CC033: Alex Rubalcava of Stage Venture Partners // investing in early-stage enterprise software

Alex Rubalcava 0:00
In a long enough timeframe, someone is going to go out there and raise a venture fund to invest in nothing but virtual reality content for dogs. And you know, maybe there is going to be one market cycle where a unicorn or two is going to be built creating VR content for dogs. But I also don’t think that that’s probably a long term and sustainable strategy. And so, if you specialize too much, at best you’re going to get one technology trend in market right.

Jay Clouse 0:29
The startup investment landscape is changing, and world class companies are being built outside of Silicon Valley. We find them, talk with them and discuss the upside of investing in them. Welcome to Upside. Hello, hello, hello and welcome to the Upside podcast, the first podcast finding upside outside of Silicon Valley. I’m Jay Clouse, and I’m accompanied by my co-host, friend of the podcast Hank’s dad himself, Eric Hornung.

Eric Hornung 1:09
Oh man, I love when we do a good Hank intro. We don’t get, we don’t do enough Hank intros. I think we should do a Hank intro every week.

Jay Clouse 1:15
Is Hank sitting there with you? Can you say hello?

Eric Hornung 1:17
Hank is not sitting here with me. He is downstairs napping as it is between 8am and 4pm, and he naps that entire time. But yeah, Hank’s doing great. He is almost 10 months old at the time of this recording. At the time this goes out, he’ll be about a year old.

Jay Clouse 1:37
You know, I think that if I had the life of a dog, I would probably take the opportunity to nap all day too.

Eric Hornung 1:42
Well, yeah, I mean, it’s really important after you sleep for seven hours at night to nap for seven hours during the day.

Jay Clouse 1:47
We have security cameras in my girlfriend’s home. And so we just got back from a camping trip. And while we were gone, at times we would check on the cameras and check on the cat. And it is a heartbreaking thing to check in on your pet when you are away, and they are just looking around feeling sad. We get notifications when there’s noise in the home, so we’ll check that, and a lot of times you just hear the cat going “meow…” like his sad cry. And it is heartbreaking man.

Jay Clouse 2:18
Does friend of the podcast Mal have one of those cameras that has the food dispenser as well so that you can talk to the cat?

Jay Clouse 2:25
No, no, it just plugs in. It does pan you can pan and zoom on one of the cameras, which is cool. But no, no food dispenser. He has a food dispenser. But often when we leave, he breaks into the food dispenser and eats all the food at once, which is a problem.

Eric Hornung 2:38
And that’s a smart cat right there. Classic fat cat.

Jay Clouse 2:41
Yeah, but he sleeps most of the day too. And sometimes I wonder if animals really need or want to sleep through the day or if they’re just really, really sad that their owners are gone.

Eric Hornung 2:51
Wow, that’s a very depressing thing to think about. Something that’s not depressing to think about is when my buddy from San Francisco comes and visits, he has one of those food dispensers and an ability to talk to the cat. And he’ll just sit in the corner of like the party that we’re having and talk to the cats.

Jay Clouse 3:07
But the cat can see him on a video screen.

Eric Hornung 3:09
No, no but it can hear him, and he can press a button, and a little treat pops out from the dispenser.

Jay Clouse 3:16
I just don’t think that’s good. You can speak to the cat from these cameras too. And he always just looks around and seems startled like oh my gosh, you’re here, but we’re not. And I think that’s actually mean.

Eric Hornung 3:27
Oh, well, Jeff, Jay thinks you’re mean.

Jay Clouse 3:30
Well, speaking of dogs today, today on the podcast, we have one of the investors in Balto, a former guest of the podcast, Alex Rubalcaba. Alex is a partner at Stage Venture Partners, a seed venture capital firm that invests in emerging software technology for b2b markets. They are not driven by thesis geography or sector. Instead, they seek out recurring revenue earned at the frontiers of what’s possible in enterprise software.

Eric Hornung 3:56
Talking to someone on the west coast, Jay. We’re getting out there. We’ve been we’ve been heading west, but we didn’t know we’re going to be on the Pacific.

Jay Clouse 4:05
Yeah. Stage Venture Partners based in Los Angeles founded in 2015. Invests a lot in areas that are not the coast. So interested to hear from Alex why they are based on the West Coast but investing elsewhere, and what they’re seeing across the country investing in companies like Balto here in St. Louis.

Eric Hornung 4:22
A lot of red eyes, a lot of red eyes to invest in the eastern part of the country and be from the west.

Jay Clouse 4:29
And you know red eyes. You live that consultant lifestyle.

Eric Hornung 4:32
I have, I have had my fair share of red eyes, both the drink and the flight.

Jay Clouse 4:38
If you guys have thoughts on this episode, you can bark at us @upsidefm or email us hello@upside.fm. You can even send a carrier pigeon if you want, but make sure the weather looks good. I always wondered how carrier pigeons got through storms.

Eric Hornung 4:51
Very strong flyers.

Jay Clouse 4:55
Eric, let’s pretend that you’re going to take initiative and start a company. You following?

Eric Hornung 4:59
Never done that.

Jay Clouse 4:59
Alright, well, you helped start the Up-company here, so a little concerned.

Eric Hornung 5:04
Just kidding Jay of course. Let’s, let’s pretend, let’s go down your hypothetical path.

Jay Clouse 5:09
And let’s pretend that you are trying to find some of the most talented engineers to help you get that company started. How many engineers do you think you know?

Eric Hornung 5:17
Not enough.

