Money for the Middle Stage: Part 2 of a Conversation with Scale Venture Partners

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I sat down last week with Kate Mitchell and Rory O’Driscoll, both general partners at mid-stage venture firm Scale Venture Partners in Foster City, CA. The firm was interesting to me because it lives up to the name: The folks at Scale don’t invest in early-stage startups, where the nature of the product is often still murky, and they don’t invest in late-stage companies, where often all that’s needed to achieve big time success is more capital. Rather, they specialize in that crucial middle stage, where a company has a proven concept but needs to find the ideal market and scale up its sales process.

Mitchell happens to be chair of the National Venture Capital Association, so the first half of our conversation, summarized last Thursday, focused on big-picture trends for the venture industry, including the relative scarcity of venture funds that’s likely to follow the excessive fundraising of 1999-2009. We spent the rest of the time delving into Scale’s investing model in detail; that’s what you’ll read about below.

One of the most interesting points that Mitchell and O’Driscoll made, to my mind, was that Scale doesn’t always look to revenue growth as a sign that its scale-up investment is working. Sometimes a mid-stage company needs to spend so much to grow that the bottom line looks “horrible,” O’Driscoll says, but the important thing is that the company is building mind (and market) share and repeatable sales.

Xconomy: You closed your most recent fund last year at $255 million. Had you been looking to raise more?

Kate MitchellKate Mitchell: We had looked for $300 to $350 million. This amount fits with our strategy, and was in line with what everybody else experienced. Our view was, “Get on with it.” We’re pleased to have dry powder at this stage. Assuming you are focused on capital-efficient sectors, it’s easier to return a multiple of a smaller fund. How many billion-dollar companies need to be formed to return some of the larger funds? There is a good place in the ecosystem for funds of this size—big enough to support a company through its life cycle, yet small enough to get the job done.

X: How would you describe the type of investing Scale does? It’s not really “growth capital,” it’s one stage before that, right?

Rory O’Driscoll: Our focus is on technology companies already doing $3 million to $5 million in revenue and looking to scale. We will fund from there all the way to companies that are just before an IPO. But the sweet spot for us is making a $5 million, $6 million, or $7 million investment in an early-revenue technology company or the equivalent in healthcare. That’s where we like to play, and for that $250 million is plenty of money. We will end up with a mid-20s number of deals in the fund, which is enough diversification to do what we want to get done.

KM: When you’re talking about software, the real test is can you sell it repeatably and profitably. We focus on underwriting that commercialization phase. The risk that’s presenting itself is … Next Page »

Wade Roush is a contributing editor at Xconomy. Follow @wroush

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  • http://twitter.com/thyaga Thyaga

    Excellent. Moral of the story is ‘Entrepreneurs must build lean organizations to operate. Focus on customers and demonstrate sales traction’.