In this episode, we chat with Dave Greenberg and Suken Vakil, General Partners of JMI Equity, the leading growth equity firm focused on the software sector.  Since 1992, JMI Equity has been highly regarded as the preferred capital partner for software CEOs and entrepreneurs.  Investing out of their latest fund of $1.2 billion they take very seriously their role in supporting companies on their path to victory.

We cover a lot of ground in this conversation from how JMI helps companies scale to the pressing issue of COVID-19 and what management teams can do today to protect and maybe even strengthen their business. We hope you enjoy the show.

(Hear the full conversation on iTunes or Listen Notes.)

RJ: Dave and Suken, thanks so much for taking the time.  Maybe what we do is kick off with a bit of background on each of you and as part of that, background on JMI.

Dave: Sounds good, RJ.  So this is Dave Greenberg talking, I’m a General Partner at JMI, I have been with the firm about 15 years and we’re a growth equity investor in software, that’s what we’ve done since 1992, pretty consistent growth strategy in partnership with founder entrepreneurs.  I’m delighted to be talking to you today about what we do and then how we’re impacted by the current environment.

Suken: And RJ, this is Suken Vakil, I’m also a General Partner here at JMI, I’ve been with the firm about eight years and, you know, very excited to have this conversation, so thanks for having us.

Excellent.  Thanks again for joining.  And for the broader audience who may not be as familiar with software investors or the growth equity space, JMI Equity is one of the preeminent firms.  Could you shed some light on how JMI developed its reputation in the industry.

Sure.  So the initial money in our fund was from a software entrepreneur, John Moores who was a product oriented guy who started BMC Software.  So we’ve always come at the software markets from the perspective of finding the best product offering that were driving the most value for customers.  All along it’s been how do we take companies from where they were at, you know, usually 5 to 30 or 40 million in ARR and get them to the next stage through capital, but always operational help, help building their teams, help making the strategic decisions to really grow their companies.  So in general we weren’t taking super early stage risk, but we were looking to help build great companies in every function around a great product.  So that’s been the history since 1992.  We’ve had good success, so we’ve grown the capital under management.  The first fund was 50 million and the current fund, JMI 9 is 1.2 billion.  But we’ve maintained a pretty similar strategy as I just described.

And from knowing folks at your firm for some time now, you seem to develop very strong relationships with CEOs.  And I’ve witnessed that first hand, has that been part of the ethos of JMI since the beginning?

It really has, I think for us when we, you know, from the founding of our firm as Dave described, and when John really put the first capital into three young software companies to help them grow, the mantra of finding extremely talented teams that we can invest with, to really grow software companies has been part of, as you described, the ethos of our culture.  And it is really one of supporting entrepreneurs and the path to victory.  And so as we think about a lot of, you know, our sort of domain knowledge around enterprise software, it’s bringing that to bear across a large number of companies to help those teams really succeed in a way they couldn’t without our advice and knowledge.  And so a lot of that symbiotic relationship that we develop generates what, I think you’re talking about, that you’ve seen firsthand, which is a true trusted relationship and trusted partnership with our management teams.  Because we’re in it, you know, not only at one company but across the portfolio to really help drive the most strategic decisions that they need to make.

I can imagine when COVID-19 started making waves, first in Asia and then gradually across the world, immediately business leaders were thinking, how is this going to impact my business and what should I be thinking about.  What should I be doing to mitigate the risks and the ripple effect that COVID-19 could have?  What were some of the things that were top of mind for you as you were thinking about your portfolio and the teams that you were supporting? 

I’m very pleased with the quality of management teams we have across our 29 companies, they’ve moved quickly to try to address the challenges that come with this environment.  In some cases, and more than in some cases, we have optimistic growth focused folks running our company.  So part of our job was to get all the people together and make sure they understood the gravity of the situation as far back as we could.

I think we started having our CEOs get together virtually every week starting maybe six weeks ago to talk about the challenges they were seeing.  But the playbook at a high level is pretty simple, it’s, you have to conserve cash, you have to look at every way you can do that.  You have to protect recurring revenue; our companies are 85% of revenues recurring with retention rates in the 90s.  So you’ve got to focus on customers, make sure you can really protect the cash that’s coming into the business and those customer relationships.

