20VC Spark Capital's Alex Clayton on How The Best Growth Investors Source, Evaluate and Win Deals, Why Market Depth Is Crucial When Analysing Markets & Why Capital Is Only A Temporary Competitive Advantage

In this episode of "The 20 Minute VC," host Harry Stebbings interviews Alex Clayton, a partner at Spark Capital's growth fund, known for his insightful S-1 breakdowns and a former ATP World tennis tour player. Clayton discusses his journey from investment banking at Goldman Sachs to venture capital, highlighting his tenure at Redpoint Ventures where he honed a data-driven investment approach. They delve into the nuances of sourcing and evaluating growth-stage companies, emphasizing the importance of product velocity, market depth, and customer-centric metrics like net dollar retention. Clayton shares insights on the competitive landscape, the role of capital as a temporary competitive advantage, and the rigorous process of preparing for an IPO. The conversation also touches on the extended period of privatization in tech and the potential of markets like public cloud, which remains largely untapped.

• Harry Stebbings introduces the podcast "20 minutes VC" and his Instagram handle where listeners can suggest questions and guests.
• Harry expresses excitement about having Alex Clayton, a partner at Spark Capital's growth fund, on the show.
• Spark Capital is highlighted for its impressive portfolio, including Slack, Postmates, Oculus, Cruise, and Twitter.
• Alex Clayton's background is summarized, including his co-leading investments at Spark, prior experience at Redpoint Ventures, and his early career in the TMT investment banking division of Goldman Sachs.
• Alex's unique past as a professional tennis player on the ATP World Tour is mentioned.
• Harry thanks Alex Curlin and Glenn Solomon for their question suggestions for the interview.
• Harry promotes Stripe and Intercom as resources for technology companies and mentions Cooley, a law firm specializing in venture capital.

"We are back for another week in the world of the 20 minutes VC with me, Harry Stebbings."

This quote introduces the podcast and the host, setting the stage for the discussion to follow.

"I'm thrilled to welcome with that Alex Clayton, partner at Spark Capital's growth Fund."

Harry Stebbings expresses his excitement about having Alex Clayton on the show, indicating the guest's significance.

"Before we dive into the show, state a lot of what we do on the 20 minutes VC is talk to experts, pick the brains of founders and investors who tell us which trends to watch out for, offer tips on fundraising, and teach us how to excel at any company stage."

Harry outlines the purpose of the podcast, which is to gather insights from experts in the venture capital field.

• Alex Clayton shares his introduction to the venture industry during his tenure at Goldman Sachs, where he worked on the Yelp IPO.
• The experience with early investors like Bessemer and Benchmark sparked his interest in high-growth businesses.
• After Goldman Sachs, Alex joined Redpoint Ventures' growth fund for three years before moving to Spark Capital.

"My first day on the job, I was actually staffed on the Yelp IPO and that became a big part of my life."

Alex Clayton recounts his entry into the venture industry, highlighting the impact of working on the Yelp IPO.

"I went to Redpoint Ventures post Goldman and their growth fund and then I was there for three years. And I've been at Spark for almost three years as well."

This quote outlines Alex's career trajectory, leading to his current position at Spark Capital.

• Alex Clayton acknowledges the importance of starting his venture career at Redpoint Ventures, known for investments in companies like Zendesk, Twilio, Stripe, and Looker.
• He credits learning to be a data-driven investor, especially in enterprise software, as a key takeaway from Redpoint.
• Alex mentions working alongside Tom Tungus and witnessing the growth of Looker from its early stages.

"I think the biggest takeaway I learned from him was just learning how to be a data-driven investor, particularly in enterprise software."

This quote emphasizes the significance of data in making investment decisions, a lesson Alex learned at Redpoint Ventures.

