What’s driving the never-ending cloud startup boom
Cockroach Labs Inc. launched an enterprise version of the open-source CockroachDB distributed database six years ago at a time when “all companies wanted to run the database themselves,” said co-founder and Chief Executive Spencer Kimball.
The business was steady, but like many firms trying to commercialize open-source software, the company had to cope with pricing sensitivity and the complexity of installing software in customers’ data centers.
Until two years ago, that is. Charmed by the scale and cost of cloud storage, enterprises begin moving data management to the cloud en masse. “Things changed rapidly,” Kimball said.
Cockroach Labs quickly pivoted to the cloud as well, launching a managed service in time to catch the tide. The payoff: Early this year the company raised $160 million at a valuation of $2 billion, doubling its worth in just eight months.
Although the majority of its revenue still comes from on-premises licensing, the company expects to see “very high double-digit growth rates” in the managed cloud business, Kimball said. “You’re delivering value faster. That typically increases customer satisfaction and also fuels growth within that business,” he said. “The total cost of ownership is three times better [than on-premises]. It’s such a beautiful business model.”
Cloud of opportunity
For anyone starting an information technology-focused company right now, the cloud is unquestionably the place to be. Investment database Crunchbase lists nearly 13,000 companies that describe themselves as delivering cloud infrastructure, software or services. Bessemer Venture Partners’ State of the Cloud 2021 report said cloud companies’ valuation multiples, growth rates and access to capital are at an all-time high. It estimates investors poured a record $186 billion into private cloud companies in 2020 alone.
“Cloud companies have not just reset in the new normal but have thrived with a record-breaking market capitalization of more than $2 trillion,” Bessemer wrote. Among its other eye-popping findings were that the five top applications companies — Paypal Holdings Inc., Adobe Systems Inc., Salesforce.com Inc., Shopify Inc. and Zoom Video Communications Inc. — were collectively worth more than $1 trillion at the end of last year.
Meanwhile, the total market capitalization of all cloud firms more than doubled from $1 trillion in February 2020 to $2.2 trillion a year later. Initial public offerings in the market doubled last year from 2019 while the number of companies that saw their market value double in value immediately post-IPO was higher than in any year since the dot-com boom days of 1999.
Why is the market so hot — and why now? Interviews with more than a dozen executives at cloud startups and venture capital firms identified several factors.
Low capital cost
The low cost of capital fueled by near-record low interest rates has left investors with few options for growth. That has helped boost both the stock market and the venture capital business for the last several years. Venture funds raised a record $69.1 billion in 2020, according to Pitchbook. Loans are cheap as well.
At the same time, barriers to entry have fallen thanks to cloud infrastructure. Entrepreneurs no longer have to raise millions and hire people to build and staff data centers. Instead, investments go directly into building and selling products.
“You used to have to rack and stack servers and build a massive scale-out system,” said Steven Mih, co-founder and CEO of Ahana Cloud Inc., which curates a commercial version of the open-source Presto distributed query engine. “Now you get as much as you want as fast as you want.”
Moti Rafalin, CEO of vFunction Inc., a four-year-old application modernization startup that has raised more than $12 million, said his first startup in 2007 had to buy servers. “Today I don’t have an IT person,” he said.
Cloud marketplaces have been a game-changer for upstart firms trying to get a foothold. They address one of the biggest impediments to entry in the software business, which is getting the first few customers on board. In most cases, customers can experiment with software in a marketplace for little or no cost. Although startups must pay for marketplace space, the exposure they get is often well worth the cost.
Marketplaces “have made software more accessible, and payments can be done through cloud providers’ billing,” said Enrique Salem, managing director at Bain Capital Ventures and former CEO of Symantec Corp. “You have the opportunity to make your product and service available to lots and lots of customers.”
Marketplaces have also become potent sales and marketing channels for some companies, which use partnerships and relationships with other players in the ecosystem to open doors with prospective customers. “The partner ecosystem gives us a lot of operating leverage from a sales and marketing perspective because we can be an upsell to some of their existing customers,” said David Sikora, CEO of ALTR Solutions Inc., a maker of enterprise data security products based upon blockchain technology.
“We used to always be in top-down sales situations,” Salem said. “Now we’re seeing pull where the buyer can use the software easily and we don’t have to do a hard sell.”
A related factor, usage-based pricing, has lowered sales costs and raised the revenue ceiling for successful startups that no longer need to persuade early customers to drop tens of thousands of dollars on an untested product. They also aren’t up against a revenue ceiling, since the upside of pay-as-you-go pricing is limitless.
