Editor’s note: Aly Lovett is a Partner at Radian Capital. Prior to joining the firm in 2017, she was an Investor at FTV Capital and TA Associates, where she focused on enterprise technology and healthcare investments, respectively. Previous to this, she was a Banker at Centerview Partners and a Fixed Income Trader at UBS.
What drove you to build Radian Capital and what’s its core investment focus?
I’ve always loved investing, but also wanted to do something a bit more entrepreneurial. So when the opportunity presented itself to partner with Jordan Bettman and Weston Gaddy in 2017, I jumped on it. Five years later, we’re a team of nearly 25 and are investing out of a $525 million fund. It’s been a crazy ride so far and one that’s given me a lot of empathy and appreciation for the entrepreneurs we partner with.
In terms of our investment strategy, it has three key pillars: concentration, focus, and support. We believe in high-conviction, high-concentration investing. Building a concentrated portfolio allows us to achieve alignment and partnership with the teams we’re backing. And, since we only invest in spaces we know and love, our focus is on software and marketplaces. Lastly, we believe it’s critical to be supportive not just at the board level, but also on a day-to-day basis in terms of strategy and tactics. To accomplish this, we’ve built out an operating team that supports our portfolio across key functions such as growth, talent, and embedded financial services.
What types of companies do you invest in and why?
At a high level, we’re attracted to capital-efficient, founder-led businesses where the CEO is looking for balanced growth and a true partnership. More specifically, we’re looking for growing companies with differentiated products in attractive end markets. We’re comfortable as either minority or majority shareholders and are happy to provide primary or secondary capital as part of a transaction. In terms of stage, we typically invest between $10 million and $60 million in businesses that are squarely in the execution risk phase of their life cycle, which is where we believe our operating team can be disproportionately helpful in optimizing key functional disciplines.
Our internal investment philosophy is guided by our Radian Maxims, a set of investment principles that frame key areas for deeper analysis during diligence. For example, we think an important question to ask of any investment is “when you turn off revenue, there should still be an asset, so why does this business have value beyond its P&L?” As an investor, it’s easy to make decisions by looking at a profit and loss statement. And as a technology investor in recent economic environments, it’s been easy to look at revenue growth, see strong performance, and decide that a business is a worthy investment opportunity. But that simplicity often overlooks why the company actually matters. Put another way, we want to understand what moat exists around the business that would allow it to out-compete its competitors.
…we want to understand what moat exists around the business that would allow it to out-compete its competitors.
For us, the starkest framing of this question is to think through what the asset value of a business with zero revenue would be. If the company had the same product and cost structure, but no dollars coming back from customers, would it still have asset value? Would it still be interesting? We believe having a strong affirmative answer to these questions is key.
What defines whether or not a company has asset value varies based on the situation. One possibility is network effect. By definition, a business with network effects gets stronger with each incremental customer and should continue to build and grow value that others would want, even without revenue.
Radian is very focused on capital efficiency. Which unit economics do you pay the most attention to and why?
From a top-down perspective, we think the overall health of a company can be viewed through metrics like sales efficiency, ARR per employee, and contribution margin-adjusted growth. From a bottom-up perspective, unit-level customer economics typically provide the most granular insights into a business.
Unit economic inspection is among the most important analyses we do to not only understand where a company has been, but also where it’s going. It also helps us be better partners to the CEOs we back because it shines a light on the capital investment decisions they’re making. For example, we spend a disproportionate amount of time unpacking gross margin and all of the associated assumptions a company has made around sales, services, customer success, and R&D. That way when we ultimately calculate metrics like payback period, LTV, and CAC, we’re able to get a better picture of the health of the business’s current growth engine as well as valuable insights that help shape our thinking around capital allocation going forward.
Where do you see the biggest opportunities for value creation over the next decade and why?
Within software and marketplaces, we’re big believers in a vertically focused approach. If version 1.0 was early, on-premise license and maintenance software and version 2.0 is horizontal cloud solutions, then version 3.0 will be more focused, tailored verticalized players capable of solving their constituents’ idiosyncratic needs.
That doesn’t mean we won’t back great horizontal software players, but in somewhat of an antithetical approach to venture, we believe that big fish in small ponds can create more sustainable and predictable value over the long run. There are two reasons why.
The first is that market leaders generally have better unit economics as CAC goes down and LTV goes up over time. The second is that most people often underestimate the TAM and SAM of these markets. When you start with core marketplaces or mission-critical software, you don’t just have the opportunity to sell software. You also have the opportunity to sell other critical services that companies need.