• Alex Clayton describes sourcing as his favorite part of the job and a critical factor in setting investors apart.
• He explains that Spark Capital's sourcing process is both opportunistic and thematic.
• The firm evaluates every Series A or B round in the market to identify fast-growing companies.
• Alex discusses how early-stage SaaS companies scale with people, and rapid hiring can be an indicator of success.
• Thematic sourcing involves focusing on areas like the future of work and software's impact on enterprise processes.
• Investments in companies like Slack, Trello, Outreach, and Justworks are highlighted.
• Alex also mentions the importance of networks and conversations with CEOs, engineers, product managers, and technologists in sourcing potential investments.

"So I guess sourcing, definitely my favorite part of the job. I think as a growth investor, your ability to source and get in the best companies is what sets investors apart."

Alex Clayton explains why sourcing is crucial in the venture capital industry and a part of the job he particularly enjoys.

"We're looking for themes as well as looking for growth. So if you're an early stage SaaS company, you can't really hide. If you're growing fast, people can check your LinkedIn headcount, see how fast you're hired on the website, what type of people."

This quote details the opportunistic approach to sourcing, using growth indicators such as hiring trends to identify promising companies.

"Then there's the thematic side, and we certainly have some areas that we're really excited about here."

Alex Clayton introduces the thematic aspect of sourcing, where Spark Capital focuses on specific areas of interest within the industry.## Network Driven vs. Thesis Driven Investing

• Harry Stebbings expresses interest in understanding the balance between network-driven and thesis-driven investing.
• Alex Clayton believes that the best investors integrate both approaches.
• Clayton emphasizes the importance of recognizing market trends and investment themes even at early stages like angel or seed funding.

"At the end of the day, the ability to both find a company early and figure out if this is going to be a winner or market that's probably more important where, hey, I don't have the luxury as a growth investor to wake up and say, hey, I have a thesis about emergency response software and I can go spend three months doing that."

The quote explains that growth investors, unlike early-stage investors, cannot afford to spend extended periods developing a thesis about a potential market because they must respond to existing market trends and opportunities.

• Harry Stebbings notes the challenge of sourcing and engaging with companies as one moves to later stages of investing.
• Alex Clayton describes the growth stage process as proactive and relationship-focused, often taking years to cultivate.
• He mentions that top companies in the growth stage do not actively seek funding, making investor engagement crucial.

"In growth, I feel like we sometimes tend to build relationships with founders over many years."

This quote highlights the long-term relationship-building approach that growth-stage investors like Clayton take with founders, contrasting with the more immediate transactional interactions at earlier stages.

• Alex Clayton advises founders on the timing and strategy of engaging with investors.
• He suggests that founders should not always be raising funds but should engage with investors who can provide tangible business value.
• Founders are encouraged to take meetings with investors who offer concrete assistance, such as customer introductions or recruiting help.

"I think for founders, they shouldn't always be raising, but they should only typically meet with investors if they're going to actually give them tangible business value."

The quote advises founders to be strategic in their investor interactions, focusing on meetings that offer practical benefits beyond just funding.

• Alex Clayton delves into the nuances of market sizing, differentiating between total market, served market, and market depth.
• He stresses the importance of understanding the actual depth of the market and the potential for a company to grow within it.

"At the very high level, there's the total market... then it's the serve market... And then there's the market depth."

This quote breaks down the concept of market size into three distinct categories, each representing different levels of potential customer reach and revenue for a company.

• Clayton uses ServiceTitan as a case study to illustrate how a company can expand its market depth.
• He explains that ServiceTitan expanded its market by offering a comprehensive suite of services, thus attracting spend from various segments.
• The discussion emphasizes the ability of companies to grow their market by creating innovative products that serve broader needs.

"They basically do and encompass every business process for these businesses. And they weren't just taking spend from products and industry. They're taking spend away from horizontal marketing software vendors, fleet tracking software, call tracking software."

The quote explains how ServiceTitan managed to capture a larger market share by providing an all-in-one solution that appealed to customers who would otherwise use multiple separate products.

• Alex Clayton talks about the importance of investing in companies that have a vision for the market's potential, not just its current state.
• He mentions that companies must think creatively about their market to succeed.

