is a prebuilt ecosystem of customers, partners, press, and business connections. Startup CEOs can leverage these ecosystems rather than try to build their own. We give our young startup CEO’s something that would take decades of being a professional CEO to build on their own. That’s powerful.