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Scott Orn

Scott Orn, CFA

What are VCs looking for in today's market? Gautam Gupta of TCV discusses what it takes to fundraise right now

Posted on: 01/22/2024

Gautam Gupta

Gautam Gupta

General Partner - TCV

Gautam Gupta of TCV - Podcast Summary

What are VCs looking for in today’s market? Gautam Gupta of TCV discusses what it takes to fundraise right now, including an emphasis on company fundamentals, significant gross profit margins, what to call out in a pitch meeting, and what to look for in a term sheet.

Gautam Gupta of TCV - Podcast Transcript

Healy: Hello and welcome to The Kruze Consulting Podcast. I’m your host today, Healy Jones. I’m joined by Gautam Gupta, who is a venture capitalist with TCV, one of the largest and most impressive technology investors in the world. Really looking forward to our conversation here with Gautam, but a quick word from our sponsor first.Hey, this is Healy Jones, VP of Financial Strategy here at Kruze Consulting, andI want to say thanks to our podcast sponsor, ARC. At Kruze, we’ve got a number of clients successfully using ARC to manage their deposits, payments, access financing, all in one place. One of the things that ARC provides that’s really great is over a quarter of a million dollars in FDIC coverage. Their insurance program goes beyond the standard limit and it secures up to five and a quarter million dollars. So, startups that have even more cash than that can go and access treasury solutions to provide yield and safety. If you’re a startup looking for a secure financial solution that can help you scale, please check out our sponsor ARC at ARC.tech. All right, we’re back. Gautam, how are you? We’ve known each other for a long time, both Coasts. How’s it going?
Gautam: Great. It’s great to see you, it’s great to do this with you. Yeah, no, excited to cap off the year with this.
Healy: Oh, yeah, awesome. We’re recording this in just the very end of November 2023. So, folks listening to this a few years from now, I’m sure it’ll be still popular, that’s the date.
Gautam: I hope so.
Healy: Exactly. Do you want to tell us a little bit about yourself and how and why you got into venture?
Gautam: Yeah, sure. So, I started my career in venture investing at General Catalyst. I had the just dumb luck actually, of joining the firm as an intern when I was in college. So, I joined the firm when I was 18 years old as a sophomore in college, spent two and a half years interning there. Joined them full-time after undergrad, spent a total of eight years at the firm and then ended up deciding to leave to start a company in the e-commerce space. So, I left in 2012 to start a company called NatureBox. Ran that business as CEO for six and a half years, and then decided after seeing what the other side looked like of operating a business, it was the right thing for me to go back to the investing side. So, I handed over the reins of that business and decided to go back into venture investing about six years ago.
Healy: That’s awesome. I actually remember, I remember the company you founded, NatureBox, we were subscribers and ate a lot of those snacks. I think you had these little salted nut things that were awesome.
Gautam: Thank you.
Healy: That was a really good service. That was really great.
Gautam: Yeah, thank you for being a subscriber. The business is still around today. We sold it, but the brand and the business still exists, so it was a fun-
Healy: That was a great product.
Gautam: … fun ride.
Healy: Very cool.
Gautam: Definitely learned a lot of hard lessons running that business.
Healy: Yeah, you picked a tough industry, for sure. Subscription e-commerce is hard. That’s really hard. That’s pretty much almost as hard as it gets, I’d say.
Gautam: I jokingly say that to a lot of founders, which is I don’t think you could have picked a worse market, but I do think, yeah, physical inventory is something that I wouldn’t wish on my worst enemy.
Healy: Particularly something that’s a little bit perishable too, that you’re really upping your game there. It’s amazing. Let’s talk a little bit about where you are now, TCV. What is TCV for folks who don’t know and which part of that business do you work in?
Gautam: Yeah. So TCV is a firm that’s been around for 27 years. The initials stand for Technology Crossover Ventures, and really that is emblematic of the history of the firm. TCV was a pioneer in crossover investing, so investing pre-IPO and then doubling down post-IPO. That strategy served the firm incredibly well over the last two and a half decades. We, as a firm, decided to launch an early-stage fund about two and a half years ago, which is called TCV Velocity, and that is the group that I head up along with my partner, Matt Brennan, where we invest in Series A, B, and C stage companies really with the thesis of trying to be a full-stack or multi-stage investor starting at Series A, B, C, but being able to double down over the life of the company and support the company both as a private and public company over its course of its history.
