October 11, 2022 | By Eric Buatois, General Partner at BGV
We live in a fraught period in global history.
There’s a war in Ukraine, a looming global recession, the remnants of a deadly pandemic, and widespread unease over climate change and the international order.
The rising inflation rate has lately grabbed international headlines, and for good reason. The US Federal Reserve recently increased the federal funds rate to 3.2% in an effort to keep prices down and promote economic stability.
Price inflation is also an early indicator of an economic recession, so the Fed’s intervention demonstrates that the United States is trying to avoid an economic slowdown. Other advanced nations have followed suit and raised their own interest rates.
Historically, central bankers have increased interest rates in order to curb demand. But in 2022, our current rise in prices is more due to the supply chain disruption that has affected the prices of food and energy, as well as other items like used cars, hotel rates, and eggs.
As the stock markets tumble and people worry over their retirement nest eggs, there is another trend that seems counterintuitive at first.
It’s called the Great Resignation, and is characterized by people quitting their jobs, or working fewer hours per week, in order to maintain a work-life balance. It seems that all those hours spent at home during the Covid pandemic reminded people that there is more to life than weekly meetings and a long commute.
Corrections, or Back to Normal?
The financial markets are trying to make sense of all these (sometimes conflicting) data points. One result is that the valuation of public and private technology companies has returned to a pre-Covid level.
According to Crunchbase, VC funding in the US is down 53% year over year, and down 37% from Q2. This decline is even more pronounced with late stage investments, which are down 63% in the quarter that just ended. At the early stage, the decline is less exaggerated, with a 40% drop since last year and a 28% drop since Q2. Nevertheless, gritty entrepreneurs are managing to fund their businesses with a reasonable dilution, and corporate venture funds are staying in the game.
On a macro level, venture capitalists seem to be reacting to market trends by moving away from Unicorn investing and moving toward Centaur plays. A recent report by Crunchbase showed that companies that quickly gain Unicorn status don’t sustain their high valuations. As a result, investing in Unicorns is down, prompting venture capital firms to look at more modest, and sustainable, investment opportunities.
A New Wave of Enterprise Productivity
At BGV, we believe that the next wave of venture capital will focus on Centaur companies, or those with $100 million in annual recurring revenue (ARR). VCs looking to invest smarter (and more modestly) should take a good look at these businesses.
Many of these businesses exist in the Enterprise 4.0 sector, which BGV characterizes as B2B startups that combine artificial intelligence, intelligent automation and proprietary access to data to deliver actionable insights for enterprise businesses. Our investment thesis is available here.
In the current climate, large enterprises have no choice but to accelerate their digital transformations. All those people working at home during the pandemic have proven to the C-suite that cloud computing is both invaluable and resilient. In addition, customer-facing services are increasingly cloud-based and data-driven.
The Great Resignation is not just for managers and executives. Employers are having a hard time filling service job positions in the restaurant, retail, and health industries, leading employers to accelerate efforts to automate those tasks.
Therefore, the search for innovative productivity solutions (while at the same time rethinking the supply chain) demands a new set of IT solutions that combine data insights powered by artificial intelligence (AI) with real-time insights and recommendations.
Long Investment Horizon
Compared to traditional product businesses, Enterprise 4.0 companies have a longer development cycle. For example, data sets must be identified, cleaned, secured, and then paired with the appropriate AI algorithm. Then they must be fully tested and audited to ensure repeatable insights.
The entire process must be carried out with ethical standards in mind, and have as its goal not to replace the human worker but to augment human productivity and automate their more mundane tasks.
To accomplish this complex goal, the management team must possess deep domain expertise and be attuned to the operational habits of customers within the niche or vertical with a maniacal focus on customer needs. These kinds of teams are rare, which means that very few companies will be able to deliver the polished solution that the market desires.
When these Enterprise 4.0 companies do succeed, they will be rewarded with six- and seven-figure, multi-year contracts by large multinational firms while at the same time attracting channel partners like system integrators. Just a handful of companies will win out in their given industries, delivering a superior return for investors.
These “AI inside” companies stand in stark contrast to the first wave of AI companies created by Data Scientists producing tools and enablers for Data Scientists in a very niche enterprise population. Today, the C suite wants to understand how AI can solve concrete business problems immediately, and does not have the patience for esoteric but cool science projects. This is why enterprises have scaled back a large majority of their internal development spending.
Hurrah to the New Centaurs
Enterprise businesses will take eight to ten years to reach $100 million in annual recurring revenue (ARR). However, by the end of that period, they will be rewarded with strong customer loyalty and generate economies of scale to expand their solutions within large corporations, delivering outsized returns to their investors.
A management team at one of these companies can grow top line by 30 to 70 percent annually – without hemorrhaging cash. In a word, Enterprise 4.0 businesses combine a strong growth rate with the benefit of value investing. Even lofty revenue growth targets become reasonable when the enterprise customers generate large purchase orders and the provider secures deep customer loyalty.
BGV is proud to lead this new wave of B2B tech investment with companies such as Drishti, Flytrex, Folloze, Madkudu, Zelros, AI Dash, Everest Labs, Evinced and Boostup.
Artificial Intelligence is not about building a new Terminator, or displacing labor. Instead, it is about automating mundane and routine tasks and augmenting the work of individual contributors. By liberating the best part of the human brain, problem solving and creativity, the next generation will produce deeper insights for their businesses, their customers, and the broader society.
