Stephen Chandler (Notion Capital): The qualities that we’re looking for in teams are some real ambition and a desire to change the world.
30 Nov, 2020
Cindy Padnos is Founder and Managing Partner of Illuminate Ventures, an early stage Micro VC firm focused on Enterprise cloud and mobile software investments. Cindy has deployed over $100 million in venture funding to help dozens of start-ups reach successful outcomes including prior portfolio companies Red Aril (acquired by Hearst Corporation) and WildPockets (acquired by Autodesk).
I had the opportunity to work with several other firms as a venture partner before deciding to launch my own firm, Illuminate Ventures. Prior to ventures capital, I had spent most of my career working in and starting software companies before I decided to go on the investing side of the table.
My first experience working in venture capital was not one I had planned on: Shortly after the SaaS procurement software company that I had founded was acquired, I was invited to start working with a number of venture capital firms. Because of the financial crisis that was going on at that time (the Dot-com bust) many VC firms were looking for strong operational executives to help them with their portfolio companies, and I was one of those people. Through the process of working part-time with several prominent VC firms, I discovered that my background and interests were well-suited to venture capital. I realized that the combination of my educational background, work experience and perhaps most importantly my broad network could serve me well as a venture capital investor. I had built a strong network of both entrepreneurs and VCs while I was honing my operational skills in high tech startups. I suddenly realized that these skills could be applied to do something entirely different from what I had ever done before. That was exciting to me. Venture Capital was a way to leverage what I had built in my career thus far, but also to learn something new while continuing to collaborate with talented entrepreneurs. I’m a big believer in continuous innovation and learning, so the transition felt great to me.
I was fortunate to have some great mentors as I thought about moving into a VC role. I had the opportunity to work with partners at firms like Scale Ventures (where half the partners were women at that time), Mohr Davidow and Benchmark, among others. Then I was invited to join a firm in a full-time role by two male founding partners, one of whom I had worked with early in my career in a management consulting firm. Given that good fortune, it actually felt to me at the time that it was harder to be a woman founder/CEO than to be a woman VC. When I had been out raising capital for my own software startup I have never once met with a female VC partner, so it felt pretty daunting. I was excited to help change that for other women founders.
I had worked in high tech my whole career, and I was fairly used to being one of the few or even the only woman in the room as I rose into more senior roles. It wasn’t shocking to me to move into the VC world where less than 10% of partners were women at the time. I saw it as an opportunity to make a difference, by encouraging more diversity, not just amongst VCs, but also in the founding teams we would identify and invest in. What is more surprising to me is that 15 years later, we’re still below 10% women VC partners.
For the most part I was warmly welcomed into the venture business, but I have to admit that there were some odd comments from time to time. I still remember one male VC saying to me, “Cindy, don’t you understand that venture is a young man’s sport?” And I thought: “Young? I’m not that young anymore, as I’d done these operating roles already. Definitely, not a man. Sport? I liked sports. So, 1 out of 3 isn’t bad.” I chose consciously to keep a “glass half full”, positive attitude. I knew I could do this job as well as everyone – I didn’t think I was necessarily better than any man doing it, but I knew I could be at least as good.
Some people might think it’s boring, but I think the B2B software world can be pretty interesting and even kind of sexy. We’ve invested in a really interesting range of companies that have unusual business models in some cases. We’ve invested in companies like Pex, where the founder decided to flip things on end – going from a traditional SaaS revenue model to a revenue share model with the customers. Pex is a platform that started out with the focus exclusively on digital rights management and now allows not just the major music video groups (like Warner and Sony) to claim the rights for their digital content when it’s played on any platform like YouTube or anywhere else – but now enables ALL individual creators of user-generated content (UGC) to do so as well. Honestly, we thought that the founder was a little bit crazy at first. “Are you really you going to go and tell the music majors that they now have to share revenue with you, seriously?” But he is brilliant and persuasive, and he has a product that is not replicated by anyone else. He was able to persuade customers to convert into something that ended up sharing the real value of what the company’s product does. I think it took a lot of guts and it was a very smart thing to do.
We see roughly 1000 companies a year that fit our overall criteria (Enterprise Software, seed stage, North America, etc.). Many entrepreneurs approach us directly, but the most interesting companies gain access to us via one of three methods:
Obviously, we very quickly sort the wheat from the chaff to define those that we’re going dig into deeper.
We invest in 4 -6 companies a year, so that gives you a little bit of an idea of the ratio. We do thorough due diligence on, perhaps, 2 to 3 times this number, roughly 10 or 12 companies per year.