Jay Clouse 5:18
Not enough. And that’s why I would recommend you work with our friends over at Integrity Power Search. Integrity Power Search is the number one, full stack, high growth startup recruiting firm between the coasts. They partner with venture capitalists, private equity groups, and CEOs like you, Eric, to build amazing teams, for the world’s most disrupting companies. If I’m hiring, if I’m trying to find good engineers, I’m not gonna rely on my small group of connections. I’m going to go to a group like Integrity Power Search who has thousands and thousands of potential connections, potential hires for my company.

Eric Hornung 5:50
That sounds like enough to me.

Jay Clouse 5:51
Sounds like enough. Sounds like you’re going to find the best talent when you can dip into a larger pool. They’ve executed more than 600 searches successfully and they’re on track for more than 200 in 2019 alone. Their clients have collectively raised over $2.5 billion with a B, Eric, in venture capital funding and counting. So if you guys want to learn more about Integrity Power Search, go to upside./integrity to get started with their team.

Jay Clouse 6:23
Alex, welcome to the show.

Alex Rubalcava 6:24
Glad to be here, gentlemen.

Eric Hornung 6:25
On Upside, we like to start with a background of the guests. Can you tell us about the history of Alex?

Alex Rubalcava 6:31
Sure. So I founded Stage Venture Partners with my partner and co-founder, Rob Vickery in 2015. Before that, I had been an analyst at another venture capital firm, Anthem Venture Partners, when I was right out of college. I was the only analyst there supporting four partners at a time when there was much less venture capital activity than there is today. And in fact, we were picking through the rubble of the dot.com explosion that had happened in 2002 to 2001. And we were very lucky to be a firm with fresh capital to deploy when others didn’t. And when I was there, I helped the partners to source and work on investments like Truecar and MySpace and Android. After that, I went out and spent a number of years doing mostly public market investing, but angel investing occasionally along the way. And after a while, the public markets were becoming a little less interesting for me. And my interest in venture capital was increasing. And so I decided to come back to my roots in VC. And here we are.

Jay Clouse 7:39
Was Anthem based in San Francisco or where was anthem based?

Alex Rubalcava 7:43
Anthem is based in Santa Monica, and they are still an active firm today.

Jay Clouse 7:46
So I’d love to spend a little bit of time setting the table here and explaining the ecosystem differences and proximity or non proximity between Los Angeles-Santa Monica, and San Francisco.

Alex Rubalcava 7:57
Yeah, absolutely. So venture cap in the Los Angeles area has changed a lot. When I started at Anthem, there were nine venture capital firms in the LA area. You could do your pitch meetings on Tuesday and Wednesday in Santa Monica, Thursday in Pasadena and Friday in Irvine and Orange County, and you were done. That was it. You got all your pitches taken care of in one week. And now there are over 225 venture firms in LA that I’m aware of that have written the check in the last year or so. And I know at least five people who are out there trying to raise a fund one right now, most of whom I think are going to succeed. So the ecosystem is much larger, much more developed. We’re seeing that in the scale of the companies that are being built here in Southern California as well. You know, we’re never going to be the Bay Area. We’re never going to have the density that the Bay Area has, but the ratio of size and activity and intensity of the market from here to there will continue to shrink as it has for the last 20 years.

Eric Hornung 8:58
Where did you play in the public markets when you moved over?

Jay Clouse 9:01
I was running a long short-fund investing mostly in special situation value investments, things like companies going through restructurings, bankruptcy emergence, things like that.

Eric Hornung 9:14
How did you learn about that coming from your background as an analyst in a venture fund?

Eric Hornung 9:20
The University of Amazon.com.

Jay Clouse 9:22
So in a book, is what I’m guessing that means.

Alex Rubalcava 9:24
That’s correct.

Jay Clouse 9:25
How did you even come across that book to, you know, buy and read? Why? Where did your interest come from?

Alex Rubalcava 9:30
I have read almost every thing published in the last 20 to 40 years about investing in public and in private markets. I’m, I like learning and studying the history of investing. And you can learn a lot from things like that.

Eric Hornung 9:44
What kind of, when you’re making a decision, what’s your decision framework for making a long investment?

Alex Rubalcava 9:50
So we’re talking about investing in public or in startups now?

Eric Hornung 9:55
I would be interested to hear about the things that thread through both and the things that are different.

Alex Rubalcava 9:59
Yes. When you’re when you’re looking at investing, whether in public markets or in startups, you’re basically, if you’re a fundamental business analyst, which most people are, you’re looking at the quality of the business, its valuation, its growth prospects, the risk that you’re taking associated with that investment. And the skill sets and the language are not all that different. You know, I like how startup investors now talk about defense ability and moats just as much as public equity investors do. That was, that language was not as common 20 years ago as it is today. And now I think there’s a lot of overlap between the way that investors in both of those worlds talk.

Eric Hornung 10:39
We had someone on from Chicago who referenced Bill Gurley and said that Bill Gurley talks a lot about his public market experiences as being foundational to his private experiences. And you’ve had kind of this first, I was private and venture capital that I went public, now I’m back to private. What did you bring back from the public markets when you came back to venture investing?

Alex Rubalcava 11:02
I think one of the things that was really valuable is that I have spent time investing in and interacting with executives of all sorts of businesses, whether we’re talking about building material companies or retailers or insurance companies. And I’ve gotten a lot of exposure and knowledge of the drivers of businesses like that. So the when I see startups that are going into markets like that, I think I have a perspective that is a little bit different from some of my peers in venture capital, who spend most of their time, you know, between San Jose and San Francisco and between the 101 and the 280. It’s a very different perspective out there in an insurance company in Hartford, Connecticut, or a building materials distributor in Atlanta, Georgia, than it is in Silicon Valley.

Jay Clouse 11:57
Since you’re such a student of investing, I’d love to hear you talk about how you think about venture capital as a place to allocate someone’s capital as an LP versus the public markets or private equity.

