This week on the Capital Allocator Series of the podcast, Matt sits down with Sean Koffel, co-founder and managing partner of Watchfire Ventures to discuss their approach to venture capital that is focused on asymmetric outliers, or sturdy underlying businesses that present an intermediate path to cashflow positivity or profitability. They focus specifically on company formation to series A opportunities for funding in four verticals: consumer infrastructure software (aka any software that powers how you buy or sell things online), consumer 4.0 products, industrial commerce modernization, and adjacent tech enabled services businesses. Sean continues in the episode to share what he looks for in companies that they are looking to invest in, especially in early stage ventures and Matt and he discuss the growing entrepreneurial ecosystem in Northwest Arkansas. They finish the discussion with a focus on consumer infrastructure software and the intersection of the consumerism and industrial industries.
Episode Trancript
Sean Koffel 00:00
We're very early stage investors that write meaningful checks. At the very beginning
versus kind of a spray and pray strategy. We have a very concentrated high conviction
strategy.
Matt Waller 00:12
Excellence, professionalism, innovation, and collegiality. These are the values the
Sam M. Walton College of Business explores in education, business and the lives of
people we meet every day, I'm Matt Waller, Dean of the Walton College and welcome
to the Be Epic podcast. For next few episodes, I will share my conversations with
capital allocators in the seed, venture and private equity space. They will discuss
how their capital allocation works, and provide tips to entrepreneurs on how to stand
out. I have with me today, Sean Koffel, co-founder and managing partner at Watchfire
Ventures. Thank you so much for joining me today, Sean.
Sean Koffel 00:56
It's great to be here, Matt, thank you for inviting me.
Matt Waller 00:59
So, Sean, I know you have a lot of experience. You for several years were a captain
of the United States Marine Corps. You're an Iraq war veteran. You've worked as an
investment banking associate at Morgan Stanley, you have co-founded and run companies.
And now you're Co-Founder and Managing Partner in a venture that provides funding
for companies. So thank you so much for joining me today, really appreciate it.
Sean Koffel 01:35
Oh, it's wonderful to be here.
Matt Waller 01:38
Sean, before we get going, why don't you tell me a little bit about Watchfire? You
know, including, what is the purpose of Watchfire? What are the verticals you focus
on? Those kinds of things.
Sean Koffel 01:56
Yeah, no, absolutely. Maybe I think that the best way to describe watchfire is to
kind of give you a little bit of background on my career journey. It was kind of a-
Pat, I always say that we both took the long way around to venture capital, and in
doing so, gave ourselves a differentiated viewpoint on how to invest and create value
through the allocation of capital on behalf of our LPs. So I grew up as mentioned
in San Francisco, California, went to University of Arizona, and was a freshman on
9/11. So I wanted to go fight and joined the Marine Corps officer program and had
the opportunity to do two tours overseas, came back to Stanford Business School where
I met Pat and Pat had previously played football at Notre Dame and then worked in
technology as both the Investment Banker and Product Manager. And we then both went
to New York, where he worked at McKinsey. And I was working at Morgan Stanley doing
investment banking. During that period had the opportunity to be a junior coverage
banker on the JB Hunt account at Morgan Stanley, which gave me my first exposure to
your wonderful part of the world. And my wife and I really thought about moving there
from New York at that point. After seeing the incredible growth in Northwest Arkansas,
and Pat and I actually then decided to move to Nashville, Tennessee, where we founded
our first business in the adult beverage space, which we scaled and then exited in
2016. Prior to starting a venture studio in Santa Barbara, California, that we ran
for three and a half years. Upon getting a lot of encouragement from past investors
and several partners we were working with, we closed our venture studio and launched
Watchfire Ventures in 2019 to approach venture capital in the earliest stages of the
areas we invest with a differentiated lense. And the lessons we learned as operators
for the previous decade really informed a view that at the time was a little bit contrarian
in venture capital, which was that what had- we created this idea of asymmetric outliers,
which meant combining the traditional venture capital goal of finding asymmetric return
opportunities either created by market opportunities or entry point opportunities
with asymmetric risk profiles, meaning sturdy underlying businesses that presented
an intermediate path to cashflow positivity or profitability, which, especially in
2019, was was quite different than a lot of folks in venture. And as we brought that
strategy to market, we focused on the areas we operated in, and the areas where we
had the largest kind of advantages from a sourcing perspective. And we could present
the most value to our partners post deals. So what we look at at Watchfire Ventures
is what we call zero to one where we've done most of our operating so company formation
through series A of product market fit across four verticals, which is kind of bifurcated
across consumerism and industrialism. So in the consumerism in vertical, we invest
in consumer infrastructure software, so any software that kind of powers how you buy
or sell things online, as well as a limited set of what we call consumer 4.0 products,
which are currently focused on products that execute an effective and ROIC meaning
profitable revenue efficient omni channel strategy, then on the industrialism side,
we invest in what we call industrial commerce modernization. So think of software
businesses that kind of create the pipes and scaffolding that are enabling legacy
industries to power their commerce as they enter the digital ecosystem, as well as
a limited set of adjacent tech enabled services businesses. And we've fully deployed
our first fund and are currently investing in our second.
