Scott Sandell is the managing general partner at one of the oldest and largest venture firms in the Valley, New Enterprise Associates. He joined the firm, which over its 39-year existence has managed $17 billion, in 1996. Over his two decade stint, Sandell is best known for his winning bets in the enterprise space. He has seen 22 exits in his portfolio including the widely successful IPOs of Workday, Salesforce and Tableau and strategic acquisitions of WebEx (acquired by Cisco for $3.2 billion), Fusion-io (acquired by SanDisk for $1.1 billion) and Playdom (acquired by Disney for $763 million). Sandell says the physics of building a business has changed both in terms of starting a company and scaling up, throwing up some very
interesting investment opportunities for investors like him.
>> In Silicon Valley, innovation is a state of mind. What’s driving the current cycle of innovation?
The cloud and mobile revolution has not only enabled tremendous innovation in technology itself, but has also revolutionised every industry by creating a platform for building both online and offline businesses. Traditional industries have stagnated and haven’t really innovated for a long time. We have around 36 industries being disrupted by our portfolio companies, with their new business models and products. I’ve been doing this for over 20 years now, and I’ve never seen a time this exciting.
>> Give us some examples where there has been significant disruption by your portfolio companies?
There are many examples, but I’m going to start with the one that I think makes the point about how unusual the time is — Casper. About three and a half years ago, we gave them $5 million. A year later after we funded them, they came back to us and said that they had gone from zero to a $100 million in sales in a little over a year. While that was fantastic, what really got my attention was the fact that they had become profitable within one year with $5 million as capital. When I heard that, I started to dig into it and realised that the physics of building businesses has now changed; not just the cost of starting a business, but the cost of scaling a business. The amount of innovation that companies can achieve in a short time with very little money is game-changing. You can now develop a software at 20% of the cost than it took ten years ago. There are online API capabilities to do things that used to be difficult, but now we have a company in our portfolio which essentially enables you to authenticate a new bank account in around three minutes, which earlier took two days. This kind of transformation and capabilities are, on one hand, reducing friction of doing things and are increasing the scope of what can be done in the future. That was never possible before.
>> You talked about how the physics of building businesses has changed. Have businesses across sectors become efficient or is it only restricted to technology?
To test my hypothesis, I asked myself whether I knew the software business well. I’ve been investing in software companies; I was part of a software company. So, I decided to go back and look at some of them. I asked one of my associates to do this and what they found was pretty amazing. They looked at software companies in their first two years after they had gone public, to study how fast they grew. So, the first decade they looked at was the 1990s. It was a very good time for building software companies. It was the client server revolution and there were a lot of great companies that were built. All of them who went public in the 1990s grew 18% a year. Back in the 90’s, that was very exciting. Then, there was a decade from 2000 after the bubble burst. Those 10-years were a tough time to start a company. Those companies grew 28% on an average in the next 10 years. Do you know how the companies have been growing in the decade that started in 2010? The companies grew 50%. Back in the 1990s, there wasn’t much consumer innovation because the only platform that was viable was Windows, which was controlled by Microsoft. There was a lot of enterprise software, but only one route to sell it. The sales force made in-person visits and sold licenses for products that customers couldn’t try. Now, this required a tremendous amount of customisation. Sale cycles were long and the cost of selling was high.
Today, development costs have gone down drastically. There is a huge library of open source code available if you want to build a software product. There is a stronger foundation and a global distribution network because of the internet. There is also the SaaS model of selling software, where many SaaS companies can offer their products for free on a trial basis. So, you can actually try the software in the real production environment and gauge how it works for you. And then there is the appliance model, which is an off-shelf hardware box with somebody’s software in it. Each one of it is relatively better than the previous version. Because of these developments, software is a better business than it was before. It is not just a unique business, but is also indicative of how fast other companies are growing than they’ve ever grown before, thereby creating more value.