For example, we have a portfolio company called Traxero that serves the towing industry. Although their primary business is selling dispatch and routing software to tow operators, they also have the right to sell them payment services, small-business insurance, payroll and background checking, digital certified mail (to formally notify consumers that their car has been towed), and auction capabilities (for when a car is not reclaimed). All of this creates a reinforcing mechanism that makes the company’s products even stickier with customers and improves unit economics through additional revenue and higher margin per logo.
In addition to Traxero, we’ve invested in numerous vertical marketplaces (e.g., TCGPlayer, Niche, Aper, and Yardzen) and vertical software providers (e.g., BriteCore, Encompass Technologies, Ungerboeck, and Vantage Point Logistics). And we think this trend is just getting started.
Can you tell us about a few of Radian’s other recent investments, why you’re excited about them?
Sure. Many of our recent investments are the result of thematic sourcing initiatives, including vertical-specific deep dives where we think version 3.0 solutions will be better positioned to solve the unique needs of their end markets, or market research into pain points that enterprise buyers are flagging. Two of our more recent investments in companies called Browzwear and GreyNoise reflect these efforts.
Co-headquartered in Israel and Singapore, Browzwear provides 3D design software to retail and apparel companies to expedite the design process for garments. We’ve been excited about vertical-specific design tools for a while and identified the apparel industry as one ripe for tech enablement. Clothing design is still largely analog and requires multiple physical sample garments to be produced before the design is finalized. Browzwear greatly reduces the time between an initial conceptual design and a ready-to-produce final design because it’s a tailor-made tool for the industry.
In the case of GreyNoise, we kept hearing about the challenges facing SOC analysts and the acute security labor shortage — too many security alerts to triage and not enough people to do the work. Based in Washington, DC, GreyNoise is a cybersecurity company that collects and analyzes internet background noise to reduce false positive security alerts and identify emerging threats. Their software and data product identifies safe vs. malicious IP traffic in real time by filtering out the noisy traffic from friendly internet scanning tools, identifying malicious automated mass exploitation, and enabling automated responses. GreyNoise has an almost immediate efficiency ROI, driving better security outcomes by helping teams identify threats faster so they can focus their attention on the scary, targeted stuff.
How would you characterize the current venture capital market and where do you think things are headed?
We believe that what started as a crisis of valuation will become a crisis of performance for many software businesses. Continued economic and political uncertainty plus a higher cost of capital will inevitably change buying behavior. As such, the next incremental CAPEX project, software RFP, budget allocation, or headcount addition must be weighed in the context of the current environment. In that sense, even the smallest change to the equation — and the changes will likely start small — will elongate software sales cycles, defer decisions, or right-size technology budgets, thus deteriorating metrics for software vendors. Put another way, CAC will likely go up and customer LTV will likely go down.
…what started as a crisis of valuation will become a crisis of performance for many software businesses.
Companies that are meeting or beating numbers may stop doing so, which we believe will have negative implications for valuations and the cost of capital. Similar to our stance in early 2020 when we were just entering the pandemic, we have been counseling our team and portfolio company CEOs to adopt this cautionary view. Once they do, the implications are clear. The first is to assume that the fundraising environment has become more difficult. Thankfully, this isn’t a departure from business as usual for Radian portfolio companies, where we urge an approach to capital predicated on raising only out of opportunity rather than necessity and focusing on solid unit economics and capital efficiency. The second is to ensure businesses are resilient by baking in buffers to budgets, balance sheets, and operating metrics based on the assumption that headwinds are coming.
What advice would you provide founders on strategies to navigate an increasingly difficult market for venture capital?
The fundraising environment has become more difficult for founders, and those choosing to raise equity are doing so at compressed multiples relative to 2021. As I mentioned earlier, it is preferable to raise out of opportunity rather than necessity and to have enough capital to provide an adequate buffer to navigate a range of scenarios.
While equity plays a critical role in helping many founders achieve their desired outcome, it’s not the only option. There have been several instances across our portfolio where we’ve successfully employed venture debt to extend the runway, invest in growth initiatives, and fund acquisitions, all while reducing dilution and maximizing strategic flexibility as it relates to our initial underwriting.
That said, often the cheapest form of capital is revenue from your customers, so be focused on building tools and services that will attract and retain the entities you care about most. That’s not to say that growth isn’t important — it is. But now may be the time when companies need to go slow to be able to go fast later on. Survive, then thrive.