With $60M Fund, “Anti-VC” Scaleworks Looks to Buy Software Startups

San Antonio—[Corrected 4/10/17, 1:27 p.m. See Below.] For many entrepreneurs who leave their business, investing is an easy next step. That’s what Lew Moorman did after he left Rackspace in 2013. But he didn’t like it.

“I found myself not enjoying my day. I was spending all my time hearing pitches, and then doing very high-level check-ins with founders,” Moorman says. “The rhythms in that business did not make sense to me, nor did I figure out how I could do something unique that no one else could do.”

Four years later, Moorman believes he’s helped create an investment model that works for him. He and another entrepreneur-turned-investor, Ed Byrne, raised a $60 million fund in 2016 that they call Scaleworks. The investors are marketing it as a mix of venture capital and private equity, and have developed a term to brand it: venture equity.

Byrne

Focused on software-as-a-service businesses with between $2 million and $10 million in revenue and moderate growth, Scaleworks buys its targets outright like a private equity shop, and will invest additional capital if needed to help a business grow, like a VC, Byrne says. Scaleworks isn’t expecting rapid early growth from its portfolio companies that some VC might, he says, at least in the early years—though it still hopes for around 50 percent annually for the three to five years before a potential exit. Unlike private equity, Scaleworks isn’t using debt financing, though it does typically replace the management team.

Additionally, Byrne and Moorman work closely and directly with their portfolio companies, getting involved in everything from sales calls to interviewing new hires. Spending 90 percent of his time working with the companies is what Moorman found more appealing about Scaleworks’ model versus traditional venture capital, he says.

“We kind of view ourselves as the anti-VC,” Byrne says. “If you’re at $5 million in revenue and you’re not based in Silicon Valley, and you could be losing money hand over fist, you can’t raise more because you’re not growing fast enough.”

Byrne has been dabbling in this type of venture investing since 2013, after selling a couple IT and hosting companies he ran or founded.

After closing its $60 million fund in January, Scaleworks is now opening up more about its model in an effort to reach more of those businesses. It has deployed most of the money on seven deals, two of which Scaleworks hasn’t yet made public.

The Scaleworks model has similarities to investors like Benchmark and Sequoia Capital, which provide Series B growth funding to startups, says Harlan Beverly, an entrepreneur and lecturer at The University of Texas at Austin. Beverly is also the assistant director of Texas Venture Labs at the university. (He says his comments are his opinions and don’t reflect his employer.) There may be some added risk to Scaleworks’ style of investing because the investments aren’t growing as fast as typical Series B companies, it’s a small portfolio, and the firm owns each business, Beverly says. [Paragraph updated to correct Benchmark’s name.]

The “venture equity” term seems like a marketing effort to attract fund investors, rather than anything particularly new, he says. “I live here, I’d love for there to be more funds. I wish them great success. At the end of the day, there’s nothing special about venture equity as opposed to venture capital investing in Series B.”

Byrne says Scaleworks actually used private equity as the descriptor of the $60 million fund when presenting to limited partners, not venture equity, to make sure they understood what type of asset class in which they were investing. Scaleworks is avoiding risk that VCs engage in by acquiring companies with revenue and a proven product market, he says, not taking a stake in many “high-risk bets” with the hope of one or two working out. Disagreeing with the VC comparison, Byrne says the better analogy might be to PE firms Silverlake or KKR—but a lot smaller.

Beverly did say that the active investor strategy that attracted Moorman may be unique. If they’re good operators, Scaleworks could make an impact with a small portfolio. “Really putting operational expertise to work, their personal experience, it makes sense, because if they were investing in 30 companies, they wouldn’t be able to put their time into each one,” Beverly says.

Moorman

That indeed is what Byrne and Moorman are counting on to make it successful. In a blog post about founding Scaleworks, Moorman noted he joined Rackspace in 2000 when it had $2 million in revenue and left his role as president in 2013 when it was up to $1.5 billion. (Notably, Rackspace sold to private equity in 2016 for $4.3 billion.)

“I am sort of a hands-dirty kind of person,” Moorman says. “We’re dealing with companies that need to be rethought a little bit. A lot of people don’t want to take on that work. It’s a lot of work. In the grand scheme of things, it’s not deploying a lot of capital. It’s an inefficient market with a lot of opportunity. We think we can do multiple funds, and they can probably be bigger.”

Scaleworks has seen some progress with one of its first investments—Filestack, a business that was founded at MIT and went through the Y Combinator program. After being acquired by Scaleworks at the end of 2015, … Next Page »

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David Holley is Xconomy's national correspondent based in Austin, TX. You can reach him at dholley@xconomy.com Follow @xconholley

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