Alex Rubalcava 12:10
Yeah. So that’s a really interesting question, and that’s something that we talk a lot to our LPs about. There are a whole bunch of things that make venture capital particularly interesting from an LP perspective today. Number one is that VC is largely tax free now. And investing into startups is a largely tax free exercise. And the reason for that is something called Qualified Small Business Stock. It is a tax exclusion that has actually been around since 1990, but has been, like much of the tax code, complex and arcane and difficult to put into practice. But in 2015, Congress passed something called the Path Act, the protecting Americans from tax hikes act of 2015. And they simplified all these rules. So now if you invest in a startup with less than $50 million in gross balance sheet assets, it’s not in a non qualifying sector, like oil and gas or real estate or financial professional services, and then you hold the shares of the company — and it has to be a C corporation — for more than five years, you can exclude from taxation when you sell your investment, up to 10 times your investment, or $10 million, whichever is greater. So you pay no federal taxes. And many states actually align their tax system with that tax exclusion. Sadly, California does not. So California taxpayers get to pay the Franchise Tax Board there, 13.3%, when they have a gain. But you still don’t have to pay the IRS. And that’s a really unusual and valuable thing. You know, you get in the asset class that has the potential for the highest returns, you now have a tax treatment on there that is somewhat similar to a municipal bond.

Jay Clouse 13:53
I’ve never heard of that before. Is that something that is well known within the venture community and everyone just kind of doesn’t talk about it because it’s a competitive advantage to talking to LPs? Or is that something that you think you have kind of uniquely found?

Alex Rubalcava 14:06
I guess other people don’t spend as much time reading the Internal Revenue Code as I do. It’s really thrilling. You would be surprised how many accountants, lawyers, and financial professionals, including VCs and angel investors, are actually not aware of that provision of the tax code. Certainly, if any of your listeners have in the last few years paid capital gains on a startup investment that they held for more than five years, call your CPA and ask if it is possible for you to file an amended return to try to get that money back. I have actually suggested that to, I’ve suggested that to dozens and dozens of people, and a few have actually gotten money back which is amazing.

Jay Clouse 14:48
That’s amazing. I want to dial in on this a little bit more. With, you know, you said you got your start after the dotcom bust and you’re picking through the rubble and that turned into investments in Truecar, MySpace, Android, obviously, well recognized companies, probably good returns. Since that time, VCs in the LA area alone you said have increased from 9 to 225. What does the proliferation of VCs mean for you in that area? Are you still trying to pick through rubble? Is that a different type of rubble? Is it good for you?

Alex Rubalcava 15:17
There is, there’s no rubble today. There is no fear. There isn’t much in the way of open access, like there was back in the early 2000s. But what it means is that there are now lots and lots of resources for founders and entrepreneurs to get their businesses started. And in particular, there is the opportunity for specialization. You know, there are 200 plus venture firms in the LA area. And I compete with maybe half a dozen of them. There are plenty of people who are doing stuff in blockchain and crypto, and we don’t really touch that sector. There are untold number of venture funds looking for anything they can in cannabis, and we don’t touch that sector. Our focus is enterprise software. We are seed investors in enterprise software applications. And you know, there are a number of firms here in LA that do that. We all know each other, we all co-invest with each other. So we have, you know, we have a relationship sort of like the Coyote and the Road Runner have with each other, which is we kind of need each other, we compete with each other while also being codependent. And it’s a fun kind of a relationship to have with your peers.

Jay Clouse 16:26
Where’s the line drawn between specialization being a good thing for a firm versus it being this pigeonhole that actually restricts quality deal flow?

Alex Rubalcava 16:35
Oh, so that’s a great question. And that’s actually something I spent a lot of time thinking about and something that we have really worked on as a firm. I think specialization is often driven by marketing to LPs rather than by what’s good for a business and for an investment firm in the long run. What I mean by that is that, you know, we all, in raising capital, have to position ourselves as being really good, being world class at something, and the more narrowly you draw the box, the more likely you are to be the best there is inside that box. And so in a long enough timeframe, someone is going to go out there and raise a venture fund to invest in nothing but virtual reality content for dogs. And you know, maybe there is going to be one market cycle where a unicorn or two is going to be built creating VR content for dogs. But I also don’t think that that’s probably a long term and sustainable strategy. And so if you specialize too much, at best, you’re going to get one technology trend in market right. If you are too broad, then nobody knows what you stand for, nobody knows who you are. If I’m going to do deals from seed to series F and I’m going to write checks from 1 million to 100 million, and I can do biotech and cannabis and software and consumer apps and medical devices, who on earth is going to have any idea of what deal to send me? Who’s going to know what stage venture partner this is all about? So what we do is we try to be oriented around the kind of business we like but without being thesis driven. And so what I mean by that is we do enterprise software only; we do seed only; we’re geographically agnostic, we have portfolio companies from Los Angeles, to Seattle, to St. Louis, all the way to Tel Aviv; we invest across sectors and technologies; and we have a preference for companies that are pushing the boundaries of what is possible in software today. We like companies that are taking significant product and technology risk, and we don’t like to take competition risk. Within those boundaries, we have an open ended kind of opportunity set that we can pursue, and it often takes us in directions that we would not have expected when we started, and that’s a really good outcome when that happens.

Eric Hornung 18:55
So when you compete, you said you’re competing with about six other firms in LA, but when you compete on this enterprise software metric, how many firms are you competing with across the country? And how do you as someone who’s in LA compete with maybe someone who is in Cedar Falls, Iowa, who focuses on the exact same spot as you?

