Tech investor who got in early on the cloud software boom discusses what happens next

Published Tue, Sep 1 202010:51 AM EDT

Key Points

Byron Deeter, whose firm has backed LinkedIn, Shopify, Twilio and DocuSign, said the coronavirus has accelerated the trends in software, forcing companies to deal with remote workers and distributed systems.
The Bessemer Cloud Index, consisting of over 50 cloud software companies, has jumped 68% this year, outperforming all major U.S. indexes.
Deeter said dozens of private cloud software companies are worth at least $1 billion, with many looking for the right time to go public.

A View from the Top is a Q & A series exclusively available on CNBC Pro . CNBC reporters will regularly speak with a business leader about decision-making, investing and industry news. The stock market's rally through a global pandemic and economic catastrophe may be the most surprising business story of the year. But for one particular sub-sector that's outperforming the broader market, the narrative is fairly straightforward. Cloud software was seemingly created for this era of remote work. Thanks to infrastructure from Amazon , Microsoft and Google , businesses no longer need to operate their own data centers and can have employees spread across the world, accessing critical applications from laptops, tablets and phones. Hundreds of companies have developed cloud-based tools for communication, collaboration, knowledge sharing and productivity. The BVP Nasdaq Emerging Cloud Index (ticker: EMCLOUD), consisting of over 50 cloud stocks, is up more than 70% this year, topping the Nasdaq and S & P 500, which are up 31% and 8%, respectively. The top performers in the index include video-chat vendor Zoom and content delivery provider Fastly , which have both gained more than 350%. The index gets its name from Bessemer Venture Partners, which created the basket in 2013 and five years later partnered with Nasdaq on an exchanged-traded fund. Byron Deeter, a partner at Bessemer focusing on cloud, says the coronavirus has been a "catalyzing moment" for the sector and a "whole class of companies that were essentially purpose-built" to guide employers through the current set of challenges and make remote work workable. Here's the full Q & A: (This interview has been lightly edited for length and clarity.) Ari Levy, CNBC: What's the macro story around cloud software over the last few months and the performance on the public markets? Byron Deeter: For cloud, this has been that catalyzing moment. It's essentially that iPhone moment where there's a convergence of a number of forces that accelerated this trend that was already taking root. Suddenly when people have to work from home, on-premise software, by definition, doesn't work or is clunky, and you start to realize that distributed collaborative systems can be better. Decisions that had been on the back burner that were viewed as important but not urgent are suddenly now also urgent and pulled forward. That's why we're seeing Zoom, Shopify for online storefronts, Twilio for telecommunications and collaboration, DocuSign for digital document processing, Square , CrowdStrike , just this whole class of companies that were essentially purpose-built for distributed collaborative cloud-based interaction and communication. (Bessemer was early investor in Twilio, and Deeter is on the board. The firm also backed DocuSign and Shopify.) A large part of the reason the economy is holding up and why people are still able to do business is that we have cloud platforms that allow it. If this had happened 10 years ago even, it would've been a very different experience. Business would have been broken and the social interaction piece of this would have been much harder. As you look across your portfolio, what are some of the things companies are doing differently in this environment? Companies have moved from defense to offense in the cloud space. The absolute decimation of physical events, which was a big driver of cloud sales, has caused a reset in go-to-market models. A lot of these groups are restructuring how that SG & A line is allocated and you're shifting meaningfully away from physical events spending, enterprise sales activity and doing much more account-based marketing in targeted one-on-one ways. The virtual events have been surprisingly effective. There may be some fatigue factor over time there. But if you look at DocuSign, Gainsight, Okta , Twilio, they all had spring annual events and scrambled to move from in-person to virtual. Attendance levels were up multiples from where physical events would have been. They're seeing the pipeline is actually real. The efficacy of that event was net higher than in-person events. There's the question of what does 2021 and beyond look like. This has definitely opened eyes to lower-cost more hybrid customer acquisition models and some of those shifts will be permanent. How are they dealing with office space and what are they communicating to employees? A lot of our companies have said across the board, don't come to office this year, whether that means the calendar year in most cases or, in some cases, the next 12 months. Many of those are sitting back saying longer term we're going to reevaluate our office culture. That hasn't been a cost-based decision yet. Companies aren't yet adjusting salaries by geographies, aren't yet scaling back real estate. These are often long-term leases. From the work-from-home adjustment, are you seeing any companies where it's a net negative so far? A lot of our teams are saying they miss the collaboration, mainly in small groups. In early-stage companies, where daily white board collaborations or product launches with the team, just getting the personal connectivity and trust among executives and sub teams has been much harder, particularly for extroverted team members who get energy from those interactions. But right now people say the net positives are surprisingly good and in some cases outweigh it to the point where they're saying maybe the work model of the future is one where the office is the meeting spot, not the place you go daily to do your emails and write code. You could envision scenarios where several days a week people are allowed or encouraged to be home and you're coming in for those group activities and in-person interactions. A lot of early-stage companies we work with are trying to provide more collaboration and provide this foundation for companies to operate in a distributed environment. Some gaps are going to be filled, and the human interaction