Healy: That’s actually really interesting. So, let’s say you’re a founder. What are the advantages of choosing a venture investor who can support you from the A all the way through to the IPO?
Gautam: Yeah, so I think it’s a couple things. So obviously one, I think the market is seeing today just the power of deep-pocketed investors and investors that can support you through a cyclical low from a macro perspective. That doesn’t necessarily mean that the firm has to invest across pre-IPO and post-IPO, but I do think people are sort of seeing the importance of just investors that have deeper pockets and that ability to support the company when capital markets are soft. I think the added advantage of being able to go to crossover and invest in the public market is often technology companies have multiple chapters of their life and new products that define the next 10 years that are fundamentally different from the prior 10 years of the company’s history. And in the evolution of a business and going from chapter one to chapter two, or chapter two to chapter three, there can be low points and just harder points of that journey where having an investor that has been able to see the quality of execution and understands the strategy and how these products or markets or initiatives align, I think can be really helpful and not only gives you the support that you need during a tough time, but also gives the market a signal that can be very powerful as well.
Healy: Right. Yeah, just to say that there’s a smart investor who’s been with the company for a while, who’s continuing to invest in the business is a pretty strong signal. That’s great. So, at the end of 2023, we’ve experienced a pretty big pullback in the venture market and it started-
Gautam: Just a little.
Healy: … at the public companies, and just a tiny one, yeah somewhat, you may have noticed, but it started at the late-stage public and has worked its way down through the stack. What was it like to live that and watching the contraction out of fund that bridges a huge percent of the companies’ lifecycles?
Gautam: Well, the first thing is you start to think about your existing portfolio and because the Velocity Fund was launched two and a half years ago, we’re still building the portfolio. So, we were in a very fortunate position where most of our portfolio companies have raised fairly fresh capital and have a lot of runway. Many of them are funded through profitability or are profitable today. And so, I think, look, we were in a very fortunate position, but I do think the first place that your mind goes is shore up your existing portfolio and make sure that your existing portfolio doesn’t have to go out and raise capital in a tough market. And so, I do think that was a big part of the back half of ‘22 and even coming into ‘23, just what a lot of folks were spending their time, where they were spending their time. And then I think you sort of transitioned from there to, okay, well, where are the new opportunities? And I would say 2023 has had two forces at play. One is obviously where are the opportunities relative to the downstream capital risk? And so, I think that has favored businesses with strong fundamentals, unit economics, low cash burn, the ability to get to cash positive with an incremental $20, $30 million of capital, like a manageable number of capital, manageable size or quantum. And then I think the second force that’s really come to play this year has just been the question of how AI will impact industries broadly, and then at more of a micro level, how AI will impact company-building. And so, I think the two ways of thinking about that are will AI make technical moats and product moats more commoditized from an industry perspective? And then how do you build a company? Will companies require less capital because they’re leveraging things like Copilot or AI assistance to do knowledge work more efficiently? And what’s the implication of that on the venture business? So, I think there have been those two forces at play this year that I think all in, you’re seeing fewer financings. The financings that are getting done are heavily favoring companies with great unit economics, essentially companies that have figured out how to grow with fundamentally [inaudible 00:09:27]-
Healy: With decent fundamentals, right? Yeah.
Gautam: Exactly. And then the other piece of that is industries or businesses that are maybe more at risk as it relates to what the potential impact of AI could be are certainly falling further out of favor. On the flip side, industries that have the potential to be disrupted by AI are garnering much more interest. So, think about legal tech. How many legal tech AI businesses have been funded this year that maybe a few years ago just would really have not been that interesting.
