March 26th, 2004
“People talkin' about is,
they got nothin' else to do,
When it all comes down we will,
still come through,
In the long run” – Eagles – Long Run
The undisputed king of software investments, from and
angel or venture capital point of view, is, well, you
guessed it… Microsoft.
Investing in 1975 in a fledgling start-up of
pimply-faced teenagers (who made a software tool that
interpreted BASIC on a new Intel 8080 chip for a
fledgling desktop computer market) would have been a
good idea. They
made $16,815 in revenue that year in royalties from a
company called MITS. Definitely a seed deal.
Two years later, bailing out the same company when it
ran short of cash because it ran into a legal dispute
over licensing rights (!) with its key partner would
have been an even better investment opportunity.
The employees hadn’t been paid and Bill Gates
was desperate. Unfortunately
for the guy who did bail them out, saving Microsoft from
imploding that summer, he and his company didn’t take
equity, but paid them up-front for a year’s worth of
licensing royalties for their computer platform.
Seems this guy was flush with cash from his
investors and probably, in hindsight, blew the best and
most interesting equity partnership in history.
His name was Steve Jobs and his company was Apple
Assuming you bought 10% of the company as a VC in 1977
in those desperate hours, for $100,000, you would have
had roughly $100,000,000 worth of stock at the 1986 IPO.
In nine years, Microsoft went from $381,000 in
revenue to over $200,000,000, the best hockey stick in
thousand times your original investment is a pretty good
Where are the best investment opportunities in software
we go there, it is an interesting sidebar to look at
what a software company actually is today.
Software is ubiquitous.
At its most elemental form, it is a set of
instructions that moves electrons and magnetic
polarities in silicon and a variety of other mediums.
Companies like Spectrum Signal Processing and PMC-Sierra
could, at the most elemental forms of what their
products do, be called “software” companies.
A lot of hardware companies, making boxes (e.g.
assisting in moving VoIP traffic) like Convedia, have
some of their intellectual property tied up in
But we don’t categorize these companies as
software companies because, although they have software
developers working at their facilities, their products
incorporate the software into a hard good that they
Venture capitalists like to taxonomize their
helps us enter the deals we see into a database…
(anyone see the irony there?)
These categorizations change over time as
technology innovation forces us to look at new
software companies fall into three major categories at
Greenstone: Applications, Tools and Systems/Control.
are the easiest to understand and, by far, the most
opportunities that we see in software.
Applications companies are those that sell
software products or services where an end user derives
benefit without (usually) writing any software code.
The software has been abstracted far enough away
from machine code that it is easy to use and
understandable in its utility.
Local companies successful at software
applications are numerous (Electronic Arts, Business
Objects (Crystal), Fincentric, MDA, Pivotal etc., etc.)
Tools are a bit more esoteric as they are companies that
sell software products or services typically used by
developers or hardware manufacturers making
are the development environments, interpreters, data
access, compilers, test and measurement, quality
assurance, optimizers, database tools and middleware,
XML, web services and open source tools to name a few
companies making (or made) Tools include ActiveState,
Flowfinity, MAKE Technologies, Simba, XML Global and
Systems/Control software is the most esoteric and
“hard” area of software.
Usually, it is a sub-group of a hardware or
semiconductor company making the control systems or
operating instructions for their end products.
So there are very few opportunities to create
entire companies here.
But sometimes companies can emerge here because
we include things like operating systems, drivers,
libraries, embedded software and algorithms in this
pop up a lot in areas like compression, network
communication, authentication, encryption etc.
Sometimes the company morphs into a DSP or ASIC
company as the algorithms are interpreted in silicon.
Other times, the company licenses their
intellectual property and lives and grows off royalties.
Microsoft started out as a Tools company, bought a
“platform” in the Systems/Control area (DOS),
created a standard in the Windows OS and then made gobs
of money as an Applications company.