"You have to invest in companies that in some ways are creating or thinking about a market in a different way."

This quote emphasizes the forward-thinking approach required when investing in companies, suggesting that investors should look for those that have the potential to redefine or create new markets.

• Harry Stebbings brings up the topic of market timing risk, which he and his partner Fred find uncomfortable.
• Alex Clayton acknowledges the difficulty of taking market timing risks, especially in growth investing.
• He mentions Pendo as an example of a successful bet on a market that was not well-defined at the time of investment.

"We can take a bet on where we think the market is moving and bet on a team in a product, but we usually don't invest in a market that just does not exist in any way today."

The quote reflects Clayton's approach to market timing risk, indicating a willingness to invest in emerging markets with potential but avoiding markets that are entirely non-existent.## Competitive Analysis in Markets

• No large, interesting market is without competition.
• B2B and SaaS markets are highly competitive with no "free lunch."
• The key is to identify which company is poised to win in the competitive environment.
• Investors seek companies that provide exceptional business value and win customer loyalty.

"If there's no competition, it's not really a large, interesting market. I don't think there's any free lunch in B, two B or SaaS anymore."

This quote emphasizes that competition is inherent in significant markets, especially in B2B and SaaS, indicating that any successful company must outperform several competitors.

• Talking to customers is crucial for understanding a product's value.
• Customers who are willing to pay more for a product indicate high business value.
• A product's price point relative to competitors can reveal its market positioning.
• Engaging with customers provides insights into which products deliver the most value.

"Talking to customers is, to me, the most important thing."

Alex Clayton highlights the importance of customer feedback in assessing a product's market fit and value, suggesting that investor decisions are influenced by customer satisfaction and product perception.

• Capital can be a temporary competitive advantage.
• Companies will eventually need to show sustainable unit economics and business models.
• Public market investors require justification for high burn rates, such as rapid growth.
• While private companies can raise significant funds, long-term success requires more than just capital.

"It's certainly a competitive advantage, but I think it's only temporary."

Alex Clayton acknowledges that while capital injections can provide a competitive edge, they are not a long-term solution for success, as companies must ultimately demonstrate financial viability and growth to public market investors.

• Rapid product development is key to staying ahead in the market.
• Successful companies often start with a single product and expand their offerings.
• Innovation and launching new products are critical for growth and maintaining a lead.
• ServiceNow is cited as an exemplary case of continuous product innovation.

"The companies that continue to build and get really big and stay ahead is the ones that have a ton of product velocity over time."

Alex Clayton stresses the importance of continuous product development and innovation as a driving force for companies to grow and maintain market leadership.

• Product velocity is assessed by tracking product announcements and executing historical roadmaps.
• Customer feedback on product development is a vital indicator of a company's innovation pace.
• A company's ability to anticipate and meet customer needs is a sign of strong product velocity.

"We track every product announcement they do, and then when we really get in the nitty gritty of it during a fundraising process, we want to look at their product, their historical product roadmaps and how far, how much they've executed on those."

Alex Clayton describes the process of evaluating a company's product velocity by monitoring their product development activities and customer satisfaction with the evolution of the product.

• The core value proposition is determined by a product's essential role in business continuity.
• Products that customers cannot afford to live without are highly valued.
• Growth stage investments should focus on products that are integral to a customer's operations.

"The best products are things that customers just can't afford to live without."

Alex Clayton explains that products that are critical to a customer's business are the most attractive for investment, as they represent a significant value proposition and are essential for the continuity of the business.

• A good quota attainment rate is when 75% of ramp reps hit 100% of quota.
• An acceptable payback period for high growth businesses is 15-18 months, with 12 months being rare.
• For SMBs, a payback period closer to 12 months is preferable, depending on sales strategies.
• Impressive growth rates vary by stage, but 7.5-10% month-over-month growth is best in class.
• Capital efficiency is a comfort factor for investors, with specifics depending on the context.

"I think you want to have at least 75% of your ramp reps at 100% a quota. That's amazing. That would be awesome."