Healy: Yeah. So many different ways I want to take the conversation now. I was definitely going to ask you about AI and you already opened that box up, so very tempted to go that way, but I also wanted to ask more about just what it takes to raise A, B and C rounds in this environment. I’ll let you pick which way you want to go first.
Gautam: Well, why don’t we take the last part of that, which is just what does it take to raise in this environment? And look, I think the best way that I can explain it… Well, so maybe stepping back, I do think that in a market climate today, if you ask 10 VCs for their opinion on how best to raise capital, you’ll get 11 answers. So, I do, with humility, just want to say it’s one data point, but I think the best way that I’ve found to explain just how the market has reset is it’s really gone back to rule of. So, if you remember or think of the construct of rule of 40, essentially what rule of 40 or just rule of tries to combine is the growth rate of a company along with the profitability. And so, you get more credit for growing faster and you get more credit for being more profitable, but you get less credit or sort of negative from an addition perspective of low growth or high cash burn. And I think the market has essentially gone back to that, which is we’re looking for companies that are growing well and are either profitable or have a path to profitability. Obviously at a Series A, what you’re looking for there is going to be very different. Companies have to over-execute or out-execute on growth, and there’s going to be less sensitivity around profitability, maybe a path to profitability or at least fundamentally good unit economics and go-to market efficiency. And then as you get to the B and the C and even later rounds, there’s going to be a lot more focus on profitability even at a reduced growth rate. Right?
Healy: Yeah. So that being said though, from the data from our clients, it still seems like there’s a threshold of growth you can’t go below. Right?
Gautam: I think that’s absolutely right. That’s absolutely right.
Healy: You still have to hit those crazy-high growth numbers, like numbers that are really challenging to hit. You just have to do it with better unit economics. Does the triple-triple-double rule still apply coming through the As and the Bs? Are you still seeing that high of growth rate?
Gautam: I think that that’s generally right. What I would say is look, at an A or B, you should be thinking about doubling your business. Obviously dependent on the base. So, if the base is $1 million bucks of ARR, it may be a little different if we’re talking about $5 or $6 million of ARR. But I think generally, at least a double to at least get around done. And then I think as you get to the C, it probably becomes even more dependent on what the threshold is that we’re talking about. If we’re talking about $20 million or $50 million of ARR, very, very different. But even there, you’re seeing a prioritization of 50% plus year-over-year growth. I think it’d be very hard to get something done at lower than that.
Healy: Okay, that’s really good to know. What about metrics that were popular in 2020, 2021, like LTV to CAC? Are people still looking at that or has that gone by the wayside?
Gautam: It’s funny. I think there’s still a lot of focus on LTV to college and career, payback periods, just overall go-to-market efficiency, less focus on metrics like CARR. If you think about contracted ARR, if you think about some of these things that maybe were very forward-looking metrics, there’s a lot less focus on things like that, a lot more focus not surprisingly, on gross margins and making sure that there’s either gross-margin leverage in the business today or a very clear path to see what’s-
Healy: I’ve always loved gross margins and I was a very unpopular guy at cocktail parties in 2021, but people will talk to me now.
Gautam: Yeah, yeah. As I think probably anyone that thinks of themselves as a more fundamental investor, right?
Healy: Yeah. So, a little bit about what I’m seeing is that at least for Series B, either having or having a good path toward a 70, 80% gross profit margin seems to be like a bar that is necessary at this point. How are you looking at that? What are you thinking about when you’re evaluating gross margin?
Gautam: So we look at a lot of different verticals, and I would say it’s definitely vertical-dependent.
Healy: Good point.
Gautam: In healthcare, it might be slightly lower, but I do think that for a typical software business, 70s to 80 is a good benchmark and that’s a good place to be. I think there’s a lot of credit you can get with having demonstrated ability to improve gross margins. So, if an investor looks at, hey, where were margins a year ago relative today, and you’ve shown the ability to improve and you have a credible path to continue that improvement, I think you can potentially de-risk some of whatever the number is today. Let’s say it’s 60 today, it was 40 a year ago and you’re on track to get to 70-plus in the next 12 months. I think that’s a story, that’s a narrative that works from my perspective.