“It minimizes the friction of getting started by allowing the customers to start at a low cost and only pay more as they receive more value,” Bessemer wrote. “Essentially, you’re… sharing in your customer’s success as you scale with them.”
The combination of marketplaces and usage-based pricing has even helped rejuvenate the market for commercial open-source software companies, which have long struggled to persuade customers to pay for software they can get for free. Managed services in the cloud enable organizations to dial up often complex open-source applications and start using them immediately without the hassle of installation and configuration or the need to find the requisite skills.
“Managed services is part of what we see as the evolution from on-prem to the cloud,” said Ahana’s Mih. “It is where we see a lot of this business going.” Ahana launched a managed version of Presto last fall and said it saw a “phenomenal” response.
New exit options
Every entrepreneur dreams of an IPO, but the more likely exit event is a sale to another company. A new class of involved and growth-oriented private-equity firms has created in recent years to become a third alternative.
Tech-focused investors such as Thoma Bravo LP and Vista Equity Partners LLC have broken with the stereotype of private-equity firms as ruthless cost-cutters by showing a willingness to invest in their acquisitions for the long term. Cross-fertilization among their portfolio companies can make each acquired startup stronger and open cross-sale opportunities.“There are a lot of great business models that these portfolio companies can tap into to see what best-in-class looks like,” said Christal Bemont, CEO of Talend SA, which recently went private in a sale to Thoma Bravo. Rather than being an endpoint, a sale to an activist PE firm can ready an acquired company for a new round of growth and another IPO. “I hope to be right back giving quarterly earnings in the not-too-distant future,” Bemont said in an interview with SiliconANGLE last month.
A recent Gartner Inc. report forecast that acquisitions by financial services firms grew 30% in the fourth quarter of 2020 compared to the average of the prior two years. “There’s a shift toward more companies going public through acquisition where it’s difficult to establish valuation otherwise,” said Max Azaham, the report’s principal author.
A dash of paranoia
Even as all these factors have reduced the cost and time of launching a business in the cloud, the benefits of cheap capital, managed infrastructure and marketplaces are available to competitors, too. Cloud startups also need to constantly look over their shoulder to be sure someone isn’t gaining on them.
“We had the first-mover advantage, but within the first six months there were three new competitors,” said Om Moolchandani, co-founder and chief technology officer of Accurics Inc. a two-year-old maker of self-healing infrastructure software that has raised $20 million.
Far from being a problem, though, Accurics saw challengers as validating its business. “Lack of competition isn’t good for an industry because you can’t attract more money,” he said.
Most executives who were interviewed said competition isn’t a major problem because the potential market is so big. “Seventy percent of the market still uses some version of on-premises software,” said Bain’s Salem. “That will shift, and a lot of customer dollars will flow to cloud companies.”
That’s one reason early investors aren’t obsessing over TAM, or total addressable market, a favorite acronym on Wall Street. The database addressable market is rather large – so large it is almost meaningless.
“I typically do not like TAMs; however, investors do,” said Michael Howard, CEO of open-source database supplier MariaDB Corp. With Gartner estimating that the cloud database market is already $10 billion and growing 40% annually, the rising tide will lift even small boats. “If you can have a low penetration rating, and still come up rosy, you are in a good place,” Howard said.
Early-stage investors, in particular, assume that growth will take care of itself. “Trying to fully size the market at that stage is a little naïve,” said Vivek Ladsariya, founder and partner at venture capital firm Sinewave Ventures LLC. “There’s so much growth at that top line that the bottom line is going to be so much larger than it is now.”
The elephant in the cloud, of course, is the big three infrastructure-as-a-service providers: Amazon Web Services Inc., Microsoft Corp. and Google LLC’s Cloud Platform. Each has the market power to squash upstarts. Bt they also rely on ecosystem companies to validate their platforms. Every entrepreneur who was interviewed was aware of that threat, but none expressed much concern about it.
“They have the resources to build anything under the sun, but they don’t have the focus,” said Accurics’ Moolchandani, echoing the opinion of others. In the meantime, “they can help startups like us by reducing the cloud bills.”
“On balance, they’re good for us,” said ALTR’s Sikora. “We run our platform on AWS and a lot of AWS capabilities have been woven into our workflows.”
Software-as-a-service firms are especially preoccupied with ecosystems and many actively cultivate the startups in them. “Salesforce has invested from the beginning and continues to help us coordinate and scale our joint go-to-market campaigns,” said Ted Elliott, CEO of Copado Solutions SL, which makes low-code agile development tools specifically for the customer relationship management giant.