The vast majority of our investments have been sourced through our direct network. From day-one of launching Illuminate we sought to build a platform that could support our efforts across the entire investing lifecycle – all the way from selecting which sectors to invest in through the successful exit of a company – and all the steps in between. Deal sourcing is just one of the steps along that path, but an important one. With that in mind, we built a broad Business Advisory Council, now with more than 45 members. One part of their role is to act as deal scouts for us. Each member has played a role in the enterprise software world. More than a dozen members have been Enterprise Software founders with successful exits and across the group they have held seats on over 70 public company boards. These people bring us unique deal flow and much more. The access they enable is helpful not just to our partnership, but also directly to our portfolio companies.
As part of our platform strategy we have also had more than 70 students from top MBA and Law schools “graduate” from our ongoing class-year internship program. During that program the students learn about how Illuminate evaluates investment opportunities by assisting with the diligence process. As they move back into industry they continue to act as sourcing scouts for our firm as well. One of the strongest current investments in our portfolio, for example, was referred to us by one of our prior Haas School interns who had moved to Deutche Telekom Ventures when he graduated.
Our own founders are another great source of investment opportunity. Roughly 10% of the companies we have invested in were referred to us by them and we expect that to grow over time as the number of founders we have worked with continues to increase. Of course, we also receive many, many unsolicited inbound inquiries from entrepreneurs. We also have many opportunities shared with us by other investors. One thing that works well for us is that we syndicate and share nearly every investment we make with at least one other like-minded investor, and that means we’re able to share a lot of our deals with others and gain similar opportunities in return from them.
I’ll start at the top and work down – we invest exclusively in B2B/enterprise software companies. Some of the fundamental criteria we apply, such as whether or not the market size a company is operating in is large enough and likely to grow rapidly, whether or not there is a whitespace of some kind and digging in deeply to understand the leadership capabilities and demonstrated resiliency of the founding team members are similar to other VCs. Thereafter I think how we evaluate companies is quite different from most Seed stage investors.
We tend to invest in teams and companies that are a little bit further along versus raw startups. We think about our Series Seed (the first institutional round of investment) a bit differently than most venture capital firms. We’re aware that there are interesting companies that are not your typical startups – companies that are bootstrapped, are spin-outs from a larger corporation or perhaps are converting from a services business to a productized SaaS software company. Most VCs are not focused on these types of businesses, where we see not just value in the company, but also a great fit with the value we can add from the platform we’ve built. These companies typically already have a product, and revenue, and a team that may have worked together for several years. What they don’t have is a deep knowledge of SaaS metrics, near instant access to B2B customers for feedback, channel relationships, extra arms and legs to assist with competitive assessments and pricing strategies and equally importantly – experience with and access to great Series A investors. Our firm can offer all of that and more.
Fundamentally, we apply our skills and experience as successful operators and investors across dozens of SaaS companies and those of our Business Advisory Council and interns to help accelerate the companies. That leverage can best be used by applying it to companies that are beyond the MVP stage and are ready to jump start their go-to-market strategy, product positioning, and early customers versus at the pre-product stage.
We are B2B/Enterprise software investors, but are not typically focused on specific vertical industries. We have invested primarily in companies that are industry agnostic, more horizontal in nature. As an example, Xactly is sales compensation management, and it doesn’t it matter what industry you’re in: if you have a sales organization, you need to manage compensation. Similarly, BrightEdge is the market leader in search engine optimization. There is a very horizontal need across many different industries for SEO. We have a couple of companies that are more vertical. One is in CPG (consumer product goods) analytics space, but I wouldn’t say that we’ve chosen that as a specific category that we will focus on. It just happened to be a great team with strong domain knowledge in a B2B tech category that is growing quickly.
We invest all across North America, and that is one way that we’re a little different from many Bay Area VC firms. For example, we have had companies in LA, Philadelphia, Pittsburgh, New York, and in Canada as well as in the Bay Area – all across North America. Of course, nearly all of our portfolio companies have at least some resources off-shore and many are now considering full-time virtual situations.
Our diligence process is quite thorough – from technology assessment, gathering target customer feedback, reference checking he team and more. The timeframe required, however, can vary quite a bit depending on a variety of factors – how well do we already know the sector, have we known any of the founders previously, who will be our co-investors, etc.
We recently made an investment in a company very quickly, but it was a founder that we had previously been an investor with (his company had been acquired by Cloudera three years ago) and we were already familiar with the space he was targeting. The other extreme, of course, especially today, with the COVID situation, is the additional reference checking needed when you cannot spend time with teams face to face. We do feel at some point in time, even if it’s the last thing that you do, that a “live” meeting is an important element in making an investment decision in early stage companies. We tend to work with our most successful founders for many years and want to feel good about the chemistry.
Our more typical initial check is $750k to $1M. We reserve 2x of that for the future financing rounds. We frequently lead or co-lead financing of $2-4M in size and once in a while make a smaller early investment of as low as $250k in a company where we may hope to lead the next round. We generally participant in 1-2 follow-on rounds, because we believe that if you’re making a commitment with a company, it should be a long term.