Healy: That makes sense and I think that’s reassuring to founders who are thinking about creating a profitable product. That’s good.
Gautam: Yeah. And Healy, one other thought just on margins real quick, and this kind of came from some of my time as an operator, but I’m seeing a lot more companies think about pricing and I think it’s a really positive thing, taking pricing up where they can or just being more thoughtful about how they package and bundle. And I just think that that’s a hugely important driver to the business. Often price changes are one of the fastest and easiest ways that you can improve gross margins in the business. Look, sometimes you’re squeezing, whatever the expression is, blood out of the stone or whatever it is. And sometimes it’s maybe not the long-term smart thing to do for the business, but I am starting to see a lot more founders take that seriously and I think that’s a really positive thing.
Healy: I mean, the ability to raise your prices or have slightly higher prices is a sign. It can show that your product is differentiated or a premium product, and it can also show that the clients are really loyal to you and willing to stick around if your prices go up some. But having done the price-increase exercise at maybe three companies now as an operator, I can tell you it’s hard, and a lot of founders are afraid to do it. It’s intimidating.
Gautam: Yeah, it is. And I think the market was so incentivizing growth over the last few years that I also think a lot of founders just… The incentive to take price up and introduce friction just wasn’t there. And so, nobody has thought of pricing in the last three, four years, so I think that’s the other unique angle there.
Healy: What are you looking for when you’re seeing a pitch these days? What makes you happy when someone comes and pitches you and like, “Oh, this is something I want to dig into”?
Gautam: Yeah. Look, I think what we’re seeing that really resonates is we tend to look for businesses that do have strong fundamentals where there’s been a track record of capital efficiency. I think the other angle is really category leadership. I think there are a lot of companies, just because of the amount of seed funding that exists in the ecosystem, there’s a lot more competition today in tech markets than there was 10 or 15 years ago. And so, the ability to be the category leader, have a unique product-driven moat or the beginnings of a product or a moat in a category is really exciting. And so, I do think one of the things that we hear is it’s not just the fundamentals and the numbers, the quant, but it’s how you marry that with the narrative, and the narrative being the sort of early category leadership and what you can do to extend that with the addition of new capital from the outside. And so, I think those are the two big components of the successful pitch is showing that you’ve built fundamentally a strong business and that you have a perspective or an approach for how to win the market.
Healy: Awesome. That’s really good advice. I guess my follow-up question would be how can, as a founder, you approach that “Let’s build a strong moat in this market” when there may be several other competitors nipping at your heels in the market? We’ve definitely seen some of our clients that are really great suddenly have a bunch of competitors come in when other VCs realize that this is an interesting market, and all of a sudden you went from having one or two old-school competitors to having a dozen new venture-backed competitors in your space. How would you counsel a founder to deal with that?
Gautam: Yeah, totally. I tend to think of these things as there’s two buckets of potential advantage or edge. So one is around distribution, and so if there’s anything that the business has done to give itself an edge in distribution, it could be as simple as how you’ve built your go-to-market or the channels that you dominate and win in relative to others and your share of that channel, I think that’s one bucket is the distribution edge. And the second edge is around product stickiness. I think in many markets, there are always going to be a number of competitors. The reality I think in most software-driven markets is if you can get a customer to sign up and have a sticky product, even if the cost to acquire a customer goes up, it becomes more competitive, et cetera, the unit economic math of the business should still work. It’s heavily retention-dependent or sensitive towards retention. And so, I think the second bucket is what are the things in the product that drive stickiness? It could be everything from integrations to your approach to collaboration to how you think about the new product roadmap or product extension, future development in the future.
Healy: That’s really good advice. That is awesome. All right, let’s do it. Let’s talk about AI. It’s obviously pretty big. Halfway through the year, I think our clients collectively had raised about $2 billion and $1.2 billion of that was AI companies, so there’s definitely something happening in this space. First of all, is this a bubble or is AI for real?
