Venture capital is an industry in which the exceptions are often more important than the rules. For many years, investors believed in a golden rule that software was the key to minting returns, leaving hardware as one of the most underinvested areas of venture. Then things changed as new technologies like 3D printing allowed hardware startups to accelerate their product design, and several large exits like Nest Labs, Dropcam, and GoPro encouraged investors to take a new look into the sector.
So I was deeply interested in our story yesterday that the development platform Xamarin raised $54 million in a series C investment from Insight Venture Partners, among others. Like hardware, developer tools has traditionally been a sector that received very little attention from venture capitalists. The reasons have remained persistent: the market isn’t very large, preventing huge scale; there are only a handful of potential buyers, leading to small exits; and most venture capitalists don’t understand the needs of developers in the first place to even make an informed investment.
Just take some of the notable recent exits from the space. Parse, a popular backend for scaling mobile applications, was purchased by Facebook for north of $85 million after $7 million in venture capital investments. Crashlytics, which tracks crashes on mobile apps, was acquired by Twitter for a reported $100 million just shy of the company’s two-year anniversary. More notably, Flurry, a mobile analytics service and ad network founded in 2005, was sold last month to Yahoo for more than $200 million.
Such exits are certainly not abject failures, but they are also not the kind of outcomes that venture capitalists are hoping for when they invest. Given those sorts of exits, investment in the space has been mostly limited to seed and series A investments, according to CB Insights, which ran an analysis of the market for developer tools investments last year. Those sorts of investments can still provide a decent multiple on investment on exits in the low nine-digits.
There have been, of course, some notable growth-stage exceptions for developer tools, most prominently Andreessen Horowitz’s $100 million investment in GitHub, and several large secondary (non-equity) investments into Atlassian. But the lack of growth capital in this sector is clear. In fact, if Xamarin’s series C deal had happened last year, it would have been the largest investment at its stage.
It’s hard to glean from one investment whether the calculus for investing in developer tools is shifting. But looking at the challenges that the sector has traditionally faced, there may be changes in the market that will allow devtools startups to be a more exciting focus of investments in the coming years.
The most obvious change is the opening of developer platforms. For years, large companies like Microsoft carefully controlled access to their developer technologies. Microsoft built its own IDE, Visual Studio, and carefully orchestrated its products together in ways that made it difficult for startups to gain significant market share. Startups were always facing the possibility of extinction with a single policy change, limiting their value to both investors and potential buyers.
Now, openness is the watchword of the industry today. Google’s Android ecosystem remains fundamentally open, and many developer products have been created targeting that operating system. Xamarin itself is the embodiment of Microsoft’s change in stance on its developer technologies like C#, which it now sees as a potential opportunity to get its language and libraries used across all mobile operating systems.
Interestingly, the only exception to this trend happens to be Apple, which has kept its developer ecosystem almost as closed as the iPhone walled garden itself. The main IDE for iOS apps remains Apple’s XCode, which is the only way today to compile apps and deploy them to iPhone. But even here, there might be changes, with the company appearing to show a willingness to be more open if its comments at this year’s WWDC conference are any indication.
Openness is providing more opportunities for startups to build original toolsets, but the real potential for scale is coming from the growing size of the developer workforce itself. The U.S. government predicts that the workforce will grow 22% over the next ten years, and many in Silicon Valley would argue that such an estimate is quite conservative.
Due to the growing clout of developers, there are now dozens of startups offering developer-focused services such as continuous integration, real-time database engines, social coding, and error management. Even products not traditionally considered devtools are putting more emphasis on developers. The payments service Stripe, for instance, is unabashedly focused on developers as the acquisition model for new customers.
Ultimately, more customers means more revenues and greater potential for building sustainable companies. Perhaps no company embodies this trend as well as Atlassian, which had revenues of $150 million in fiscal year 2013 and was recently valued at $3.3 billion by investors.
While the terrain may be shifting to allow for more highly-scaled devtools startups, Atlassian is also a case study of the challenges that such startups face in growing. The company is hardly a single product company, offering solutions for everything from hosting code in the cloud to handling coding workflows, and it has never taken equity financing. That bootstrap approach is similar to GitHub, which waited four years before its first (massive) infusion of cash.
Ultimately, the real change going on is the ability of venture capitalists to provide enough capital to allow these companies to bootstrap their way to profitability. Devtools are never going to grow like consumer startups, and so a different model and tenor of investing may be the order of the day. If venture capitalists can be flexible in how they think about these sorts of startups, there may be tidy returns ready for the taking.