Emergence Capital: The Sequoia of SaaS, aka the House that Salesforce.com Built
Even in Silicon Valley, where the profusion of venture firms means that there’s a lot of specialization, you don’t often run into a firm as focused as Emergence Capital Partners. Many firms confine themselves to investing in Web or software startups, but Emergence is far narrower than that: the four-partner firm restricts itself solely to early-stage investments in Software as a Service, or SaaS-based companies. Their word for this category is a little broader—they call it “technology-enabled services.” But what they’re really talking about is companies that help other companies do business by providing subscription access to Web-based infrastructure software, whether it’s for storing or transferring files, measuring the performance of an ad, or tracking prospective employees or sales leads.
If that definition sounds a lot like Salesforce.com, it’s no accident. Emergence founder and general partner Gordon Ritter was previously the co-founder, with Salesforce.com CEO Marc Benioff, of Software As Service, a Web services offering that grew into Salesforce.com’s Force.com and Database.com cloud computing platforms. After leaving Salesforce.com and setting up Emergence in 2002, Ritter’s first investment was in—you guessed it—Salesforce.com. It was a move that repaid itself 80 times over when Benioff’s company went public in 2004, and that success made Emergence into one of the most sought-after investors for any startup building a SaaS product.
Many Silicon Valley entrepreneurs may be too young to remember it, but there’s a firm with a very similar story in its past: Sequoia Capital. The now-legendary firm invested $2.5 million in Cisco in 1987, obtaining a 32 percent stake in the company. When Cisco went public in 1990, Sequoia’s shares were suddenly worth $225 million—a 90x return. Not only that, but as Cisco grew and became acquisitive, it bought up many of the Sequoia’s subsequent portfolio companies, becoming a lasting engine of returns for the Sand Hill Road firm.
“In our space, we are the Sequoia,” says Ritter. Of course, Sequoia itself would probably say that it’s the Sequoia of SaaS. Be that as it may, the Sequoia-Emergence and Cisco-Salesforce.com parallels are nearly exact: the huge initial return after an IPO, setting up the venture fund to attract even more capital and make more investments, followed by massive growth at the former portfolio company, making it into an acquirer of yet more companies. In the last year alone, Salesforce.com has bought up seven other SaaS startups, paying venture-exit-worthy prices for at least two of them—Heroku fetched $212 million and Radian 6 brought $326 million. Neither of those was an Emergence company. But Ritter says he’s pretty sure that Salesforce.com “not only is our Cisco, but is going to be the acquiring company for our companies, as well as others’.”
There’s definitely a long list of Emergence portfolio companies that might welcome a call from Benioff or his lieutenants. They include HR-automation firm SuccessFactors—itself a $3 billion company, about one-sixth the size of Salesforce.com—as well as Bill.com, Box.net, Echosign, InsideView, Intacct, Genius.com, Lithium, MedeAnalytics, PivotLink, ServiceMax, Veeva, Yammer, YouSendIt, and Zuberance. (There are other Emergence companies, of course, that wouldn’t be such a great fit for the cloud service giant—for instance, mobile analytics firm Ground Truth and Doximity, a mobile social network for doctors. But the preponderance of the Emergence portfolio is in cloud-based business services.)
Regardless of whether any of these companies end up as part of the Salesforce.com empire, they’re already benefiting from the SaaS expertise that Ritter and his three fellow general partners—Jason Green, Brian Jacobs, and Kevin Spain—bring to the table. That’s the real advantage Ritter and Spain talked about when I visited them recently at Emergence’s San Mateo office.
“What makes Emergence different is that we are willing to focus,” says Ritter. “We decided that we’ll have one area where we are going to be the best in the world. We wake up in the morning thinking about things like retention rates and how the virality of one solution is going to be different from the virality of another.”
Pricing is another typical topic of conversation when Emergence partners see their SaaS entrepreneurs at board meetings. As it becomes less and less expensive to build and deliver Web-based applications, there’s a temptation to give it a lot of it away—but freemium models “can be a rapid road to the bottom,” says Spain. “You have to build products that end users love and will find it hard to live without,” he says. “If Salesforce.com knows how to make my salespeople more effective, that is something I can’t part from. We’re always encouraging companies to add enough value that they can substantiate a real price point.”