Who’s getting funded
The factors that make for success in the cloud aren’t all that different from other markets, but the speed of everything has been accelerated. Investors currently favor firms in large and fast-growing markets such as data analytics and cybersecurity, but they also look for innovation in disruption-prone mature markets such as data backup. They like startups that aren’t tied too closely to a particular IaaS platform or, even better, that can help those platforms grow their businesses.
VC Ladsariya cited the example of Databricks Inc., a maker of a platform based on Apache Spark that unifies data from across multiple locations. The company was exclusive to Microsoft’s Azure in that cloud platform’s early days and became an indispensable partner “because they were primarily focused on bringing more data to the Azure platform,” said Ladsariya, who was an early Databricks investor. As both companies grew, Databricks diversified to other clouds and was recently valued at $28 billion.
In another example, Ladsariya likes ShardSecure Inc., developer of a security technology that deconstructs data into small pieces for storage across multiple locations. “That way, even if the cloud storage is compromised, the data is secure,” he said. “For companies that didn’t adopt cloud for security reasons, this will help drive cloud adoption.” And that’s something the big cloud providers will want to promote.
A feel for the market
In a high-growth, rapidly changing market, startups are likely to be less the product of rigorous research than of field experience and knowledge of customer struggles. Events such as COVID-19 also shifted some market opportunities in overdrive.
“In 2020 there was a massive shift as customers were moving their entire data estates to the cloud and the need for protection was critical,” said Simon Taylor, CEO of data backup and recovery-as-a-service startup HYCU Inc. The four-year-old company originally sold its software tied to hyperconverged hardware, he said, but “we saw a drastic increase in inbound inquiries with more referral business from the public cloud.” HYCU pivoted, with immediate results. Taylor said sales grew 450% in the past year and HYCU closed a giant $87.5 million funding round in March.
Copado was launched by two former consultants who had specialized in Salesforce.com implementation. The frustration they encountered configuring parameters by hand sparked the idea of an agile development platform specific to Salesforce.
“All of our investors are consistent that the important thing is to focus on solving the biggest customer problems,” Elliott said. Having been in the trenches with customers, it wasn’t difficult to figure out what those problems were. Copado has raised more than $130 million and estimates it has penetrated less than 5% of the potential market with minimal competition so far.
Similarly, cloud media management firm Cloudinary Ltd. started out as a consultancy and built its product to make life easier for its own people. “It was a solution we needed for ourselves,” said CEO Itai Lahan. “We knew the problem and we knew the landscape. This was our domain.” The privately held firm claims to have reached an $80 million annual run rate without raising outside capital. “Throughout 10 years we had more than enough revenues to fuel all the initiatives we needed,” Lahan said.
It just works
With self-serve cloud marketplaces becoming a prime sales and marketing channel, ease of use has also become a top funding draw. The faster a prospective customer can see value in a trial, the quicker the sales.
“Ease of use allows startups to have a wide range of users, not just those in the traditional tech bubble,” Ladsariya said. Startups that simplify multicloud complexity or help manage software containers have done particularly well. Simplicity is also a strong selling point in multicloud environments, which can be orders of magnitude more complex than single clouds.
The best candidates show value quickly out of the box. Cloud security startup Wiz Inc. built a tool that performs a rapid scan of a company’s entire cloud stack to identify vulnerabilities that may be buried deep in virtual machines. “Companies deploy the tool and, in a few minutes, they can see what they’re going to get,” said CTO Ami Luttwak. “I can prove it in any environment in minutes.” Wiz has raised $350 million.
HYCU made simplicity a core design principle for its cloud backup service. “We wanted it to be so simple to use that customers would get up and running in minutes,” Taylor said. Ease of use “is a massive part of our retention strategy and can’t be added on after the fact.”
Bain’s Salem likes the simplicity proposition of Moveworks Inc., a Bain-funded venture that integrates with a company’s IT service management platform and uses machine learning to handle common service requests without requiring involvement by IT administrators. “They’ve done a great job of serving up content that integrates with IT’s existing tools,” he said, thus making life easier on both sides of the transaction.
Investment firm Tercera LLC is betting on services, believe that customers’ needs to simplify increasingly complex private, public and hybrid cloud environments in a skills-constrained market will spur demand for specialty firms. “Companies will continue to add more cloud capabilities across their value chain and there will be a greater need for specialized services partners to support them, especially with the growing talent gap that exists out there right now,” said Tercera CEO Chris Barbin.
Launched in January, Tercera has already made its first two investments, managed identity services firm BeyondID and Terazo, the business name for APIvista LLC, which specializes in application programming interface-based integration.