Gautam: Well, I think with everything in the venture world, there’s always going to be some failure rate. I do think tech and venture specifically are cyclical. It’s a cyclical business industry where you’re never going to be able to get away from the bubble effect. There’ll always be some amount of bubbles being created and popped. But I think in this instance, I’m pretty bullish on just the impact that AI as a broad-based technology will have on business. There’s no doubt that some of the things getting funded today probably will not exist or will not be durable businesses, but I also don’t think of that as anything that dramatically unique relative to past technology cycles.
Healy: So when you’re evaluating a business that has a strong AI component or AI’s central to the pitch, what are you looking for to prove that this is a durable business?
Gautam: Yeah. So, look, I think it goes back to those two dimensions. I think one of the biggest things, if we’re talking about applications, the application layer, I think one of the biggest things is, is there something about the AI feature, the native AI approach that the company has taken that unlocks a distribution edge or a product stickiness edge? I just think companies… It’s tricky on the first bucket because the incumbents tend to have a pretty significant distribution advantage in a given vertical. And so, by just being AI or having a gen AI feature, does that allow you to compete from a distribution perspective? Maybe, maybe not. And then how quickly can incumbents replicate and develop that feature set before you can get to scale with your business? So, I think those are some of the big questions around some of the AI applications is, hey, where are the true unlocks? But look, I do think where it comes to AI as an ingredient and the software product is really about a fundamental rethink in workflow. I think that’s super interesting because to me, even if there’s not a distribution edge there, there should be a product stickiness edge because you’ve taken a completely new approach to workflow and it’s not just about the gen AI feature. Right?
Healy: Right. So obviously we see clients using AI in a bunch of different ways, and at this point, I think about… I don’t think, I know. Just under 60% of our clients are paying OpenAI on a monthly basis. A subset of those are using the API. So, it’s not just a marketing person using it to write something; they’re actually using the API to do something interesting. And some of those folks are using it to unlock a new product offering or make something less manual where they had a lot of data they were transforming and it’s either something they have to do one-off, or it’s just sort part of the stream of how their product works. There’s this big data thing that’s created and it needs to get cleaned up or moved around or some analysis needs to go on top of it. They’re using AI for that. And then we’re seeing another subset where they’re using OpenAI to actually build a particular feature. Most popular one seems to be like a chat-with-me type of thing or chat-with-the-product, but we’re seeing folks leverage a third-party, in this case, OpenAI, tool to do that. Do you have an opinion on using OpenAI to run your AI company or somebody else’s model, or does it have to be your own special proprietary model that you’ve built?
Gautam: Well, look, I think in most of what we’re seeing today, the returns to building your own model, that math is pretty hard. And so, I think it obviously depends on the application and there’s some verticals where maybe it does make sense, but I think by and large, the models that exist are improving at such a fast rate and pricing is commoditizing at such a fast rate that it just doesn’t make sense to do that work. I think the best-in-class approaches that we’ve seen are flexible approaches where you may be leveraging OpenAI today for the majority of gen AI needs that the product has, but you’ve built your software in a way where you can be multimodel and sit across multiple vendors in the future.
Healy: Very cool. That’s really awesome. Wow. So why don’t we shift to more of a rapid-fire question phase here?
Gautam: Yeah, sure. Yeah.
Healy: So first of all, what’s one piece of advice that you wish every founder knew before they walked into a pitch meeting with the VC?
