Brad Bernstein explains how growth equity firms are navigating “false positives” in the SaaS market.
Video Transcript
[17:14] Host
FTV Capital is one of the many investment firms tailoring its software investment strategy to the AI era. To talk more about the software landscape at large, I want to bring on Brad Bernstein, managing partner at FTV. Brad, welcome to the show. It’s great to have you here.
[17:29] Brad Bernstein
Thanks so much for having me. It’s a pleasure.
[17:31] Host
So just remind us here, FTV — are you private equity? Are you venture capital? Are you both?
[17:36] Brad Bernstein
So we are a growth equity firm, so we only invest in high growth businesses. Our average company that we invested in had about a 50% growth rate last year and we specialize in those high growth businesses that have demonstrated and validated their markets, their products, but are still in high levels of growth. And we don’t use much debt. So we’re not leveraging up these companies. We’re really leaning into operational leverage.
[18:03] Host
Got it. Okay, so I want to get your take then on a couple of the hot button issues that we’ve been reporting on here at The Information. Look, the last reporter that just came on before you, we were talking about the pricing model changes that Anthropic has embarked on and how customers are eating those costs. And we haven’t really seen a diminishing in demand yet. You work with dozens of software companies in your portfolio. How are they dealing with the issue of pricing model changes at Anthropic and also pricing model changes broadly around the AI ecosystem?
[18:38] Brad Bernstein
It’s such a great question because right now is really a period of massive experimentation and so people are less focused on the cost and more about figuring out what they can do with this technology, especially when you’re comparing it to the cost of additional headcount. So the ROI is there and people are trying everything, but there’s also real risk that there’s false positives in the market where people look at the demand or the usage and think it’s sustainable forever, or think it’s just going to keep growing forever. But to your point, as pricing is changing, we are going to see people evolve what they do, how they do it. You’re going to see more interest in open source smaller LLMs. You’re going to see smaller LLMs that serve purposes in a more cost effective way. Even at FTV we have certain things that we encourage people to use ChatGPT for because it’s cheaper, and then we have other things that are more complex where we might use Claude. So there’s already starting to be this and I think that’s going to be a bigger and bigger issue as time goes on.
[19:40] Host
When you say false positives, expand more on that — what do you mean?
[19:44] Brad Bernstein
Absolutely. The reality is that right now everyone looks at the growth in the AI market and they just see it as long term, permanently sustainable. But take myself for an example. I had three LLMs that I subscribed to last year. This year I’m down to two. I have a feeling that over time I might go to one. At a certain price point I’m willing to have multiple LLMs, but as the price goes up, I’m likely to reduce the number of LLMs I want to pay for. So I think there can be a lot of early adoption where people are experimenting and where the costs are subsidized and low, that drives demand that may ultimately go away.
[20:28] Host
I want to ask you a little bit about your strategy at FTV insofar as keeping talent at the portfolio companies that you’re working with. And the reason I ask this is because the talent wars is a topic that comes up time and time again in an era where all these application layer companies, AI startups, even AI labs, are hiring like crazy. What is the pitch that you’re making to folks working at your portfolio companies — some of whom are software companies that have been around a lot longer — to say, no, no, no, stay with us. Don’t go to the AI coding startup. I imagine the pitch is getting a bit tougher, right?
[21:08] Brad Bernstein
Well, look, all of our companies — the management teams have significant equity and in many cases the people we have at our companies are not necessarily AI experts. So we’re leaning into the training and helping them develop skill sets and they’re pretty excited about the equity they have. If you look across our portfolio, we have very high growth businesses, proven businesses, where they see a lot of opportunities. So the key is to demonstrate that we’re committed to innovation, we’re committed to growing the company and that we’ve given them fantastic equity packages. And very honestly, while there’s fantastic opportunities at many of these frontier labs and so forth, the work-life balance at some of those firms is pretty terrible. And you see some churn because of that, even with the high economics. And if you’re coming in at these very high valuations, it’s much less clear about what the future holds or how much higher you can go when your options are struck at close to a trillion dollar value. So that really hasn’t been an issue that we’ve seen with our talent.
[22:10] Host
Even with the SaaS apocalypse taking a beating to public market valuations of these software companies, you haven’t seen concerns from employees saying, hey, I have this equity, but I don’t know how much it’s going to be worth — given that ServiceNow is down 50% in the last year?
[22:29] Brad Bernstein
That’s a really key point. So let me unpack it a little bit. So where I think you do see the kind of issues you’re talking about is people that were doing these large, mature software company deals where they have very low growth rates, they’re using leverage. In some cases, the leverage is making it hard for them to pivot and invest aggressively in R&D. And they’re really worried that the buyout was done at too high a price. It’s a value trap and they don’t really see the path to an exit. I think you’re right.
In that segment of the market, where we sit, we’ve always been pretty disciplined about value at entry and making sure that even post-SaaS apocalypse, our entry prices still make a lot of sense. And we’re really investing around the fundamentals of exiting on an EBITDA multiple that makes sense in any environment. It’s sort of a cash flow fundamentals basis. So when you have businesses that are growing 50, 40, 30% a year and you have the opportunity to take AI as an accelerant and enhance the growth opportunities, and everyone can see that the model still makes sense and the exits still make sense, you don’t have those kinds of churn issues.
[23:43] Host
I wanted to ask you about the partnerships we’ve seen recently between AI labs and consulting firms. We saw OpenAI has now embarked on their own sort of consulting venture with a couple of other firms involved. They’re also partnering with firms like PwC. The role of the consultants is something that has fascinated me certainly in an era where the labs have their own forward deployed engineers. It’s sort of intriguing to me — is this competition? Which one is better? Do the consultants have a role if the labs have their own FDEs? What do you think of that?
[24:27] Brad Bernstein
I think it’s really interesting. The reality is we just don’t have enough skilled people to be forward deployed engineers or to do the consulting work as it relates specifically to AI. So I think it’ll be interesting to see — can these consulting firms that are coming together with multiple PE firms actually execute the vision? Sounds great. But it also sounds like there are going to be a lot of cooks in the kitchen and there’s going to be a lot of questions about whose portfolio companies get prioritized. Why one company versus another? What if the management team of a portfolio company has a different point of view on which LLM to use? I can see a lot of issues for conflict between the different shareholders at the private equity level, the portfolio companies, and even finding the resources. So I’m rooting for their success. But the execution sounds challenging from my seat.
[25:20] Host
Last question for you. We’ve reported on the GPU supply crunch and how in some cases venture capital firms — I’m thinking of General Catalyst — will help to negotiate these larger deals en masse for their portfolio companies to access chips and access compute. I’m not sure the extent to which the companies in your portfolio are actually involved in building their own models. But are you doing any of these kinds of mass negotiations on behalf of your portfolio companies?
[25:53] Brad Bernstein
We are not. We’ve built a lot of partnership relationships with the LLMs and other key players in the ecosystem. We feel it’s very important and valuable to be providing that connectivity for our portfolio. But we are not having any kind of GPU crisis or compute problem across our portfolio today.
[26:13] Host
Well, Brad, I want to thank you for coming on. That is Brad Bernstein, managing partner at FTV Capital, here on TI TV.