It was a beautiful Tuesday San Diego evening as local software founders and operators gathered around SEG’s patio at our Fireside Chat. With cold beers in hand, guests networked and engaged in discussions around the evening’s topic – raising capital. Sheldon Lewis, our guest speaker, drew from his diverse background as a strategic buyer, private equity buyer, and early stage investor to lead the discussion.

Sheldon originally worked with Mainsail Partners, a San Francisco-based growth equity firm, as an Associate and Senior Associate. During his time there, Sheldon was responsible for sourcing and executing new investments, as well as working with portfolio companies. Sheldon sourced and executed Mainsail’s investments in Steelwedge, The Bar Method, and notably, San Diego-based PayLease. In 2009, Sheldon recalls sourcing PayLease when he was unable to find his missing checkbook to pay his rent. He was shocked there was no easier solution at the time, especially being in San Francisco – a major tech hub. After conducting due diligence and scouring the web for “pay your rent,” Sheldon came across PayLease, and eventually Mainsail invested in the company.

After the acquisition, Sheldon was relocated to San Diego where he worked at PayLease for four years. In 2014, PayLease was acquired by Francisco Partners. Instead of transitioning back to Mainsail Partners, Sheldon fell in love with San Diego and stayed with PayLease as the Senior Vice President of Corporate Development and Business Development, identifying and executing strategic initiatives to accelerate the company’s growth trajectory. In 2017, PayLease was acquired by Vista Equity Partners. Sheldon recalls it was a successful exit for everybody involved, and it allowed him to get back to what he always wanted to do: invest and be on the buy side.

About four years ago, Sheldon started his own investor syndicate, The Investor Group, and started making local investments in San Diego. Among others, Sheldon has made investments including Slantrange, eSUB Software, Chubbies Shorts, CureMetic, PetDesk and Mana Ventures. Sheldon recently started a new fund, Blueprint Equity, and is the Managing Partner. Blueprint Equity is a technology-focused investment firm based in San Diego.

Here are a few highlights from the discussion:

Q: What does the market landscape of early stage investors look like in San Diego?

Sheldon: The market has definitely changed over the last five to six years. In my opinion, it has improved significantly for both investors and entrepreneurs. Investors and software entrepreneurs are interested in San Diego for many of the same reasons.  Nowadays you can work wherever you want. You can still have great talent and live at the beach without having to pay for San Francisco office space rates.

In addition, more funds recently arose in San Diego. For example, Clear Vision Equity Partners, a new fund started a little over a year ago, has made a number of investments in San Diego. Seed San Diego, which invests in early stage technology companies, has also been active. Blueprint Equity, my new fund, will be active in San Diego as well.

Q: For someone new to the process, how do you define early stage investments?

Sheldon: Typically, people view investment types as bifurcated – either venture capital or private equity. Over the last 10 years, however, a third category known as growth equity has emerged which sits in the middle of the two. Backing up a little, venture capital invests in companies that are brand new or have the opportunity to be a unicorn. These companies don’t necessarily need to have revenue or a product for that matter. In comparison, private equity firms typically invest in companies with $25M in revenue or more. A lot of times private equity firms are using leverage – utilizing debt to help them buy companies.

Additionally, the return profiles are very different. For venture capitalists, there is a loss ratio of about 60%. In some respect, they’re throwing darts in the dark, but they do have the chance for 1,000x returns. Alternatively, private equity is a lot more steady. They are targeting later stage investments and more modest 2-3x returns.

Growth equity, which has become more popular in recent years, invests in companies generating $5-25M in revenue. They typically look for companies that are growing and often times bootstrapped. My fund, Blueprint Equity, is classified as early stage growth, indicating that we invest in companies typically in the $1-5M revenue range.

Q: What is the biggest mistake (or top 3/5) a company can make when raising capital?

Sheldon: The biggest mistake you can make when raising capital is being dishonest. In the diligence process, dishonesty doesn’t always get caught, but it probably will. If it does go past the diligence process and the deal is completed, it can lead to serious implications down the road. Not having a thorough handle on financial related information and key KPI’s can certainly create risk.  Missing projections is another common drag on valuation… A process may take 3-6 months and during that time frame you will provide buyers and investors with financial projections. Forecasting is a tricky balance because you want to provide aggressive projections to drive valuation, but significantly missing projections may very well imperil a possible deal.

Q: Can you rank order your view on key valuation drivers? (i.e. growth, TAM, EBITDA, etc.)?

Sheldon: The market is number one on key valuation drivers. Services businesses or a restaurant, for example, are not going to drive the same multiple as a software business. Second, growth is important to driving an outsized valuation. Obviously, IP is important for software companies. Certainly, investors will also take into account a host of key metrics, including churn, customer acquisition cost (CAC), lifetime value (LTV) and so on. Nevertheless, I believe market and growth are the top two valuation drivers.

Thank you, Sheldon, for being our guest speaker. We look forward to another insightful discussion at our next Fireside Chat!