Alex Rubalcava 19:13
Yeah, we all are going to have different deal flow. We’re all going to have different networks that we get access to. We try to make sure that people are aware of our firm, we travel frequently, we speak at events, we tried to build relationships with angel investors, with accelerators, with attorneys who do corporate formation all around the country so that folks know we’re here and that we are open for business. And it’s a game of constantly being out there. In high school, I interned at an advertising agency, and I asked my boss at that agency why McDonald’s advertised because everybody knows who McDonald’s is. And he said, they advertise not because you’ve forgotten about them, but they advertise because when you’re driving down the road, you need to remember the ad that you heard most recently. And so, we try to be very accessible so that we are a firm that people think of recently. And hopefully that means that when they know someone who’s doing a startup, we get the call.

Jay Clouse 20:11
I’d like to hear a little bit more about, when you and Bob started talking about in forming stage Venture Partners, what the order of operations was. Did you guys say, let’s start a VC firm, let’s look at some industries and then came to enterprise software, or did you guys share a love for enterprise software and said, why don’t we invest in these things?

Alex Rubalcava 20:27
We got to enterprise pretty quickly. We made three investments in 2016, two of them were enterprise oriented and one of them was consumer oriented. And the consumer oriented company would call us up and would ask, what do we do to improve retention of our app and usage of our app among teenage girls. It was a social networking oriented company using interactive video. And I did not understand teenage girls when I was a teenage boy and as a Christian pushing 40, I certainly understand them a lot less. And so we realized pretty quickly that we weren’t as effective as investors for companies in that sector as we were for our enterprise oriented companies that were trying to sell the big businesses. But what we also realized is that the base rates in consumer oriented software are very different from what they are in enterprise. For your listeners who have iPhones. One thing that you can do right now as you’re listening to this is get out your phone, go to settings, and look for a green icon inside settings that says battery. And if you look in that section of your settings, it will show you which apps you have used most frequently over the last 7 days and over the last 24 hours. And what you will find when you look at that, what 99% of people find is that there is no app that they are using on a regular basis that was developed by a venture-backed startup that was released in the last few years. Most of us are using the built in Apple apps, or we are using apps from the giant public companies in tech, Google, Apple, Amazon, Facebook, Netflix, etc.. In general, the most recent apps that people have downloaded and use frequently are things like Snapchat and Pinterest, which are both pushing ten years old.

Jay Clouse 22:24
Even Slack. Slack just went public, and that’s… I’m looking at my list right now. Spotify, Gmail, Instagram, Twitter, Slack, Facebook, LinkedIn, Amazon, Venmo, yeah, you’re right.

Alex Rubalcava 22:35
Yeah, it’s all giant public companies. And it’s all companies that got their apps up on the market the moment that the app store opened up nearly a decade ago. And that was the Cambrian explosion of consumer apps. That was the time when we figured out all the different ways we could use this new tool that was available to us. We are now past the Cambrian explosion and the rate of innovation is much lower. And that’s at a time when there are, you know, 3 million apps in the Apple App Store. There’s more than that in Google Play. And the modal person downloaded zero apps last month.

Eric Hornung 23:14
We’ve heard that stat before, which is crazy.

Jay Clouse 23:16
Twice in the last week, which is crazy.

Eric Hornung 23:18
Yeah. How do you define enterprise software? Like is Zoom enterprise software?

Alex Rubalcava 23:23
Yes, I would consider Zoom to be enterprise software. So we consider enterprise software to be any kind of software that is solving problems for businesses and that monetizes usually on a subscription basis, but not always. It can be transactional, or it can be some other type of model. We’re agnostic to that. In general, we think that there are three tiers or categories of enterprise software. There are horizontal, low cost products. Those are things like Zoom and Slack, whose market is all office workers and that are sold mostly through freemium plans and through wide marketing and hopefully network effects. Then there are vertical oriented products that are much more expensive, often $10,000 to $40,000 a year. And that software is usually sold through direct sales, through inside sales mostly over the phone. And then there’s software the cost over $100,000 a year, that is usually sold through outside sales. You have to put somebody on a plane and go meet a buyer, meet a vice president or a chief information officer or somebody in order to convince them to spend 100,000 bucks a year on your software. We tend to play in the latter two categories. We tend to be vertical application specific, high annual contract value products.

Eric Hornung 24:46
How do valuations change between those three buckets, and when you think about pricing and valuations?

Alex Rubalcava 24:52
So in general valuations don’t change too much depending on what kind of company you’re dealing with But risk profiles and risk term profiles are different. And so it’s actually a little bit harder to get a low cost product like slack to work. There’s a lot more of those that are launched every year. But when you get them, you get Slack or Zoom, they often get incredibly premium multiples in the markets. If you’re making a very vertical oriented software investment, often in an area where you have to have substantial domain expertise to be a founder, there are a lot more of those created every year, a lot more than get to some degree of scale. And it can be a really attractive area to invest in.

Eric Hornung 25:36
What does the pipeline look like in those last two categories? Like how many of these companies are being created every year?

Alex Rubalcava 25:42
Oh, untold thousands. Our firm gets 1,500 new business submissions a year. We meet with 500+ and we invest into 7 to 10 per year. And many of the companies that we pass on that are not right for us, where we will not be the right investor, are great businesses that other people will be the right investor for. And they get funding from very good people and go on to do really good things. And so, there is a real proliferation of companies out there right now. And we see no sign of that slowing down.

Eric Hornung 26:17
We talked about the things that Stage Venture Partners would be the right investor for. When aren’t you the right investor?

Alex Rubalcava 26:23
We are typically not the right investor for startups that are creating a product for data centers or for networks and infrastructure layer products. We are much better suited for application layer products that are being used by actual business-end users. We really try to keep our focus area at that application layer.