Alex Clayton provides a benchmark for sales performance, indicating that a high percentage of sales representatives meeting their quotas is a strong indicator of a company's health and potential for growth.## Burn Rate and Capital Efficiency Ratio

• The burn rate and capital efficiency ratio are key indicators of a company's financial health.
• Net New ARR (Annual Recurring Revenue) divided by Net Burn is a critical metric.
• A ratio of one suggests the company should maintain its current spending rate.

If you take net new ARR divided by net burn, if that number is one, you probably want to keep going and spending at the current rate.

This quote emphasizes the importance of balancing new revenue against the rate of cash burn to sustain a company's growth without overspending.

• Net Dollar Retention (NDR) and churn are closely related metrics for SaaS companies.
• NDR is considered a "North Star" metric, with a target of 130% or higher.
• High NDR indicates strong customer retention and account expansion.

Related, I think, on a net expansion or net dollar retention, which is kind of the North Star number that we focus on. You want to be 130% plus, no, I totally agree.

This quote highlights that achieving an NDR of over 130% is a goal for SaaS companies, signifying healthy growth through existing customer expansion.

• SaaS companies going public must meet certain financial and operational metrics.
• Key metrics include age, revenue, growth rate, gross margins, and funding.
• Companies typically have a long journey to IPO, with a median time of 15 years.

Here are some of the high level metrics and sort of medians of these businesses. You had to be around about 15 years, you're about 200 million plus in ARR growing around 40%, have 75% GAAP gross margins, are losing money, have at least 120% net dollar expansion rate, sell a 30k product per year on average, have about 1000 people and have raised $300 million from venture and growth investors and have burned about 200 million of it at IPO last year, those companies, they sold about $250,000,000 of stock at a valuation around 2 billion.

This quote provides a detailed breakdown of the typical profile of a SaaS company at the time of its IPO, including age, financials, and operational size.

• The trend towards extended privatization and delayed IPOs is noted.
• Despite longer times to liquidity, the opportunity in the market is considered greater than before.
• Public cloud penetration is still low, indicating significant growth potential.

It's an interesting topic. Always these 100 million dollar rounds that seem to be happening or announcing almost every week used to be ipos. [...] We're really still kind of in the second inning here.

This quote discusses the shift from early IPOs to larger private funding rounds, suggesting that while the path to going public is longer, the market opportunity justifies the extended timeline.

• Previous experiences, such as sports, can provide valuable skills for investing.
• Competing and training in sports teaches competition, perseverance, and preparation.
• Learning from peers and mentors is invaluable, particularly in board member roles.

I'm not as good as I used to be, but I think competing training in sports teaches you great skills. You learn how to win and lose competition, perseverance, preparation. It's great.

This quote reflects on how sports experience can translate into key skills for venture investing, such as resilience and strategic planning.

• Knowledge of building cap tables is crucial in venture investing.
• Tools like Carta have simplified the process of managing cap tables.

Indisputably knowing how to build a cap table, but fortunately we have Carta that does that for us.

This quote acknowledges the importance of understanding cap tables in venture capital and the role of tools like Carta in streamlining financial management.

• Common advice may not always be applicable; for example, the "move fast and break things" mantra is not suitable for SaaS companies.
• Delivering a great customer experience from the beginning is critical.

I think if for SaaS companies moving fast and breaking things, you can't break things for your customers, you don't get many opportunities. You've got to deliver a great customer experience from the onset.

This quote challenges the popular startup advice of moving fast at the expense of quality, emphasizing the importance of reliability and customer satisfaction in SaaS.

• Team collaboration is key in making investment decisions.
• The potential to dominate a market, such as marketing automation, is a compelling reason to invest.
• Braze is highlighted as an investment due to its strong team, product, and market position.

We work as a team here at Spark, but I would say braze. It's an incredible team and product in the marketing automation space.

This quote explains why Braze was an attractive investment for Spark, citing the team's capabilities and the product's market potential.