Micro-VC is sort of an industry moniker that was created 6 or 8 years ago, when no one knew what to call Seed Stage funds. The concept of a Series “Seed” was brand new because before that the first round of institutional investment was always a Series A. With the advent of the public cloud (Amazon AWS initially) and the much lower costs associated with starting a software company – along came the need for much smaller financing rounds. Suddenly, Seed, Pre-seed, Post-seed financing rounds were the new normal – all prior to a Series A. The industry gave the name of micro-VC to the firms that were raising sub $100M funds, which had never really been done before. Prior to 2008 there were no seed or pre-seed funds, they just didn’t exist. Series A rounds were typically $4M or larger and you needed to have reserves across a portfolio of investments, so you needed $100M fund or larger to be credible in the market.
Of course, we are seeking the Sun and the Moon and the Stars when we make our initial investments! We don’t enter into an investment to have 2X return. The reason for that is that we know, as early-stage investors, that some of our companies will inevitably fail – as much as we don’t want it to happen, as much as we never going to investment assuming that it will happen, the data proves that ⅔ of early-stage companies fail. We have a much better track record than that, but we’ll still likely see 20-25% fail to return significant capital in each of our portfolios. If you want a return of 4-5x on a fund, which is typically the goal, you have to want some outlier investments that return 50x or 100x – or, at least, 10-20x to make up for the ones that might return zero. It’s just math.
I’ll focus on answering your question as a Series Seed stage investor, typically the first institutional round and how we look at a company’s existing cap table. My partner and I have seen a fair number of companies recently, where we think the early note investors already own too much of the company. We’ve seen the same thing with spin-outs where the original owner expects to own too much of the newco. If outside investors already own 30 or 40% or more of a company before the first institutional round that’s not healthy. If you have company with high growth potential, they’re going to require multiple rounds of capital, each of those is going to dilute the ownership of the founders and the team. You need to know that the founders and others they need to bring onto the team have an opportunity to win big on their equity. Without that there isn’t sufficient incentive for them to accept the risk, lower pay and hard work of a startup. We’re very cautious when we look at companies with cap tables that seem out of balance. In some cases, we have helped founders understand how they might be able to address these issues.
I’ve learned over a decade of early stage investing is that the right team can make almost anything happen in a good market. The leadership of the founders, their ability to attract great people around them, the resilience they have demonstrated in their lives – those things are really important to us. There are some investors that believe it’s all about the technology, the depth of the team’s technical skillset. While that’s certainly important, we actually tend to look for founders who have focused on understanding customer needs and product-market fit before they build anything.
Overall, the best teams are balanced. That can mean a lot of things, but for us that generally translates into a diversity of skillsets (not all engineers), a diversity of backgrounds and other differences in experience sets that each member of the team can draw upon and share. It is also a little hard for us to get arms around teams where there is no prior startup experience at all. Startups are the ultimate roller coaster in their early years, so having lived through that before, even if not as a founder, can help a team to be better prepared.
Most fundamental of all is the need for mutual trust and respect with the founders. B2B software companies frequently have a long lifecycle to exit – frequently 10 or more years from inception. Ans since we are frequently taking board seats and investing in multiple follow-on rounds, the attributes of the founders we will be collaborating with becomes an important factor for us in any investment decision.
We have invested before in a single founder, but never a one-person company. I would say that today it would be very unlikely for us to invest in a single person team. There may be a single founder, but we’ll want to be able to assess their ability to surround themselves with amazing talent.
That’s a tough choice! They both were brilliant founders and each understood that they were better together than apart. It was the whole package that succeeded. Every organization needs that balance. I don’t think typically that one person generally can represent all that is needed to achieve.
Even before this current pandemic we would not invest in a company with the founders who say, “We just want to raise enough money for 6 months, because it will be a lot less dilutive, and then we’ll go raise the next round, because we’re going to achieve all these milestones and will have a much higher valuation”. It’s high risk and not a good plan for a founder to be raising new capital every 6 months. We don’t just run away when we hear that – we explain our position, but if the founders remain intransigent, we’re not likely to invest.
Of course, we’ve all missed great investment opportunities. I had an opportunity to invest in Anaplan when it was a startup, it was a $17M pre-money round. We all know what kind of a success story that is today. At the time, (it was 10+ years ago), I was just raising my first fund and our focus was on doing seed and pre-seed investments where the typical pre-money valuation was under $5M. I liked the company and the team, but I thought we would be inconsistent with our philosophy if we wrote a check at that valuation. Even though we missed out on that one, by sticking with our investing thesis, we’ve delivered strong performance. One of the companies we did invest in at that time has gone public and several others have been acquired by public companies.