Let’s go back to Casper for a second. If you think about the 1990s, very few e-commerce companies succeeded; most of them failed. The companies that were successful had one thing in common — they were all horizontal. They were selling things that everybody who used the internet needed — something like Google and Amazon. Since everybody was a potential user of Google and Amazon, every single person who saw it’s ad on the website became a potential customer. In the 90s, there were a lot of people who started businesses, and had a large target audience. But they didn’t have a way of reaching out to that audience in a cost-effective way because advertising tools were primitive with just banner ads available. But now, with online technologies and the data behind it, you can indulge in cost-effective, targeted advertising. Going back to Casper again, how many times do people buy a mattress in their whole life? Maybe two to three times? So, since Casper was able to grow that fast and become profitable so quickly, we can conclude that they have an amazing ability to identify people and specifically target them in a cost-effective manner. That says a lot about the impact of data and online advertising. You can see this impact across all portfolios and different industries.
>>There has been a lot of talk of how start-ups are disrupting education, but the jury is still out. You have made a significant investment in Coursera, one of the challengers to established institutions. How is Coursera overcoming higher drop-off rates?
I think we need to put things in context as far as drop-off rates are concerned. Around 7% of students globally complete class. But let’s not forget, only 3% of the students who apply, get into Stanford and most of them graduate. Since there are no admissions in Coursera, everybody gets a chance to try and the 7% finish. What first got my attention to Coursera was when Daphne Koller, one of the founders, came over for lunch at my house. She said that they had launched two graduate level computer science classes online and they sent out a tweet to announce the availability of these classes for anyone who wished to join. In two weeks, they had 100,000 people lined up in each of those classes. This is graduate level computer science, definitely not an easy course. But they had 200,000 people in two classes.
Stanford has 12,000 students in all. And Coursera had roughly 20 times the number of students. Assuming 7% of those graduate, this will take the number to 14,000 people, and that’s more than Stanford University. How much of a failure is that? That does not mean that they shouldn’t try to improve the 7%; there’s plenty of room for improvement, but I think the context in which we see the numbers is also important.
Coursera is democratising access to the world’s best education. 120 universities from among the world’s top 150 are partners with Coursera and they have around 2,000 classes online. If we want to educate the world’s population, we need to reduce the cost and that’s exactly what Coursera has done. It’s the first significant innovation that we’ve had in about 500 years since the printing press was invented. However, we are just at the beginning of that revolution because Coursera has just begun to apply the intelligence for serving a large population. They also have an entire clickstream to monitor the educational experience. With that amount of data, you can personalise education and help students in ways that a traditional teacher can’t possibly do. That makes Coursera a revolutionary company.
>> You spoke about the cost of starting and scaling companies coming down. At the same time, you see the kind of money that’s being raised. Do start-ups need so much money right now?
The market has pulled off a bit so there’s lesser capital than before, and that’s a good thing. There were some businesses that probably shouldn’t have been funded in the way they were. But today, we’re seeing a more rational environment than maybe a year and a half ago. And that’s pretty exciting. There were a lot of people who were worried that maybe this was a bubble like that in 1999 and everything was going to zero. Well, that’s actually not happening. The difference between 1999 and today is that today’s companies are real companies and not dotcoms that merely measured clicks on their website. These are businesses like Casper and Coursera which are growing fast. It’s a much healthier environment because the best companies are still getting funded in a good way.
>> There is a feeling that the biggest casualties will be among the unicorns when the deluge of capital dries up? What’s your view?
Maybe before a year or two, when we were still at the height of this unicorn bubble, people asked me what was going to happen to unicorns. I said that I would happily buy the entire basket of unicorns if I could, at today’s prices. It’s not because I think unicorns are all going to succeed; it’s because it’s a really attractive portfolio. Some of them are going to be widely successful, some decently successful while a lot of them are going to fail. And that’s alright because it will still be a great portfolio. I feel the same even today. At the height of the bubble, we bet on Snapchat and Uber. Though we were selective, we were willing to pay the current price and both the companies have proven themselves.
>> So, why did Uber and Snapchat make the cut while the rest didn’t?