And then as we look towards the future, how can we ensure we keep investing in the products that we have and be poised whenever it is, in a month or two months, three months when there is more certainty in the world.  To take advantage of the opportunities that will come from this, whether it’s hiring some of the best people who are no longer part of a travel or hospitality software company, whether it’s, you know, doing some additional buy side M&A in the portfolio.  As much as we can we’re trying to get through the planning and strategy exercises that this environment demands so that we can focus on the opportunities that will come out of it.

Presumably there is some resiliency across software, if you think about businesses not being able to rip out their software for a temporal blip in business activity.  What’s the view on the overall impact of COVID-19 on the software sector?

Yeah, RJ, I think you hit on some great points.  And specifically I think as we think about our historical sort of view on the software economy and where we’ve invested our capital, it’s been in solutions companies and teams that really drive high customer value.  And so I think Dave mentioned it, but our portfolio generally runs in the 90%+ gross retention zone.  And so we don’t expect that folks will start to turn off some of the really critical software that helps them run their businesses.  And so that I think we haven’t seen and I think we don’t expect that to change. 

Where we do think there is going to be impact is going to be on new, sort of new logos, new bookings, both from existing customers and from new customers.  I think it’s fair to say that large organizations or midsize organizations in the current environment are thinking about adopting software that’s really going to change the way they operate their business, is a difficult time to do that.  Folks are really more concerned about some of the health impacts of their workforce transitioning to a work from home environment. 

And so that, I think across the portfolio and of course some sectors like hospitality or travel more than others are going to be impacted in the near term around the velocity of new decisions flowing down.  And I think a lot of what Dave describes I think is a way that we are working with our management teams, we just understand that, accept that, your new reality at least in the short term.  But continue to make investments, and so all of our companies are growth focused software companies, so make the investments that on the other side of, you know, this crisis really to help drive more customer value and be positioned for more growth and more competitive, you know, differentiation, and a lot of that does mean more investment in product.

Given that there’s still heightened uncertainty on various levels in the current environment, do you pause before you make investments in new companies and kind of see how things shake out?  Or are you already starting to formulate your thesis on how you can work with the current environment with an eye towards opportunities that you see now?

On the new investing front our particular situation is we have an existing fund to deploy and our customers, our LPs pay us to do that.  So our plan is to continue to invest in great companies.  In the short term, we may be months but not much longer than that, our challenge is really understanding the forecast of any prospect we’re looking at and making sure we can have a view on what their business will look like for the next 12 to 24 months.  So we’re working on doing that, especially with companies we’ve gotten to know over a long period of time because we want to continue to remain active in this environment.  It’s certainly an uncertain time but what we’re very conscious of is not promising things to entrepreneurs and companies that we can’t deliver in this environment.  But we are, you know, continuing to look at investment opportunities, what would you add to that, Suken?

So probably everybody experiences it right now which is the velocity of private investing across the board has slowed down pretty considerably and that’s not unique to JMI.  But I think as Dave described, the openness to look at new investments, I think still is very high and I think that the thing that we will need to work very closely with our, you know, new teams that will be coming into the portfolio is to navigate how they see the impact of the current environment and how they view sort of the strength of their business coming out of it, and that’s what we’re going to need to be judging.

This is kind of a tough question but I’m sure it’s on the minds of a lot of software CEOs, especially ones that are in the market for capital.  What do you think about valuations today and how they may play out?

Yeah, the hardest part about valuations in the software economy is that we value companies based off their forward potential, so forward ARR, forward revenue, it’s a lot of metrics that folks look to on growth software companies.  And the question today is well, what is forward, how do we really project the forward financials of a particular company?  And so I think folks like to think about valuation in terms of multiples, usually the way that folks in our industry talk about it.  I think what will happen is we’ll see some realignment.  But even if you look back to the great recession in 08 and 09, the kind of at the bottom of that, the trough of that, most public companies and the growing software companies were trading at five times forward.  So with some realignment, but not maybe as significant as you would have expected, I think we’ll probably see the same, which is there will be some realignment, we will need to obviously adjust valuation for the change and, you know, forward performance that we expect from all the companies.  But it probably won’t be as significant as maybe, you know, other sectors are going to experience during this downturn.