I think robotics is really cool, but we’re not likely to invest in hardware. Still, the things that could be done in the future in robotics are going to be fascinating and will require amazing software to support them. That is where we could play in that segment. The Biopharma industry is exploding, but we are not experts in the category. Similarly, there are however very interesting business needs within Biopharma companies that will be addressed by software solutions. We’re evaluating a startup in that exact space right now.
I can’t say that it’s changed too much for the Illuminate team. We always operated remotely: my partner is in Seattle and I’m in the Bay Area. We have an office in San Francisco I haven’t seen in months, but that hasn’t slowed us down. We’ve made 4 new investments in the 8 months since COVID started and are ahead of our typical yearly target. We have made some adjustments. For example, we are requiring companies to raise a little bit more initial cash to ensure a longer runway than we would have in the past. We used to say about 15 to 18 months was enough, now we’re looking for 24 months.
I think COVID has represented a huge opportunity for many founders, to be honest. We’ve just completed an assessment of the overall B2B landscape and how it is impacted by COVID, where we see long-term opportunity to be accelerating in many enterprise software sectors. I’ve been an investor in enough downcycles that I know the opportunity can exist anytime and that the founders that choose to get started during a crisis typically have very strong conviction about what they are doing. We made our first investments in two of the companies I’ve mentioned (the sales performance management software company and the SEO company) during the last financial crisis and both of them are now profitable $100M+ recurring revenue companies. And both of them still have the original founder CEO’s running the business. I think, there’s a tremendous opportunity in the B2B sector today and going forward. Of course, there is short-term pain, and I feel sad at times, especially for young students and recent grads having trouble finding jobs. I am confidant, if they can weather the storm, that those companies that are able to survive are going to come out of this stronger than ever before.
I am involved with a number of non-profits and also a believer that your effort should go alongside your financial contributions. For example, I’ve been involved, since I was an entrepreneur myself, with several organizations that focus on encouraging women’s entrepreneurship, including a group called Astia and Springboard Enterprises. I’ve also served on the advisory board of Carnegie Mellon’s Tepper Business School for many years and have been active philanthropically in all of those programs over time. I care deeply about opportunities for students, about entrepreneurship and about encouraging diversity in our tech ecosystem. Related to that, I have worked with students to research and write three white papers focused on gender differences in entrepreneurship and shared them broadly as vehicles to encourage and support diversity.
I’m always interested in the materials and events from groups like VLAB and SaaStr, but I honestly think the best way to learn is directly from other entrepreneurs. Finding someone who’s active in a role as an operator, who’s “been there, done that” – it is really one of the best ways to learn. One of the wonderful things about Silicon Valley and many other communities is that many successful entrepreneurs want to give it back, to encourage and teach others.
Oh, that’s almost impossible! If I went way back in time, it’s things like the Telegraph! Whoever thought that you could electronically communicate – globally before that time? Some things are fundamental, like automating the process of manufacturing clothing, let’s name it the second one. The third category is perhaps the first mobile/handheld personal productivity devices like Handspring and Palm that existed long before there was an iPhone. I would also add the iPad to the list. It’s the next truly multi-generational device after the cell phone. It hit me like a ton of bricks when I got my first iPad. I suddenly realized that both my father and my toddler nephew had one. It was being used for everything from communications to entertainment.
Another important consideration is whether technology is the breakthrough or something else. Going back in time, it was not just conveyors and mass production that made Ford a success. Henry Ford understood that if you could offer buyers an opportunity to purchase a car over time, with several payments, you could create a much larger set of customers for your product. What Mark Benioff of Salesforce.com understood was exactly the same thing: by creating a subscription-based revenue model rather than the old one-time license fee, you suddenly expand the market of buyers multifold. That is a lesson for many of us. Innovation in our industry is not always about technology, it can also be about your business models, target markets or even your internal management strategies. We look for teams that understand that and are leveraging tailwinds across multiple trends.
I love what I do! I feel very fortunate every single day to be able to do what I do. No, I don’t see myself doing something different.
For me – integrity tops the list. Ensuring that an entrepreneur who you work with knows that you say is what you do.
Having had your own prior hands-on operating experience building organizations is incredibly helpful if you’re going to do early-stage investing. If you do late-stage investing, it likely doesn’t matter as much, but it makes a big difference if you are investing in young companies. A broad network is very important to VC investing success. With every investment you make over time, you’re responsible for helping that founder to reach out to customers, business partners, distribution partners – and to help syndicate the next round of investment. You need to have access to many resources that can help accelerate companies in your portfolio. For a VC, it’s also important to know when to be silent and to listen; not to try to impose your views.
I’d say that it’s more like sailboat racing. Early leads matter because you gain “cleaner winds”. Knowledge of the landscape you are sailing in (domain knowledge) gives you an advantage. Teamwork and the quality and experience of those you surround yourself with can be game changing. If you are leading – others will copy your moves relentlessly!
Probably, New York. The energy, the art, the food – is exhilarating!