piece will be the main driver to coming into office. What about San Francisco? The exodus is real. These discussions are extremely active. We have multiple companies in our portfolio that are talking about, do we ever need to go back to the office? Why fight the SF fight? The impact on the city is going to be significant and I absolutely think it will be long-lasting. Where are they going? The absence of an anchor headquarters has become the most active discussion. The model I think most companies are settling on is to dramatically reduce the scale and scope of SF, no longer require a headquarters presence and come up with an operating model that allows for more distributed teams and a cadence for in-person interactions. We have some companies that have decided to drop offices entirely, others where teams are moving to Salt Lake City or embracing a fully-distributed model and CEOs will rotate through their main geographic clusters throughout the year and see what model works best. It's an active topic in every company right now and a surprising number are seriously considering permanent structural change. We had this IPO filing bonanza last week, so we would expect all of those to go out in September, maybe into early October. Do you think there's another wave after this, and what's driving the activity? There's a massive backlog of private high-quality companies that have been waiting for market windows and there's a sense that the getting is good right now and many don't want to miss this opportunity. With the uncertainty of the election, with the backlog of unemployment that will have to play its way through the economy, the global health pandemic crisis continues, there's just immense anxiety about what 2021 is going to bring. Many of these companies overthought it and waited too long and probably should've been public months ago and are now trying to get out while there's still some stability in the market. We're all surprised by how quickly the tech sector bounced back. With the enthusiasm from the buyside for these offerings, I think there will be tremendous demand in the next couple months and absolutely we're going to see many more file. Other than Snowflake, we're still not seeing the filings the people in your shoes are most excited about, the ones in $7 billion to $10 billion valuation range with revenue growing 100%. Do those companies have plenty of cash so they don't need to go out or do they need another year of metrics? Most of them don't need another year of metrics, so it's the former more than the latter. Most of the high-quality cloud companies are not going to try to thread the needle between Labor Day and the election and are hopeful the market holds for what will probably be a late Q1 or early Q2 next big window. But there's immense uncertainty there. You've got this class of companies that was really pent up and ready to go that will hit before the year-end and then a gap before the others come through. It's staggering how many high-quality companies are backed up in the medium-term queue that in prior times would've been public by now. Dozens and dozens of fabulous cloud companies worth more than $1 billion are sitting there slow rolling this event and waiting for a stronger more stable 2021. Do you worry about that at all? This feels like a particularly volatile wait-out. It is a great time for offensive-minded CEOs to get public, to use that currency, to make some strategic acquisitions, solidify the balance sheet and set themselves up for the next horizon ahead. I absolutely suspect that many of these companies will have waited too long and, as this market cycle plays out, will sit back and say I wish I had been more aggressive. The ones that aren't going out now may regret it and may not have the window and may find that competitors were more aggressive and were able to use their balance sheets and cap tables in more offensive ways. There's so much private capital available. The private valuations have mirrored the public valuations and the CEOs are saying there's no rush. I do think they're missing part of the picture and part of the rationale for why companies go public and strategically they may miss those pieces over the next year when markets go through another cycle. What do you make of the SPAC boom, and how much should we expect VC-backed companies to participate? I love that there's financial innovation in the IPO process. The IPO markets structurally need to evolve and it's taken them way too long so the outside pressure continues to mount. That's why there's this flood of SPACs. That's why there's these discussions around direct listings. It's to get rid of this old and somewhat broken IPO process. I think SPACs will become much more relevant for that middle tier of companies that may not be the rocket-ship IPOs but deserve to be public. You'll see the economics of these SPACs be negotiated down so they start to look more like IPO economics, but be clean and fast vehicles and viable options. I'm also hopeful we'll see more direct listings and that ultimately that model with shorter lockups and open bidding is the right way to actually get companies public and that some companies will be bold and support the trend and help open that up more directly for the markets. Do we need a way for companies to raise primary capital in direct listings? Absolutely. A lot of these disclosure rules were well-intentioned and safeguards for the market that go back to an era where there wasn't the internet and Twitter, where information dissemination was slow and needed to be guarded and managed. That's not the case anymore and the systems are instantaneous. The reasons for the legacy IPO process are no longer as relevant. I absolutely think the direct listing mechanism is the right one, primary capital absolutely should be a part of that and that you're going to get a match for the size and a stronger shareholder base. What does the M & A environment look like heading into the fourth quarter? The multiples are making it hard. When the market pulled back, the expectation of activity spiked dramatically. If the markets had stabilized there, the second half of this year would've seen a flood of M & A. As multiples come back instead I think we're going to see a flood of IPOs. It's pushed back the M & A discussions because it's just really hard to find a match. The best companies can go public at big multiples, control their own destiny and be independent and are choosing to do so right now. WATCH: Diversified customer base has helped during Covid: Twilio CEO