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Finding the sweet spot in cloud apps

Cloud Apps Capital Partners, about a year into its inaugural $53 million fund and strategy to back early-stage cloud business-app companies, says it sees rapidly expanding opportunities in the space.

“Many more category-leading global companies … are being started,” said Matt Holleran, general partner of San-Francisco-based Cloud Apps.

“The customers are purchasing. The economics of how these companies get built and the integration enable that to be so,” adds Holleran, who previously was a venture partner at Emergence Capital and an executive at Salesforce.com.

Portfolio companies include San Francisco-based Wootric, which provides a tool to help businesses analyze customer sentiment. Wootric raised a $2.6 million Series A round of funding in April that Cloud Apps led and which included CSC Upshot. Holleran and Judy Loehr, venture partner of Cloud Apps, joined the company’s board.

Another portfolio company is Propel, which raised $4.2 million in a Series A financing led by Cloud Apps and included Salesforce Ventures and SignalFire. Matt has joined that board, as well.

Holleran said that cloud business application companies face a number of challenges, in particular developing capable products with sales and service support while often starting up with workforces of perhaps a dozen staffers.

“Your customers need to love the application because they don’t pay you one time; they pay you every year via a subscription model,” Holleran said.

Still the opportunity is there, Holleran said. The right freemium model can unlock interest from small and medium-sized businesses worldwide.

VCJ recently spoke with Holleran about cloud-app investing. What follows is an edited transcript of the conversation.

Q: What’s the update on your first fund?

A: Our strategy is to lead the $3 million to $6 million Series A financing and for us to reserve for follow-on financing.

Our first fund is an oversubscribed $53 million primary fund, 75 percent from institutions. In addition to that, we also have a pro-rata co-investment structure that the majority of our investors are interested in participating in. So that will provide us with access to more capital over time as the companies continue to grow.

Q: Are you about halfway through the fund?

A: Fund I will be somewhere between 10 and 15 investments. And yes, we have made eight over the course of the last two and a half to three years. So we’re on the pace we anticipate.

We generally try to do one per quarter, or a little less than that.

With the primary fund and the co-investment structure, we feel we and the portfolio are well situated.

Q: Is there the potential for a second fund?

A: We think the cloud business application market is big and is growing all over the world. The hole in the market we are filling is getting wider and wider. We think we’re one of a handful of market-focused Series A firms in the category that are starting to grow.

So, yes, we envision we will have a second fund and a third fund and have the opportunity to build a great firm over time.

Q: What do you mean by a “hole” in the market? Do you see yourself serving a niche that is not well served by venture?

A: We think we are. The hole in the market that we kept seeing when I was at Emergence is to lead this classic Series A financing of $3 million to $6 million. We thought it was a big market opportunity. It turns out it is getting bigger and bigger all the time.

Q: Why is there a hole?

A: The venture industry is maturing. It is consolidating around the Sequoias and the Greylocks. And those firms, as a result, are likely to see the $10 million or $15 million financing. Our firm is very complementary to those firms.

But as the industry generally has a preference for seeing more traction in companies, it makes it harder for them, from an opportunity cost, to engage when a company has two or five people.

Q: Aren’t seed investors moving up market to do these deals?

A: The pure angel market and small seed market works pretty well for consumer applications. In the cloud business application market, when the entrepreneurs run the math, they do realize they need $3 million to $6 million to build the right product and to have the right sales and service people and, as a result, to build the core team that the end-customers want to see and want to buy from.

So the headless syndicates of $1 million or $2 million were fairly popular in 2014 and 2015, but as you can imagine in this environment, entrepreneurs and those angels are reluctant. So the hole we’re filling is getting wider on that side as well.

Q: Are you seeing much of a valuation reset in the cloud business app space?

A: Fortunately, the cloud business application market has proven to be more resilient than many consumer companies. And the fact that there’s been this rebound (of public stocks) off the bottom that seems to be steady means there are a lot of rationalizations and restructurings happening in cloud business applications companies this year, and some (companies) that won’t make it.

Q: Does this create opportunities for you?

A: The industry in 2016, and the industry in 2017, is now starting to do some of the rationalization that is needed.

When you are a general partner at a $200 million or $1 billion fund, and your firm has 15 or 20 companies that need to be reset, that is a lot of work. It’s a lot of work to negotiate that with your other investment partners, with the companies, with the lawyers.

As a result, this year, we think the hole that we are serving, which is growing naturally, is suddenly much bigger. It’s very hard for existing larger firms that are working through those changes to have the time to do the diligence on a new project, especially one that is 15 people and they need $5 million or $6 million. From our perspective, you should expect to see us be more active in that range.

Q: Cloud business app companies seem to require significant resources to get going. What explains this?

A: First, to the extent you are a business with a freemium model, you have to make the application ready to perform at the appropriate speed and reliability all over the world. Fortunately, cloud platforms help with that.

Second, if you’re serving small businesses in Malaysia or in Vietnam, requiring them to do business in English is probably not a good idea. So how do you think about language support for the application itself and any information captured in the application fairly early in the company’s life cycle?

Third, with the business freemium model, many customers start with credit cards. Then later they may migrate to annual payments and think about invoices. Those are things you need to think about much earlier.

Action Item: Visit the Cloud Apps Capital Partners website: http://www.cloudappscapital.com/

Photo of Matt Holleran, general partner of Cloud Apps Capital Partners, courtesy of the firm