Jay Clouse 26:46
You said you, a lot of your companies predominantly operate in a subscription model, which I see that a lot in enterprise software. Anecdotally, it seems like people are becoming more conscious of subscriptions. And how many subscriptions are paying into all the time. Do you see any types of trends in enterprise as it goes with, like, a elasticity or sensitivity to subscription models?

Alex Rubalcava 27:09
Yeah, there, there definitely can be pushback on that. And it’s easy if you’re not managing your subscriptions actively to find yourself spending a lot more money than you would have expected. I was speaking with an entrepreneur yesterday who has a customer whose Board of Directors had a heart attack when they realized how much money they were spending on salesforce. And it had gotten totally out of control with the number of subscriptions they had and, in particular, the number of IT personnel that they had within the company to just keep the beast running. And they have now been issued a board level directive to get this thing under control. And you start to see that a lot. You also see that a lot in the cloud and data center world where everybody starts on one of the three big public clouds because it’s so easy. It’s so cheap to get set up on Google, Azure, or AWS. But those costs can grow very big and very quickly if your business and product scales. And over time, I think there’s going to be a trend towards hybrid clouds, where you use one product for one and another for another instance of where some of your workloads are being done in a public cloud and some of them are being done in your own private data centers. And the balancing of that is something that will be an ongoing challenge.

Jay Clouse 28:36
You said you are geographically agnostic, and we actually got connected because of the Balto episode and your investment in Balto. So, as you’ve expanded your purview, let’s take the United States first, outside of Los Angeles, what are you seeing around the country that is catching your eye for good or bad reasons?

Alex Rubalcava 28:56
Yeah, there’s, there’s tons of opportunities to build great software companies anywhere, especially given that you are selling to a global audience, and a lot of the selling can be done online and the marketing can be done online, the need to be located in a particular geographical area is less than it has been. The challenges, when you’re outside of a major tech market like California or New York, are often talent related, and their talent related not at the bottom of the pipeline but at the top. You know, where are you, where are you going to find your VP of marketing? Where are you going to find your head of customer success? Or your most senior DevOps person or something like that, that those are challenges for companies as they grow. But getting started, the ground is fertile wherever you go.

Eric Hornung 29:49
So once you make an investment, how do you add value to portfolio companies when they’re spread geographically?

Alex Rubalcava 29:56
Yeah, so we tend to focus on just a few things in helping companies, and we tend to focus on the things that software companies have in common. And the challenges that they have in common are mostly around people, around their go-to-market, and their raising capital. So on people, recruiting technical talent and sales and marketing and finance and ops talent is by far the biggest challenge for any company and will always be for any startup. The ability to hire in many cases is actually one of the most important things that we look for in founders. You know, can you convince someone who’s really good to leave a really good job to come and work for your crazy startup that nobody’s ever heard of, and that’s, you know, renting 200 square feet in a WeWork? That, that’s a real challenge.

Jay Clouse 30:50
How do you test for that?

Alex Rubalcava 30:51
We look to see who they’ve hired and the quality of people that they have brought onto the team even before we’re invested. You know, we’re typically investing in the first institutional round that a company is raising, and they’re usually a year or two old, have fewer than 10 employees, and have raised less than a million dollars by the time that we are investing into a company. So we’re really looking at who are those 10 employees? How good are the first few developers that you’ve hired to get your product out the door? If you have an Account Executive or somebody selling for you, what kind of work are they doing? Where did they work before? How good are the? Those those are the things that we really pay attention to. There is a very high degree of variability among startups in their abilities at that level.

Jay Clouse 31:43
And so, are you more founder focused when you make these early stage investments? Are you looking at the market opportunity? What’s the criteria that you look at in order?

Alex Rubalcava 31:51
We’re looking at all of those things. And so the three things that are most important to us are three really simple questions: why you, why now, and why us? Why you is why are you uniquely credible to be building the company that you are building? And we use a word like credibility deliberately because it is an open ended word, you can earn credibility by being a world class technologist who can build things that other people cannot. You can earn credibility with unique domain expertise or reputation that other people do not have. You can earn credibility with just a blinding insight about how the world works, where you, you are the possessor of a secret that other people do not possess. And so, we never know what it looks like going in, but we know what it looks like once we see it. The why now, the why now question is a really hard one, and that’s actually something we spent a lot of time on. We really believe that startups are creatures of time, and they are creatures of time, they’re creatures of time in the sense that they have to be started when they are at the best. Startups are created in a moment when they have to be started and they cannot be started any earlier or any later. To take some examples, let’s think about Uber. Uber started nine or 10 years ago, they started right after the App Store opened up. So anybody could create a new app, you had permission-less or innovation, you did not have to go to Verizon or AT&T and ask for permission and strike a bis-dev deal to be on deck on their phone software, like you did back in the early 2000s. You had phones that had GPS chips in them for the first time, so you knew precisely where the phones were. You had the open API of Google Maps, which was given away for free back then and created an immense amount of value to make sure that you knew where you were for a car to come pick you up. And you had a country in the midst of the greatest recession that any of us have ever lived through, and you had millions of people who were out of work and needed to make extra money. And all of those things came together to enable Uber and Lyft to be born. And if you think about those criteria, Uber and Lyft couldn’t have been born even a year before they were. They were completely dependent on all of those factors coming together. And we believe that many of the best startups that go on to change the world are created like that. So when someone comes to us with a software idea that could have been built with the tools and the technologies that were available three to five years ago, it really doesn’t interest us very much unless something has changed with the customers or with regulations or with anything else in the world that would require this new solution, but usually the change is technological.

Jay Clouse 34:51
How important is it to you guys when you’re talking to a founder that they recognize why now versus you can uniquely see why now?