Matt Waller 05:33
So, let me make sure I understand so for your, your, your first one, that consumerism
focus one vertical. So any software that powers how you buy or sell things online,
as well as consumer 4.0 products, Do you mean consumer 4.0 software products or products-
Sean Koffel 06:02
Products Products, so it could be a consumer product, or a technology product, but
a physical product. And of the 13 companies in our first fund, five of those were
consumer products, ranging from olive oil to boats businesses. And we've we've brought
a really differentiated lens to investing in products businesses, because frankly,
the scar tissue we have as operators, where we really are very disciplined about thinking
through the asymmetric outlier strategy, and making sure that there really is a clear
path in that sort of asymmetric risk profile vertical towards intermediate term cashflow
positivity, which we think is usually driven, and we can get into this more later,
by either some sort of production control that allows you to have the margin necessary
to execute an effective retail and digital strategy, as well as some sort of distribution
arbitrage or differentiated understanding of the route to market.
Matt Waller 06:02
That's great, Northwest Arkansas actually has a lot of early stage consumer products
companies because there's just a lot of expertise on that here. And we we also do
have a lot of software companies related to you know, the software infrastructure
that's needed for a CPG company that's 4.0, in terms of where it is type of product,
omni channel, etc. And that's one of the reasons why I was interested in talking to
you for this podcast. So I want to come back to the products, like you mentioned olive
oil as an example. But let's, let's talk about software as- for a moment. And what
for software, I'm assuming you're interested in software as a service, software companies.
Sean Koffel 08:07
That's correct.
Matt Waller 08:08
And what kind of and I know you want companies that have product market fit already?
Is that correct?
Sean Koffel 08:17
So to clarify, we invest from formation, meaning the very beginning of business plan
and talented entrepreneurs all the way through, pre-seed, seed plus rounds, and then
a limited set of series A rounds, meaning the area we invest is no later than product
market fit.
Matt Waller 08:34
Got it.
Sean Koffel 08:35
We're very early stage investors that write meaningful checks at the very beginning,
versus kind of a spray and pray strategy. We have a very concentrated high conviction
strategy, where we bring our operating experience to bear to bring a different level
of diligence than you traditionally see in the early stage in order to make concentrated
high conviction bets across the four swim lanes that we invest I've always loved Northwest
Arkansas as you know, Matt, and we've talked about this we, while JB Hunt is my first
exposure as consumer products and adult beverage entrepreneurs, Pat and I were brought
to Northwest Ark- brought back in Northwest Arkansas, to call on Walmart. And were
blown away by the Walmart culture, the Walmart community, the egalitarian nature of
the selling process. I remember you walk in you take a number and you could be as
a small company like us in a small room across the way from Coca Cola, and everyone
had the same chance and I just thought that was so special. And I remember going to
the Walmart Museum in Downtown Bentonville. And then as Pat and I learned more and
more about the area, we always had a strong market there in our own products, and
built some real friendships there and then got to see the wonderful museums and the
incredible, the incredible schools you get that have been built there and several
of our friends have sons and daughters or athletes that have been to Bentonville High.
And so we were actually up to speed on Bentonville softball and baseball more than
most Californians are. But I think when we were there, we saw some incredible new
businesses, and growing businesses like Core beer, and the execution they had across
the area. But as we as we learned about the ecosystem in Northwest Arkansas, one of
the one of the reasons I initially reached out to you, Matt was wanting to get more
involved and, and expos- more involved and gain more exposure to the creative entrepreneurs
that are there.
Matt Waller 09:41
You all probably should get more involved here then. So, investing in these early
early stages, it's, in some ways, it's more complicated than Series, Series A, where
you can look at things like their ARR, and their sales efficiency and cohort, kind
of analyses and so forth, you have to really understand, I would think the leadership,
the vision, what is it that you look for the most in these companies?
Sean Koffel 10:55
You know, I think that in order to invest in the earliest stage, I don't know how
you do that unless you were an operator for a long time. Because there are wonderful
investors that do series A and series B, and are extraordinary, their cohort analysis
and things like that, and using the data that exists to make really informed decisions.