Because they are so massive and monopolistic now,
and other companies have developed near monopolies in
key platforms like databases (Oracle), it is very hard
to seeing any software company reaching the scale of
Microsoft, ever. It
also makes it hard to envision massive success in any
application that can be subsumed into a “bundled”
environment, recent legal ruling against Microsoft
at Netscape, Real Networks and soon, McAfee and Norton.
Microsoft can easily put anti-virus, firewalling
and spam tools into its Windows giving them 100% market
share out of the box.
The result of the domination of the big software
companies is that point applications for horizontal
markets are not great opportunities.
In other words if you application is part of a
broader need by the customer in order to form a
solution, you are not likely to win.
Maximizer was a local example of this phenomenon.
It was a great product for contact management in
the mid-90’s with growing market share, competing with
Act And Goldmine. But
the customer needed it to work with messaging,
collaborative work tools and customer relationship/sales
became the category killer because it integrated with
the dominant e-mail platform and was bundled with the
best selling suite of applications, Office.
So Maximizer was forced to compete in smaller and
Vertical applications are great opportunities.
Top Producer was essentially a contact management
application written locally for the real estate market
specific hooks, templates and usability for real estate
professionals, it worked out of the box better for those
qualified users than Maximizer.
There are far less real estate buyers than the
broader horizontal market for general contact
management, but Microsoft is not going to bother
becoming an expert in real estate.
Vertical applications afford the opportunity to
allow market leadership and fairly large growth. The
new model of delivering applications over the Net, with
it’s inherent advantages in pricing models, upgrading
and ubiquitous availability is where most of the action
is today. Vertical applications continue to be excellent
opportunities as witnessed by local successes like Class
Software, Chancery, Fincentric and others.
There are big opportunities in services that focus on
integration and processes.
As we emerge out of the nuclear winter of
enterprise spending, companies need to make new
investments work with existing infrastructure.
Building connections between applications is
still a huge business. Extending the life of existing
investments is a huge priority in the customers mind
applications and services focusing on
“extensibility” are very popular.
But even bigger in services is the “process”
are looking for ways to make “best practices” work
everywhere in their organizations to improve efficiency.
Software applications and services focusing on
compliance with best practices are hot.
Whether these be mandated by government, like
HIPAA or Sarbanes-Oxley, or simply by industry
standards, the software companies focused on process are
getting attention of buyers.
The really big software companies of tomorrow might be
in the Tools space.
With Open Source application development gaining
significant steam today and Linux getting a foothold as
an OS, there is an opportunity to define new platforms
(in database, MySQL, for instance) and create the tools
that leverage those platforms.
With the PC market essentially in
“replacement” growth mode, new hardware platforms
are emerging that never see a Windows hegemony.
Devices, especially wireless ones, are a wide
open playing field for Tools (and Applications).
Another opportunity in Tools is the development
of software moving from bug-prone current practices to
quicker, more standardized processes like code
generation (MAKE is a local example).
There is a burning need for more efficiency in
the development process.
Autonomic computing (a biology term for self-healing),
is mostly hype today, but may present excellent
Secure, instantly updated software running on
networks that don’t go down is highly desirable.
Tools companies that “harden” software to
this level will likely do very well.
With end-user markets improving, software companies look
like good investment opportunities.
They generally require less money to reach
profitability, they have extremely attractive gross
margins driving higher valuation multiples and they tend
to be nimble organizations that can turn on a dime to
meet new opportunities or threats.
would like to invest in the next Microsoft, but the
likelihood of that is remote.
A big company in software going forward will have
to strategize around the behemoths in the industry
today, which Microsoft didn’t have to do in their
time. But we
don’t really need 1000 times our investment to be
is a modest journey…
A month ago I wrote about A Good Place To Be (http://www.bctechnology.com/statics)
and mentioned that EA had turned the code bought from
Radical Entertainment into its highly successful SSX
series of games. In
fact, the SSX project was already under way at EA and
the teams merged to bring it to market.
My apologies to the dented egos of that original
make one of the best games out there and they deserve
all of the credit.
What Do You Think? Talk
Back To Brent Holliday
Something Ventured is a bi-weekly column designed
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