Alex Rubalcava 34:59
Oh, all the best founders feel it. They feel it in their bones. You know, they know that something in the world is changing. They know that an idea that they may have had for a long time is now suddenly becoming possible that the advance of technology is pulled something from the realm of science fiction and into the possibility, into the range of possibility today. And yeah, that’s not usually an issue there. They’re usually really focused on that, and they understand that they have a unique opportunity, a moment in time in which to execute their vision.

Jay Clouse 35:35
I realized I interrupted you a minute ago, you we’re talking about your three value add principles, and that was people, go-to-market, raising capital. We took kind of a right turn after we talked about people, so if you wanted to finish up talking about go-to-market and raising capital as value add from stage venture, I’d love to hear that.

Alex Rubalcava 35:50
Yeah. So on the on the go-to-market part, figuring out how to sell expensive software is not easy. It’s something that every company has to, has to learn on their own. It’s something that each company figures out at a different pace. But there are commonalities out there. There are commonalities in the way that you build up credibility and authority with things like content marketing and/or partnerships. There are commonalities to the way that you organize a sales teams. For example, we always like to say that you should hire multiple sales people simultaneously so that you get an AB test about what’s going on in your sales team. There are commonalities in the way that you price and in the way that you communicate value. And my partner Rob in particular really spent a lot of his time and effort helping our companies with that. He comes from a business to business oriented marketing background in commercial banking in the United Kingdom, and a lot of the experiences that he had from doing that are relevant to our portfolio companies. And then the final thing is about raising money, and that’s often where I tend to get involved. We always syndicate our deals, we’re often leading an A-seed investment of 2 or $3 million, and we might be leading it with a $1 million check. So we have to go find other investors, we have to help the founders to complete that round. So we help with that. And then a year or two later, when it’s time to raise a series A, we get very involved with our companies as they’re going through that process. We help them put together the pitch, we have them come and give a dry run to us. We help with introductions to all of the potential VC firms that should learn about and be potential investors in the company. We help with the negotiation process. It’s a very involved thing. And that tends to be where I get really involved.

Eric Hornung 37:46
You mentioned earlier that you when you were in investing in the public markets, you also were making angel investments. Are you still making angel investments?

Alex Rubalcava 37:54
I am not.

Eric Hornung 37:56
So given your kind of background with public markets and private markets, how do you personally invest your capital?

Alex Rubalcava 38:01
I have a lot of money in the business and in it and in my general partner commitment to each of our funds. And then the rest I have with one of my friends and peers from my public market days, and she looks after my public equity capital. And I know hundreds and hundreds and hundreds of folks in that business, and the person I picked is the person who gets the most units of return for the units of risk that she takes, and I think she’s the best Portfolio Manager I’ve ever met.

Jay Clouse 38:31
Let’s pretend that you are not running Stage Venture Partners, and somebody comes to you and they’re saying, I’m looking to become an LP in a venture fund. How would you advise them to consider venture funds that they might want to be an LP, and how would you recommend they evaluate different venture opportunities?

Alex Rubalcava 38:47
Evaluating venture capital funds is a real challenge. One of the challenges is that you have a lot of firms that are, what you would, call emerging managers people raising funds one, fund two, fund three, fund four who may have a background, maybe they spun out of a larger firm and are going out on their own, or maybe they don’t have a background, and they’re more of a cold start. In either case, evaluating the managers track record, evaluating their skill in investing is particularly challenging. And you’re not going to know whether they’re any good in any material way for a few years. The challenge then is once somebody becomes good, once you put up a good investing track record, then it becomes impossible to get in to their fund because venture capital is a capital constrained asset class. You know, we cannot raise $2 billion and put it into startups that are teams of five people working in a Wework. We would fund every single person in every single WeWork if we had $2 billion. And so obviously, that doesn’t work, And the very high profile venture firms, the ones that all of us have heard of, the Sequoias and the Benchmarks and the GreyLocks of the world, you call them up and say, I want to invest in your fund, and they’ll say, wonderful, we’ll put you on the waitlist and then you ask how long the waitlist is, and they tell you, it’s going to be 38 years. And obviously, that’s not tenable for anybody. And so you can’t get into a fund like that. But when you’re looking at earlier stage funds and younger funds, you can look for a few things. Number one, you look for who they co-invest with, you know, are they co investing with good firms? Are the people who are coming later into their portfolio companies really good firms? You know, if you’re looking at a seed firm, who’s leading the series A deals of their portfolio companieso? How big of a markup is happening between seed and series A? And how big are the companies that they’re building on track to get? That final point is a really important one because in venture capital, your hit rate is something about vanity metric. And what I mean by that is that it doesn’t really matter if, in our fund where we’re going to invest in about 25 companies, it doesn’t matter if we make money on 40% or 50% or 60% of our investments, because that doesn’t move the needle on our returns. What moves the needle is how big our three biggest winners will eventually get. And you almost don’t want to invest in a venture fund that is taking too little risk. You want people who are really swinging for the fences, because that’s the appropriate way to construct a portfolio in VC.

Jay Clouse 41:41
So would you say that it’s true that for people raising a fund one, the majority of their LPs are people who want access to the venture capital asset class but just can’t get into pre-existing funds?

Alex Rubalcava 41:54
It’s that, it’s friends and family, it’s people you know, it’s, you know, maybe people who had tried angel investing and and realized that it’s not for the faint of heart and that it’s much harder than it looks on Shark Tank. It’s a varied crew of folks who invest in fund ones, and fund ones are very hard to raise, you know. There is nobody in the world who has an urgent problem that is going to be solved by investing in some random person’s venture capital fund. Venture capital is a purely discretionary asset class. It’s something that you do after you have figured out your stocks and bonds and real estate and other more liquid, less risky investments. And if you are fortunate enough to be in a position where you have that degree of financial security and if you’re fortunate enough to be an accredited or qualified investor per the SEC rules, then venture capital can make sense for someone to invest in but it’s, it’s something that you really have to do carefully and deliberately.