And we love, we love doing that in our later stage strategy. But I think an area we
really differentiate, especially in an environment over the last three years, we're
effectively purchasing equity at a lower share price. And that earlier stage was one
of the one of the strongest ways to achieve yield was that we like to think we bring
a growth equity approach to the beginning, meaning we build our own model. So when
we look at projections or an early business plan, what we don't do is debate the assumptions
and sort of push the entrepreneurs on their LTV to CAC, assumptions, etc. We look
at it as sort of a novel of how that entrepreneur thinks about building their business.
How do they think about working capital? How do they think about spending money? How
do they think about hiring people, if they're projecting a certain amount of revenue?
Are they aware of how many people they probably need to be hiring in order to achieve
that in the long run? And then, based on our conversations, and a deep set of questions
that we follow up with early on in our process, we then build our own model, and make
our own assumptions about where their revenue will be using our kind of pattern recognition
from years and years, keep getting part of those in the trenches, and then work backwards
and kind of think through how much money are they going to need to raise? What rounds
would we participate in, and then arrive at our own assumptions and conviction around
a fully diluted cash on cash MOIC that we need to believe in in order to invest in
a business.
Matt Waller 12:47
So you know, I've been really surprised we we have the Walton Family Foundation has
something called the home region. And it's run by a guy named Robert Burns. And someone
that reports to him is Yee-Lin Lai, who is head of developing the entrepreneurial
ecosystem of Northwest Arkansas. And so there's a lot of things going on in Northwest
Arkansas around entrepreneurship. From you know, we have the what I would say ecosystem
facilitators, if you will, there's one called Startup Junkie that is real involved
here, the Northwest Arkansas Council is very involved, you know, Plug and Play moved-
Are you familiar with plug and play?
Sean Koffel 13:52
I am not.
Matt Waller 13:53
They're they're they're a Technology Accelerator out of Sunnyvale, they focus there.
They're like Y Combinator, but they focus on different verticals. And they get corporate
partners and well, they they moved to one of their verticals here to Bentonville that
focuses on logistics and supply chain management. They moved to here I want to think
two years ago, and those companies work closely with of course Walmart, Tyson, JB
Hunt, and a few other companies as well, ArcBest in Fort Smith and still other companies.
And then the university's gotten really involved. We've got so much going on, you
can imagine it around this one. For example, we even have things some like a bit of
a venture intern program. So students that want to work for early stage companies
can we have a an agreement, a grant some grants from the Walton Family Foundation
where they, that subsidizes the so that, you know, these early stage companies a lot
of times can't afford interns. They don't have the infrastructure and sometimes they
don't even know how to create an internship program. So all of this is provided through
our program we call the venture intern program.
Sean Koffel 15:17
Sounds like a wonderful program.
Matt Waller 15:19
It is, I- I love it. It is wonderful, you know, because then students before they
graduate, they can have experience working for an early stage company, they can have
experience working for the Fortune One if they want to, or many companies in between.
But we have a lot of other programs, we have something called the GORP program. And
it stands for greenhouse outdoor recreation program. And it it's like a incubator
for very early stage, companies that are either into technology or products or services,
around outdoor recreation, it's called GORP, that was another grant we got from the
Walton Family Foundation, that the university runs, but I could go on for hours, literally,
I'm not kidding about what's going on here, in that regard. But I'm also aware of
a lot of early stage, consumer products, companies that are here, that, you know,
it's kind of like some of the people here grow up with parents that have been because
we've got 1500 consumer products, companies with offices here. And of course, Walmart
and others, they grow up in this space.
Sean Koffel 16:44
Right.
Matt Waller 16:44
And so when they take well one- we have something for our MBA classes called the venture
intern program. And, you know, they've got lots of ideas about opportunities, just
because they they understand consumer product, both from an omni channel perspective,
not just from brick and mortar perspective. And so we see a lot of that popping up,
at some point you might want to visit that the other thing we have, we have something
called the McMillon Innovation Studio. And it was funded by $2 million in gifts from
Doug McMillon and other people have given gifts as well. And it is, so CPG companies
Walmart and supply chain oriented companies bring problems to the McMillon Studio
and the students learn how to be project managers and product managers. So they, they
learn human centered design, agile, just, you know, a wide range of things that a
product manager would have to learn. And so the the companies come and we have mentors
in this program, but the companies come with a problem. The students have to study
it like an entrepreneur would in terms of interviewing lots of people and empathy
mapping and all that kind of thing. And they come up with a many times app based kind
of solution. But we have a demo day, a couple times a year. I think you may see some
things there that would be of interest to you.
