Q4 2020 Quarterly VC Update: Sean Barrett on the State of Venture Capital Investing

In conjunction with our Q4 Venture Financing Report, I sat down with Sean Barrett of HMI Capital to get his take on the state of venture capital investing.

Key insights from Sean Barrett:

On going back to basics this year: “HMI made its first investment in early 2009. … Everything was for sale, and the experience taught us some important lessons – prioritize the best ideas and then invest in those with conviction, focus on high-quality businesses that can compound through cycles, and think about investing outcomes as probabilistic rather than single pathways.”

On a robust deal environment: “Q4 was the most active quarter we have seen in years. We believe the fourth quarter generally had more deal flow than usual due to political uncertainty and high valuations, coupled with lots of capital, making for a good supply-demand setup.”

On putting money to work right now: “We’ve been selective, focusing on great companies that can grow for a decade or more. The base rate for decade+ compounders is not amazing, but if you can find them, your entry valuation doesn’t matter so much. If you’re wrong, it’s a different story.” 

HMI Capital was founded during the 2008-2009 financial crisis. In March and April 2020, we saw the public markets plummet as the COVID-19 pandemic spread across the US, and VC-backed companies and investors geared up for an onslaught of liquidity problems and down rounds that largely never came. What lessons did you learn from the financial crisis, and what will you take from 2020?

HMI made its first investment in early 2009. In the firm’s early years, everything was for sale, and the experience taught us some important lessons – prioritize the best ideas and then invest in those with conviction, focus on high-quality businesses that can compound through cycles and think about investing outcomes as probabilistic rather than single pathways. As partners, we learned how to stay calm during crisis and work together as a cohesive team.

March 2020 brought us back to our roots. We had daily team calls to discuss our portfolio companies, looking at which ones were healthy and which ones were likely to have trouble weathering the storm. We spent a lot of time helping companies think through scenarios and making sure they were prepared for whichever scenario surfaced, and we were in touch with all of our portfolio companies and made it clear that we were there for them if they needed capital. 

Importantly, we are lucky to have very supportive LPs that think like we do, for the long term, and they have seen us work through times of crisis. As a result, we were able to raise $500 million in 1H 2020, mostly from existing LPs, and we put it to work quickly. We view our LPs and our relationships with them as a strategic advantage. Their support at a time of intense uncertainty created a lot of value for our partners and portfolio companies.

Figures for both deal count and invested capital in Q4 2020 are the highest Cooley has seen since the inception of our Venture Financing Report in 2003. Are you experiencing the same resilience in the deal environment?

Yes, Q4 was the most active quarter we have seen in years. We believe the fourth quarter generally had more deal flow than usual due to political uncertainty and high valuations, coupled with lots of capital, making for a good supply-demand setup.

On a micro level, a lot of tech companies are seeing larger opportunities as a result of COVID-19. For the companies with strong unit economics, raising money is value-accretive for their businesses and allows them to take advantage of the accelerated customer acquisition opportunity in the near term.

This past year, we witnessed a greater concentration of VC investment in more established, later-stage companies – and more competition for investors looking to get in. How has HMI approached these deals?

It’s a very competitive environment with lots of capital chasing the same companies, and every growth investor tries to add value in their own way. From a company perspective, deciding which capital partner to invite onto a cap table is a really tough decision.

As for HMI’s value, first, we have a very concentrated portfolio with a total of only six private investments and 10-12 core public investments at any time, meaning every company we own matters a lot to us. I think that resonates with our management teams, many of which are founder-led and have dedicated their lives to their businesses. We don’t take that lightly.

Second, we only invest in three sectors – fintech, software and internet. Our management teams appreciate our sector expertise and global view. We’ve canvased our sectors many times over the years and can provide insight based on our diligence. We are often asked to present to senior team members of our portfolio companies, and they ask us open questions about their broader ecosystem, competitive dynamics and global trends. That’s helpful for companies that are considering geographic or product suite expansions. 

As for our way of approaching deals, we know our sectors really well and try to do a lot of outside-in diligence in advance to lighten the burden on management. Once we’ve invested in a company, our capital base (evergreen, locked-up capital) allows us to scale our investments with the companies and management teams we back. So, we have a track record of supporting multiple rounds over time, which our management teams appreciate. As our companies consider long-term options, we can support them as private or public companies, depending on their needs. 

In summary, we spend a lot of time working on business quality and runway for growth. We want to make the deal process as easy as possible for our management teams.

COVID-19 has brought major shifts in consumer and enterprise spending. Has the pandemic impacted your industry focus?

We’re lucky to be tech-focused investors, and we haven’t had to adjust our strategy or industry focus as a result of the pandemic. At HMI, we’ve invested behind a couple themes in each of our sectors that we think are multi-decade trends. Investing in great businesses within this construct allows us to take a really long-term view.

Within fintech, we’ve invested in modern platforms disrupting legacy providers that generally have poor service and high fees. We’ve also invested in companies that facilitate services to large, underbanked or poorly banked populations. Within software, we really like vertical market leaders and disruptors. Our founder, Mick Hellman, was an early vertical market software investor starting in the 1990s, and we’ve carried that focus with us at HMI. And in internet, we’ve backed marketplaces that support large, important ecosystems. 

On a micro level, we’re looking for visionary management teams with product leadership in large markets – that’s a great recipe, and it’s a lot of fun when you find it.

Do you think deal terms will continue to favor companies in 2021? How have you been putting capital to work in this environment?

It’s always tough to predict future market dynamics, as there is some macro forecasting required to answer the question. With that said, valuations have been robust for a while. At HMI, we’ve been selective, focusing on great companies that can grow for a decade or more. The base rate for decade+ compounders is not amazing, but if you can find them, your entry valuation doesn’t matter so much. If you’re wrong, it’s a different story. 

About Sean Barrett

Sean Barrett is a partner at HMI Capital, which he joined in 2010. He leads the firm’s fintech practice and sits on its investment committee.

About HMI Capital

Founded during the 2008-2009 global financial crisis, HMI Capital invests for the long term in the highest quality growth businesses globally. Based in San Francisco, the firm manages more than $4 billion and invests across public and private companies in three sectors – fintech, software and internet.