Jay Clouse 42:57
I feel like I would be missing an opportunity here if I didn’t give you an opportunity to share what you liked about the Balto team when you first met them, given that they’ve been on the show.

Alex Rubalcava 43:06
Absolutely. So we lead Balots seed round about a year ago. That investment closed in August of 2018. We were introduced to Balto by one of their advisors who happens to be in Los Angeles. And we had actually looked at a few software companies in the call center voice analytics space. And everyone that we looked at was post call analytics. They would record a call, analyze it, and then give you a report about what you said and how you did on the call. That’s nice, but that’s not really useful. It’s not real time. It’s not synchronous. It’s the difference between a diagnosis and an autopsy. I would much rather have a diagnosis than an autopsy. And when we saw Balto, Balto had a product that was giving diagnoses. They were telling people what to do and how they were doing live on a call. They also, Balto also did something really effectively when they first pitched us is that they ran their software on the call. So we did a Zoom call with them, and they showed us their screen where Balto was responding to what all of us were saying and popping up suggestions and ticking off checkboxes. And when you have the confidence to demo your product like that, when you have the confidence to eat, eat your own dog food like that, boy, does that get our attention. And I mean, the the swagger of that really is something that, that we enjoy. The other thing that we liked about Balto were that they got their product out to market and in the hands of customers on almost no money. I won’t say the exact figures, but I really mean almost no money and that was actually something that concerned other venture capitalists that were looking at the deal. They said, how could this team have, you know, three founders who are under the age of 25 who had no money invested in their company get a product this good out to market and in the hands of their first five customers, when all these other startups in the space have raised 50 million bucks and don’t have anything that can make the product claims of Balto has. What I realized is that, who cares what the answer is, they’re just better. They did it. They succeeded. I did not need to take their word for it. I spoke to all the customers they had at the time. The customer said this works really well, this is increasing our revenues, and we plan to renew and to expand to more of our call center employees. So what more information do I need? That really was exceptional, the voice of the customer on, on those calls. And then since I’ve invested, the thing I admire most about Balto is that they have the most high functioning sales culture I have ever seen and that I’ve ever been a part of. They are happy warriors at sales and they take 22 year olds, 25 year olds, they take people with zero experience who come on board to be entry level sales development reps, SDRs. And they turn these people into highly effective software sales people. I think Balto is going to create a PayPa-mafia type of alumni network for enterprise software sales. They are doing something totally special. There is something special in the water over there.

Jay Clouse 46:29
That’s amazing. What a great fit for the rest of your portfolio.

Alex Rubalcava 46:33
Indeed.

Jay Clouse 46:33
This has been really fun Alex, thanks for coming on and sharing all this with us. If people want to learn more about Stage Venture Partners or you after the show, where should they go?

Alex Rubalcava 46:41
They can go to our website StageVP.com. They can also follow me on twitter @AlexRubalcava or our firm Twitter account @StageVP.

Eric Hornung 46:54
How much are the wasabi peas you buy at Kroger?

Jay Clouse 46:57
I think they are about $5, maybe 3989

Eric Hornung 47:01
That’s pretty expensive for, for a little snack.

Jay Clouse 47:03
Just a little snack, but you know, the value is there. And I think it’s worth it.

Eric Hornung 47:07
How do you afford that on a podcasters budget?

Jay Clouse 47:09
It’s tough. It’s tough. I gotta dig deep, and I gotta lean on my other business sometimes.

Eric Hornung 47:14
Well, you know what, I think the listeners could help us out here, because there’s one thing that they could do that directly correlates with our ability to raise some advertising revenue on this platform.

Jay Clouse 47:24
I think I know where you’re going with this.

Eric Hornung 47:25
Oh, yeah, I’m going to upside.fm/survey. It is our 2019 Listener Survey. And it is a key part of our growth strategy here at Upside so we can keep on telling stories about founders, community builders, and venture capitalists outside of Silicon Valley. And we can get Jay some more wasabi peas.

Jay Clouse 47:45
That’s right. So dear listener, if you would do us a solid if you would do us a kindness, please head over to upside.fm/survey, answer our 2019 Listener Survey, it should only take a couple of minutes. Myself and my wasabi peas thank you.

Eric Hornung 48:07
All right, Jay. We just spoke Alex from Stage VP. We went out west, and during the course of the conversation, we came right back to the middle of the country.

Jay Clouse 48:16
Yeah, we covered a lot of ground literally and geographically.

Eric Hornung 48:20
That was nice.

Jay Clouse 48:20
That was nice. That was good. And genuinely, we covered a lot of ground because Alex was really great at giving concise but still thoughtful responses to just about every question that we asked.

Eric Hornung 48:32
These are always challenging interviews because you have your kind of, all right, here’s my five to ten questions that I want to ask, and then, when you have such an efficient guest, you get quickly past those five to ten questions, and you have to come up with what is, what’s the second and third level thinking here.

Jay Clouse 48:49
Alex is clearly a well read, well studied, very intelligent individual. Gave us a lot of nuggets that I’ve never heard before, things like this Qualified Small Business Stock or this 2015 Act by Congress to simplify some 1999 legislation that allows venture capital to be largely tax free. That’s something I’ve never heard before. I wonder how rampant that is or how well known that is in the VC community.

Eric Hornung 49:14
I’ve only heard about it on Mev Fabers podcast, and he talked about it when he was doing a string of VC style interviews. But I haven’t really heard about it anywhere outside of that. So I don’t, I don’t see it being talked about on Twitter or anything like that.