With Uber, we analysed their business and we were easily convinced that they needed a 3 to 5x investment from here even under conservative assumptions. That panned out extremely well. The company is doing great; the team is extraordinary. To have a really big valuation, we have to believe that the market is enormous. As for Snapchat, we just loved it. We looked at their product and it’s rate of adoption. We looked at their capability of innovation, which they had under the covers, by talking to the team. We saw that this was going to be the platform for a certain generation. For my kids’ generation, it is the platform of choice and it’s worked out very well. I wish we were in Airbnb! When we were looking at companies then, Uber, Snapchat and Airbnb were the three companies that we felt would have enduring value and ultimate worth from a venture return point.
>> Going public brings about discipline in your finances and where you are investing. When companies stay private for a long time, are they using the freedom that comes with being private responsibly?
Yes, you are right that public markets enforce discipline but if you choose to stay private for a long time, you have to impose that discipline on yourself. If you cannot impose this self-discipline, then you cannot be better off as a private company.
Once you become a public company, the public markets will weigh you on your profitability or your path towards it. The sooner you get there, the better. So as a public company, you don’t suddenly start ramping up your R&D investments, as a percentage of revenue. As a private company, you can decide to take on a big new initiative which you may not have anticipated a year ago, and spend a lot of money on it. You can’t do that as a public company. It is a trade-off that you have to make.
>> You have had some great exits in the enterprise space like, Workday, Salesforce and Tableau. Among your current enterprise companies, what is going to be your next Workday?
In our portfolio, there are equally crazy, successful companies like Enigma, MongoDB, Databricks and Nginx. But in the near term, companies in my portfolio that are likely to give a Monster X kind of return are MuleSoft and CloudFlare. Those two companies, I think, are quite extraordinary.
>> What makes for a great enterprise company?
All great enterprise companies have a strong value proposition. They do something that is transformative for the users. It’s not that they just have good products because enterprises can’t afford to take a risk by banking on nice-to-have products. So, if they’re going to put your brand new product into their data centre or into the hands of their employees, it has to be something that can really be transformative. And when a product has those characteristics, enterprises choose to take a risk on it. That gives time for the start-ups to make the product better, to remove all the bugs that are inevitably present in every product. The cash received from customers funds the enterprise while it improves the product. It creates a word-of-mouth virility and eventually, some sort of market leadership. That’s how the company usually takes more than half the market. If you look at how enterprise companies have played out over time, it is usually the leader that gets 50-80% of the market, the second gets around 15-30% while the third company gets close to 5-10% of the market, and there is no room for anybody else. It’s not a winner-takes-all business technology, but it can be. The winner cashes a lot, which suggests that there’s a premium to execution — not just creating a great product, but the ability to scale a business. For that, your team has to be extraordinary because they make all the difference. You can have a great product, but if you don’t have a great team to really sell it, it hardly matters.
>> You have been leading NEA’s investment in China for a long time. Where are you putting your money in China?
The online businesses in China are undoubtedly ahead of the rest of the world. So that’s one obvious phenomenon. But I think we’re also beginning to see the early stages of an enterprise technology revolution in China that will be different from what it is in the USA. Just like the different approach taken by successful consumer companies in China, you’ll see that phenomenon in the enterprise side, too, where the domestic companies will win. Not because of any favouritism by the government, I just think that its a different market and people who understand this will adapt to local conditions in ways that are more successful than somebody from Silicon Valley, who waltzes in with bright shiny new technology.
>> What are the sectors that look exciting to you?
Broadly speaking, I think all the derivatives of the cloud are interesting because it is transformative, to enterprise computing. There is a whole lot of opportunity in artificial intelligence and machine learning, which when applied to all kinds of business problems is compelling. We are excited about Matroid, a deep learning and machine learning company, that we just funded. The other area is security — an outcome of the unfortunate reality of today’s times. When computing is free, you can build a lot of products but it’s also true that when computing is free the bad guys can misuse it, too. So, security is a big opportunity and most importantly, it has become a need in the market. We have a significant portfolio there.