To add to that, RJ, I would say we’re, you know, we’re trying to invest in great businesses and we pay premium forward multiples to do that, I think we’ll continue to do that.  The big question is just the forward multiple, what are you, you know, what’s forward bookings to Suken’s point, what’s forward revenue?  But I do expect SAS multiples to continue to be strong, given the quality of these businesses.

And which areas within software are each of you most keen on; where do you spend the most time?

One of the spots that I’m spending a lot of time in these days is supply chains, which we do think, you know, coming out of this we’ll have a lot of realignment just given the intense impact companies we’re seeing to demand, and also the supply side of their businesses, that’s an area we think there’ll be some acceleration coming out of this impact.

I think for me, one area I’m spending a lot of time with is product related areas of software.  So, for example, PLM, PDM, PIM management, but anything really related to products and product development.

Can we hear about how you’ve worked with companies in the past?  Our podcast centers around business growth and helping provide some insight to CEOs and entrepreneurs on how to accelerate growth in their business.  And by definition, JMI as a growth equity firm is particularly skilled at helping entrepreneurs and executive teams.  So maybe if you wouldn’t mind talking about a situation each where you were able to help a team scale.

One recent investment that we’re proud of is a company called AutomotiveMastermind which provided analytics and marketing automation software for automotive dealerships.  We were able to partner with two incredible founders, Marco Schnabl and Johannes Gnauck who were the two leading salespeople at Mercedes Benz Manhattan.  And they sought to build a product that replicated how they were so successful selling premium cars.  When we got involved the business was mid teens ARR, they had a phenomenal product and lots of demand.

And what we really helped them do is build a company around that, you know, we helped build out sales and marketing, we helped to recruit a senior team, a CFO, a VP of Operations, a Head of Engineering and were able to help them to take their company in about a year from 75 employees to 220.  A really unique business, a really strong product, helping their customers sell more cars and it ended up being just a little bit more than a year of partnership on the very short end for us.  And that they had a strategic acquirer, IHS Markit, who own Carfax, who was interested in the business and felt like they could bring their data to our software platform and make the software even more valuable, so a great partnership with them, a really impressive founding team that we were able to help take to their next stage.  And they’ve been very successful as part of a strategic combination.

Great.  Suken?

I’ll talk about an investment we made back in August of 2017, a company called Arena Solutions.  What the company does it provides product lifecycle management and quality management software for folks really making, you know, any product that would integrate a mechanical and electrical component.  So, in today’s environment, even your toaster has Wi-Fi in it.  So if you have software combined with a mechanical product and you’re producing that product, you need one core system of record to actually design and create that product, and that’s what Arena provides.  So we did a growth buyout as I mentioned in August of 2017.  It’s been a little more than two and a half years owning the business and we nearly doubled the revenue in the company.

The company was about 25 million in revenue at that time, it’ll probably cross close to 50 relatively soon.  And then along with that we also took the company from break even to generating pretty significant EBITDA.  And a lot of the ways that we did that was partnering with the CEO and the management team to really drive a very deep focus on the sectors which they were most sustainably differentiated relative to the competition and really drive higher velocity, higher price points and really more customer value out of the solution they have been providing.  They’re the only cloud provider in the mid market PLM space and that’s a pretty significant investment for any manufacture to make, but also a really important one, and even more important given the COVID-19 crisis, and also the trade war with China to have a resiliency in your manufacturing process, which Arena is able to help drive. 

And part of what we did along with that focus is we also then did some M&A, we acquired one of our competitors in the market, Omnify, which really bolsters the product as well.  And a lot of that investment helped drive more customer value which is demonstrated in the retention rate, which improved from mid 80s to above 90%.  So there’s a lot of success there and, you know, a lot of tactics but also a lot of strategies to help the company to continue to grow.  And I think we’re very excited about, you know, where Arena’s positioned, you know, even despite our current environment and where Arena will head after it.

Those are two great examples of how you were able to help companies scale.  I want to thank you for being generous with your time and imparting some of your insights for our audience. Thanks Dave, thanks Suken.

Thanks RJ.

Thanks a lot RJ.