Sean Koffel 18:43
Yeah, no, I would I would love to attend. I think one of the things that's so exciting
about everything you're saying that's happening in Northwest Arkansas, is that as
you think about the omni channel future, both products and software, there has been
a whole decade of entrepreneurs that have done very well on the digital side. But
I think everyone's realizing now that there needs to be a shift back to the fundamental
execution innovation within the brick and mortar retail side. And of course, because
of the Walmart creative ecosystem that exists in Northwest Arkansas, I think a lot
of those answers could and should come from that community. And you asked about software
earlier and how we think about it. And the two kind of big areas of software on the
consumer infrastructure software side that we focus on is if you think about kind
of consumer 4.0 is a circle, right? And on the top of the circle, you have the digital
side. So you kind of have Shopify being your boutique, and Amazon being your department
store, and then kind of everything in between being vertical software like Wayfair
or chewy, and then the retailers the offline retailers who have horizontal e-commerce
sites like walmart.com. Then on the other side you have retail, like Walmart or like
grocery or like, you know, high end boutiques. As we think about that, as a circle,
what exists in the middle on the product side is the need to drive profitable revenue
at the right moment in your route to market from the right channel, informed by data
insights gathered from your digital channels in the beginning, but what needs to happen
next is then the data insights from your retail channel that need to feed back into
that central machine to inform how best to optimize both your retail channel and your
digital channel. And so what we see is a massive opportunity currently in, in consumer
infrastructure software is if you replace the product in the middle by kind of a circle
that says consumer infrastructure software, a huge opportunity for software that optimizes
and drives, helps companies drive that high return on invested capital revenue, meaning
profitable revenue from the right channels, we think there's one way that should occur
is that the retailers have so much power in the data they have. Walmart, for instance,
has so much data. Now people like IRI Nielsen and Spins have kind of had a monopoly
on that data for a long time. And one thing we think is an interesting opportunity
is for those retailers, to start taking kind of to start building partnerships with
brands and then return for ad spend at their, at their stores, sell their data to
the brands directly or give the data to the brands directly in return for that that
rev share. And in doing that, those brands can target kind of the seventh say Walmart's
that they know that their customers are buying their products in and you start to
have the same flexibility that you do in Shopify, and they start to feed each other.
And the answer to that sort of central optimization software needs to come from retail,
because it's been built already on the digital side. So places like Northwest Arkansas
that have all of this creative energy around solving problems and driving the future
of brick- brick and mortar retail, and combining retail and e-commerce. It's just
I think it's a really exciting moment.
Matt Waller 22:04
So Sean, how does the consumerism, industrialism verticals that you've worked with
how do they interact with one another?
Sean Koffel 22:14
I think that the the meeting point is between consumer infrastructure software and
industrial commerce modernization, and that they both share a really exciting moment
in time right now that creates this, this green field value creation moment, which
is that in many incredible American businesses that were founded by patriarchs and
matriarchs from the last generation, for the first time in American history, we have
a tech native generation coming into those businesses, as the new customers, and wanting
to continue their family legacy and also create their own impact on driving growth
in their family businesses. So in businesses like construction, or like supply chain,
and transportation, or like specialty manufacturing, you have this whole new generation
of customers who are really open and potentially more open than those industries have
been historically, to software solutions that can drive profitability and productivity
in their industries. And I think, you know, in Northwest Arkansas with the presence
of leaders like JB Hunt, the same creative ecosystem exist, and that's really exciting
for us to watch develop for businesses that are solving these kind of vertical solutions.
And what I mean by that is, what we don't think is the answer is some kind of computer
science whiz, who has no experience in an industry parachuting in with a vertical
software solution that we call hypothesis SaaS, meaning what they think would drive
value. We think that the answers will actually come from within the industries, from
people that have the understanding of those industries in their DNA, whether they
grew up listening to their parents complain about those industries for 30 years around
the dinner table, or whether they've worked in it for a decade, and they see the profitability
and productivity bottlenecks that need to be solved, and then build the software solutions
or off the shelf, but proprietary tech stacks to solve those product productivity
solutions. And so as we look at industries like the supply chain and logistics, finding
those vertical solutions that take traditionally legacy industries and I mean legacy
in the best way meaning like amazing American businesses that have driven our economy
for a century, and then empower them to enter the digital age in an even more advanced
and profitable way.
Matt Waller 24:27
Well Sean, this has been so interesting, congratulations on the fund that you've created,
are running and I look forward to seeing you in Northwest Arkansas sometime.
Sean Koffel 24:43
I would love to do that-
Matt Waller 24:44
-But thank you for taking the time to visit with me.
Sean Koffel 24:46
Absolutely. Thank you so much for the opportunity and looking forward to seeing you
soon.
Matt Waller 24:51
Great, well have a have a great one. Bye bye.
Sean Koffel 24:53
Bye now.
Matt Waller 24:55
On behalf of the Sam M Walton College of Business, I want to thank everyone for spending
time with us for another engaging conversation you can subscribe by going to your
favorite podcast service and searching be epic. B E E P I C.