Gautam: Well, so I think as I think about my own experience pitching venture capitalists and trying to raise capital, I always took the approach of the two things you want to achieve in a first meeting are convey why someone should invest in the company. Essentially, what’s the most exciting thing about the business? It could be the growth rate that you’re seeing. It could be the fact that you’ve achieved a technical achievement or advancement or a product achievement, but there’s usually one thing that sort of maps to why you are raising capital now. Either you de-risked something in the business or you’ve found something that enables you to accelerate the business with the addition of outside capital. The first part is clearly articulating that as early into the slide deck as you can, and so that’s literally the second slide is the growth rate or whatever. And then the second piece is to not shy away from the risks and reasons that someone would say no. And I think a lot of founders sort of wait for the questions to come up. I can’t tell you how many decks I’ve seen that don’t talk about gross margins or the burn efficiency, the cash burn of the business and how that’s been problematic. And I think waiting for an investor to ask that question takes the opportunity away of being able to craft the narrative and be able to, from the get-go, convey why this was an issue, but you’ve de-risked it, or why it is maybe not as material as someone might think. And so, I do think sometimes people avoid the bad news. I think making sure that you understand what that is and message against it is really important.
Healy: I like that. It builds a lot of credibility. Right?
Gautam: Totally.
Healy: It builds a lot of credibility to say, “Here are the things that haven’t gone well or that we’re still working on or that we’ve just started to figure out.”
Gautam: Yeah. One of my friends used to characterize this as, you don’t want to bet on stupid, which is essentially, you don’t want to bet that an investor is an idiot and won’t figure something out. It’s way better to assume that people will eventually ask the question. And so rather than wait for them to ask it, why not just frame your answer in the pitch?
Healy: Yeah, be upfront with it so you can control the narrative.
Gautam: Totally.
Healy: Yeah, that’s really good advice. That’s really good advice. All right, next rapid-fire question, although you could take a few minutes to answer if you want. Okay. What item on a term sheet do founders least understand?
Gautam: That’s a great, really interesting question. I’m trying to think back to my own experience of raising capital and what were the things I least understood. I think probably, and a lot of this is not actually in a term sheet, but they’re in the definitive docs of a financing are voting thresholds. Hopefully, you never get to a point where you really need to worry too much about these thresholds, but they’re certainly in sticky situations, like if you end up needing to do a recap or if there’s a down round or let’s say an acquisition that maybe some investors are happy with and some investors are not, typically these voting thresholds can be pretty important. And just understanding where those are and how much of your investor base you would have to gather to be able to effectuate something is important.
Healy: That’s pretty interesting advice. I hadn’t often thought about that, but now that we’re seeing more and more down rounds, that becomes pretty apparent that hey, maybe the folks that invested later don’t like this, but the earlier stage people do or vice versa, depending on how the preference stack is built. That’s a good tip. That’s really good. All right. And then one final question here. What is the most satisfying aspect of working in venture capital?
Gautam: You know, I feel like this industry, there’s two ways to think about this business. There’s the company-building side, which is not that we are building companies, but we get to help and assist founders and companies.
Healy: You’re there. You’re at the table, yeah.
Gautam: And then the second piece is capital deployment or investment management. I’ve always really been uncomfortable thinking of this business as the latter because I think that if you think about it as capital deployment, you end up prioritizing the wrong things, which is just how do I scale and invest more dollars and that sort of thing. And so, I’ve always thought of it as just company-building and that is the most satisfying part is being able to work hand in hand with the founder. There are going to be good times and bad and there are going to be companies that work and don’t work, but being able to work with founders to hopefully build companies that change the world in anywhere from small to big ways is really rewarding and exciting. And I think we’re incredibly lucky to do these jobs, so couldn’t be happier about it.
Healy: Yeah, I agree. It’s really inspiring and sometimes a lot of fun to be there as it’s happening and to be part of it. That’s awesome. Well, Gautam, how do people reach out to you if they want to connect?
Gautam: Yeah. I’m on Twitter, @gRamblings, and then email, I live in my inbox for better or worse. So, I’m at ggupta@tcv.com.
Healy: Amazing. Excellent. Well, thanks for joining us. Maybe we should do this again next year and we’ll see how the market ends up next year and we can see how we did with our AI predictions, but thank you so much for joining.
Gautam: Thanks for having me, Healy. Great to see you.
Healy: Awesome

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