All this focus has a cost, of course. For one thing, it means Emergence, which is investing out of a $200 million second fund, has to resist some very tantalizing opportunities, including almost every deal relating to consumer-facing products and services. “Zynga, Twitter, Facebook, these are all beautiful investments, but sometimes it’s like a bunch of 7-year-olds going after soccer balls—the [traditional VC firms] all swarm around the same three or four consumer investments,” says Ritter. (Some of Emergence’s portfolio companies might have interfaces that look consumer-ish—think document-sharing company Box.net, for example —but that’s only because today’s business apps “need to speak to people the same way Facebook speaks to them,” says Spain. “Increasingly the first user of an application is the individual making the buying decision,” not the CIO or the IT department.)
And the firm’s focus on Series A or B investments of at least several million dollars, rather than earlier, smaller seed-stage investments, means it misses out on a few legitimate SaaS deals, too. Okta was one recent case. Back in January, I wrote about the hot San Francisco startup’s cloud-based service for managing access to other cloud-based services. CEO and co-founder Todd McKinnon shopped the company to Emergence “just about before he went to any other venture firm,” says Spain, but Emergence had to say no. “Our sweet spot starts at the Series A, when they have a product and some customers and we can invest a lot of time and energy to scale the business. It was a really tough decision because Todd is such a compelling individual, but we ultimately decided we had to stick to our stage.” As a result, Andreessen Horowitz was able to swoop in with seed funding—which gave it the inside track for the $10 million Series A round a bit later.
But there’s no shortage of other SaaS startups to invest in these days. Despite Salesforce.com’s remarkable success getting businesses to use its cloud-based software for sales, marketing, and customer service, not to mention its hosting and database infrastructure (see yesterday’s Xconomy profile of Heroku), there’s plenty of room for other companies to develop Web-based services that make life easier for businesspeople.
“Our thesis is that Salesforce.com is going to continue to hoover up a lot of these interesting startups and get bigger and bigger, but they are not going to be able to cover all the bases equally well,” says Ritter. That leaves openings for Emergence companies like Veeva Systems, which is developing a customer relationship management software tailored for pharmaceutical companies, and Lithium Technologies, which helps companies engage with customers over social-media channels. Says Ritter, “There are lots of vertical opportunities that are going to be enormous where Salesforce.com isn’t going to be the winner.”
Only a couple of things could derail the SaaS movement, from Emergence’s perspective—and maybe only one. Cloud-services outages like the one that affected thousands of users of Amazon Web Services for several days in April are still a concern. But Spain says he thinks companies that depend on the cloud are getting more thoughtful about how to design around such eventualities. “You can’t just assume that Amazon is going to provide a fail-safe infrastructure,” he says. “The good news is that this failure will cause everyone in the ecosystem to become a lot better at handling these situations.”
That leaves a more threatening problem—privacy. But not the kind you’re probably thinking about. As SaaS companies host more and more of their clients’ data on their own (or Amazon’s) infrastructure, there will be a growing temptation to mine that data to extract interesting or useful patterns. Since such data is usually about a client’s customers, it can only be used with extreme care; a single misstep could cost a company all its customers’ trust.
“The positive side of this is that having aggregated all this data, we can use it for good, to help our customers get better at whatever they are working on,” says Ritter. “The risk factor is that if you are seen as harvesting data or selling it, that would be a disaster. We’ve seen a little of that in the consumer space, and if it happens in the business space it will be a disaster.”
But you can bet that it’s one Ritter, Spain, and their partners are working hard to prevent at their portfolio companies. In the mold of the very technologies they invest in, they’re offering reassuring outside assistance that keeps their companies from having to reinvent the wheel. You might even call it Venture as a Service.
“Back in 2002, we said the world doesn’t need another VC firm if there is not some area where we can help our customers, the entrepreneurs,” says Ritter. “And we’ve been very lucky. In what we do we have the best track record and the best companies behind us. And [SaaS] has become the biggest trend in IT.”