The brass ring for any enterprise technology business is to become so essential to customers’ operations that it becomes impractical for them to switch to something else. One way to do that is by helping enterprises manage services across multiple cloud infrastructure platforms, which is something the major cloud platforms won’t do on their own.
“A lot of companies don’t want to be their businesses on one cloud,” said ALTR’s Sikora. “Maintaining that agnostic perspective will be strategically important for us.”
Technology that traverses multiple clouds also, by definition, deflects direct competition from the large cloud vendors and simplifies deployment for customers. “It’s like going back to the day when we had to port to Windows, X86 Solaris and Linux,” said Ahana’s Mih. “We need to be cloud-native in each one.”
“Every cloud vendor will have backup and they should,” added HYCU’s Taylor. “Customers want to have one simple platform. Being able to move between clouds prevents them from being locked in.”
Startups that spring from the open-source world use their domain knowledge to underline their indispensability to the projects they support. Databricks’ deep involvement Apache Spark helped burnished its image as the best commercial partner for companies wanting to use that technology. Dremio Corp. does the same with Apache Arrow, Ververica GmbH with Apache Flink and Confluent Inc., which filed for an IPO in April, with Apache Kafka.
Ahana’s active involvement in the Presto project not only keeps the product fresh but serves as a passive marketing platform. When AWS customers run into trouble with the cloud giant’s Athena, a serverless version of Presto, “they come to us,” Mi said. “With five of the top 50 contributors, we have a competitive edge.”
Turn on a dime
Although agility is a given for any startup, it’s even more important in the cloud, where new competitors come out of nowhere and cloud platform providers can acquire rivals and use their market might against smaller rivals.
Most cloud entrepreneurs who were interviewed said their path to the market took several twists and turns, and that the ability to avoid becoming too invested in the original business model was essential. “That thing you build first will never be what you finish out on,” said ALTR’s Sikora.
Sunlight.io Ltd. originally set out to design a virtualization stack for Arm processors. “We quickly realized that the requirements for deploying enterprise applications at the edge, in constrained compute environments, had the same set of requirements,” said Chief Strategy Officer Kosten Metreweli. “We’ve now built out the full hyperconverged stack to support running any application on edge hardware.”
Accurics’ Moolchandani advocates a “fail fast” approach. “Decide whether you want to launch an iteration or addition and do it quickly,” he said. “Try to get real feedback from people who are not your friends but who want you to become successful.”
Advice can come from investors, customers, ecosystem players and close monitoring of rivals. For open-source companies, communities are invaluable. “We received quite a bit of feedback from the open-source community in terms of how we were offering our solutions,” Moolchandani said. “We had to make adjustments to our pricing model and change our product delivery model in a way that was more acceptable.”
Added, MariaDB’s Howard, “Open source certainly keeps things moving in terms of innovation, opinions and even open criticism. That’s the best part of open source.”
Successful entrepreneurs never assume that a successful launch is a long-term franchise. Competitors will inevitably emerge and bring down prices. Investors advise companies to think about enhancements and extensions even as they are bringing a first product to market. That’s why backup vendors say they’re in the data protection business and Snowflake Inc. shed the “data warehouse” label from its products in favor of “data cloud.”
Bain’s Salem cites Redis Labs Inc., a database vendor in which it has a stake, as having done an outstanding job of expanding beyond its roots as a cached key-value database management system to position itself as a real-time platform with global reach. “Ideally, you’re looking for opportunities that are across multiple segments,” he said.
Up and to the right
The last great internet investment frenzy petered out in the early 2000s in large part because of overinflated expectations about the speed at which businesses and consumers would change. That isn’t the case this time, executives and investors agree. In fact, few companies are thinking about exit strategies at this point because so many options exist.
“I try not to focus too much on where this will end up,” said ALTR’s Sikora. “None of the positive outcomes are possible if we’re not focusing on the day-to-day blocking and tackling.”
Copado’s Elliot agreed. “Too many start-ups are thinking about the end when they should focus on growth and customer success,” he said. “Companies that deliver real customer value and solve problems others can’t have a multitude of options.”
Unlike the first dot-com boom, there is abundant evidence that the cloud market is still in the early stages of a growth story that will play out for years. “Seventy percent of the market still uses some version of on-prem infrastructure,” said Ladsariya. “That split will shift, and a lot of customer dollars will flow to cloud companies. The venture dollars will follow.”
With few alternative paths to growth and all trends pointing up and to the right, it appears that there will be plenty of investment options available to entrepreneurs who can navigate the cloudy, tumultuous skies for some time to come.
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