Jay Clouse 49:29
You’re much deeper into fintwit it than I am, Eric. How common is it for someone to go into the public markets and then into the private markets and kind of switching between?

Eric Hornung 49:39
I think it’s actually pretty uncommon. I think what you see more is you have public market investors who do angel investing on the side, because they want private market market exposure. So it could be angel investing in small, really risky startups, sometimes they’ll put money into private real estate deals or something in the private markets that is more of a, maybe a PE fund, maybe something like that to diversify their holdings. What you don’t see is, from a career perspective, people jumping back and forth much, because you’re building up this expertise in the public markets, you’re building up this track record, and the deeper and longer your track record goes, the stronger a signal it is to other potential investors in your fund that you — or in your strategy or whatever — that you can be successful in the public markets. So when you switch and you make a change to VC, for instance, now you’re committing to 10+ years of private markets before you could ever even go back to public markets. So it’s a big switch to go from one to the other.

Jay Clouse 50:39
If you’re knee deep or even chest deep into fintwit, I would say I am, I don’t know, base of my foot deep, maybe ankle deep, and every time I get close to people who make a living in the public markets, it seems like they all have this mantra of VC is a terrible asset class. There aren’t good numbers to show like historical returns that are really good over the long term. So that was what was surprising to me about someone going back and forth. It seems like once you enter into the public field, you kind of take on this, this badge of decrying VC.

Eric Hornung 51:11
I think in the public markets, you have such deep data for even the smallest companies. You have a very specific standard of data that has to be provided you have disclosures, you have all this stuff. And when you go to private markets, and you look at it and you say, okay, well, what are your returns? And they’re like, well, we’re marking all this stuff to market and using, like, these valuation metrics that really don’t have any, like market based reality, they’re just the valuations that the company and the VC are kind of coming up with, and people are checking the box and saying this seems right. It’s a lot more gray area than in the public markets where it’s, this is the price because millions of people are trading this stock, and this is the price and this is the underlying fundamentals that have been audited by, you know, a big four accounting firm. There’s just a certain level of trust that comes with the public markets that maybe, for a traditional public market investor, it’s just always gonna be hard to get your head around VC when so much of it is an art as compared to, well, and there’s an art in the public markets as well, but it’s more scientific.

Jay Clouse 52:15
I don’t think we spent any time publicly in LA here on the pod. We’ve had some conversations behind the scenes, but Alex mentioned, when he got started at Anthem out of college, there were nine VC firms in the Los Angeles area. And now they’re something like 225, which is a huge explosion. And I think about areas in the Midwest or the rest of the country, even if I just look at this little bubble of Columbus that I’m in, there are probably not even nine VC firms that you count here. It’s probably very close to that. And so for me to imagine a world where suddenly there could be 225 VC firms here in Columbus, that would be a seismic shift in what the landscape of the ecosystem looks like. And I can’t imagine.

Eric Hornung 52:57
How big the population of LA? Call it 10 million?

Jay Clouse 53:00
Let’s find out. Alexa, how big is the population of LA?

Alexa 53:04
According to another Amazon customer, there are about 7.6 billion people in the world. Did that answer your question?

Jay Clouse 53:12
Not at all.

Alexa 53:14
Thanks for your feedback.

Jay Clouse 53:16
All right, so I don’t know.

Eric Hornung 53:18
That was amazing. That would have been so cool. We’ll just say that there’s 10 million people in LA, right? So you have a population of nine VCs serving 10 million people. That’s like your population basis. Now. There’s 255. In Columbus, there’s a population of, in greater Columbus 2 million and 9 VCs. So, I mean, there’s definitely some balancing out to do there. There’s also probably more risk-appetite in LA. I mean, you have the entire film financing industry that’s there. You have a lot more high net worth individuals in LA than in Columbus. So there’s just more, I get that there’s a boom there. I’ve also heard a lot on Twitter that LA is kind of a nice place to get away from San Francisco to start a company because you’re close enough to the Bay and you’re still the same time zone to get venture funding from the Bay Areaut, but the community and lifestyle is just, like, better.

Jay Clouse 54:12
One last note from our conversation here with Alex that really stuck out to me. We hear a lot of VCs talk about some of the things they look at when they invest in founders, one of them being why now. Alex spent more time talking about the now aspect of the founders he invests in than most investors we talk to do, and maybe because we just questioned it more. But I really enjoyed that part of our conversation, because more and more that’s becoming apparent to me as well, that timing is super, super critical for hitting the market at the right time, when they’re ready for something but not too late to be behind other technologies. We’ve had few founders on the podcast here recently that seem like they’re hitting that timing.

Eric Hornung 54:48
Yeah, I think, to bring this back to public markets, everyone says, don’t time the public markets. That’s like the number one thing you can’t do. And people try to time the public markets and they call it different things because that’s such a cliche to say, oh, yeah, I don’t time markets, but we do this thing that tries to time markets. And I think in the private space, you have to be someone who’s timing markets. You have to be making bets based on time. Like, you couldn’t have invested in YouTube in ’92. You couldn’t have invested in Chewy in ’97, because their competitors that were out there, the infrastructure, the underlying user demand wasn’t there to build that company.

Jay Clouse 55:27
Circling all the way back to Chewy, a true full circle moment on this podcast that mentioned dogs more than any other podcasts we’ve done.

Eric Hornung 55:35
Yeah, it was, it was pretty rough in terms of puns.

Jay Clouse 55:38
Alright, guys, if you have any thoughts this episode, you can tweet us @upsidefm or email us hello@upside.fm. We’d love to hear your take on Alex’s thoughts with Stage Venture Partners. And if you have any more dog puns that you feel like we missed through course of this interview, let us know about that on Twitter as well @upsidefm. We’ll talk to you next week.