The Human Side of the Equation in VC

Pitch Confidential #001: Yrjö Ojasaar of Change Ventures

Pitch Confidential is a series of candid conversations on fundraising, sales, leadership, and communication. The show combines street-level insights from practitioners and a quant-like focus on data. Each episode aims to reveal the ‘kitchen-side’ stories from pros who do the legwork.

To deliver on that promise, the first one kicks off with self-deprecating banter. It then continues with a run-through of the fund’s fact sheet. This written piece builds on the content of the episode. It also adds a layer of analysis and insight to help founders prepare their stories for the long-term game of venture capital. It has cases and patterns from investors like United Angels VC, Superangel, and Change Ventures. It then digs into behind-the-scenes fundraising stories of Bolt and Slack.

Snapshot

Change Ventures recently snagged commitments from EBRD and the European Investment Fund (EIF). With this, they’ll become the largest seed fund investing in Baltic start-ups. By September, they’ll have over €40 million under management. That’s a big deal for a region with a little over 6 million people. This region has one of the highest numbers of start-ups per capita in Europe. It also has one-third of all the unicorns in the CEE, according to Thomas Padovani of Bellone Invest.

Change Ventures’ first $6.5 million US-based fund has invested into nine companies. It includes Nordigen, MeetFrank, Giraffe 360, Interactio, and Timbeter. These also happen to be companies that I got to meet and train during different stages of their journey.

Their second €21 million fund has made five investments. The ones featured in the news are askRobin, 99Math, Qoorio, and two more are coming. The practical takeaway for founders is that the fund is yet to deploy over 80% of its capital. That’s a lot of dry powder.

The question

The state of their two funds meant that I had to ask Yrjö about their focus, given market conditions. Would they be chasing all the new opportunities at the expense of their existing portfolio companies? The question lead to a predictable affirmation of their commitment. It also provided a gentle reminder that their scorecard is dependent on exits delivered by their previous bets.

Those bets include companies like FanSifter — a fan data management platform. It helps rights holders in music, entertainment, and sports increase sales. Just a few months ago, they were featured in Rolling Stone and moved into the Techstars Music office in Los Angeles. They were helping promoters, live festivals, tours, and concerts understand their audiences better. Now, it’s an industry that has hit pause for the time being.

Except — it seems that it didn’t. I reached out to Aivar Laan, the CEO of FanSifter, for comment before publishing this piece. He, one of our early listeners, provided an insider’s look at what’s happening in the industry from his vantage point.

Promoters and the live part is just a slice of the story. The drivers for our growth are artists, artist management companies, and labels who increasingly need to work on their global fan data collaboratively. This forced hiatus on the live side of things is enabling a lot of strategic initiatives. It kicked off an interest in the industry on how to capture, analyze, and put their existing fan data more effectively to work when live returns.

So, the ‘hit pause’ part is a semi-truth, in the industry context, as the music industry is even more active than before. Previous release plans have not been altered. The number of new music that will be put out in the upcoming months has increased. We’re seeing fast growth in our inbound traffic from all facets of the industry, just from a few Billboard and Musically articles and with zero outreach.

The question highlighted the importance of investor relations during times of rapid change. I’ll leave it at that.

Hot categories

This part set us up to talk about which categories Change Ventures would say ‘no’ to right now. It’s the same question that I got to ask from Maria Barsuk of EBRD and Gerri Kodres of United Angels VC. They were taking part in a virtual fireside chat hosted by Ragnar Sass. It’s a hard one to answer. The question might signal to founders in that category that it isn’t worth pitching the investor. That, in turn, might lead to a loss of access to deal flow.

Yrjö, being the seasoned attorney that he is, parried with a shameless, yet skillful plug.

He answered that they hadn’t changed the fundamentals of their decision-making process. It’s still about picking ‘solid’ founding teams that are building good companies. This selection happens regardless of COVID-19 or any other kind of ‘black swan’ event. It’s this focus on fundamentals that got them to lead a €1.6 million seed round for AskRobin. The company provides a financial services marketplace for middle-class consumers. Those consumers get to compare rates between around 100 lending providers across Latin America. That, and the fact AskRobin has grown to €26 million in originations and 5 million users in two years. Pretty solid fundamentals indeed.

The team

The talk about fundamentals made me think of three points and focus on the last one in particular.

1. My research into lending platforms and the list of top angels and VCs that were investing in the category from five years back. The example that came to mind was Rocket Internet’s former company Lendico and their operations in Brazil;
2. Was it a ‘black swan’ event? Yrjö should know better. He hosted a Q&A with Nassim Nicholas Taleb, the former options trader, and risk analyst who coined the term, on stage in April 2019;
3. What the heck is a ‘solid’ team? Is it just a bunch of ad hoc decisions? Do they get bundled under the ‘solid team’ tag for the sake of convenience? Is it some form of choice-supportive bias?

The answer that follows is an edited version of Yrjö’s quote delivered during the 4th minute of the podcast.

There are clearly some fundamentals for a solid team. There is no one formula to cover them all. I think it’s also different based on what kind of a start-up you’re doing. A start-up that requires a lot of publicity and a lot of consumer interaction might require one type of CEO to lead it for it to be the best fit. On the other end of this is an enterprise software company that might need a CEO who’s wheeling and dealing behind the scenes and making over EUR 1 million in transactions. Those are the things that matter, and that’s two very different personas potentially. Both might be the right answer but not for the same companies.

So in that sense, it is challenging to create this one winning persona. Yet the thing that always seems to come through is that these people do have a pattern of achievements. Maybe it starts as high school track that they were winning in. Then perhaps it was debating. It could have been the best salesman after that or something else. Looking at some of these success points, you begin to see that the person is a leader and that they value success. That’s sort of the one thing that connects them all regardless of the different personas.

Personas: ‘Jocks vs. nerds’

A pattern of achievements, sports, leadership, and a drive to succeed have something in common. They might lead you to think of the archetypal jock persona. For those unaware of the age-old conflict between jocks and nerds, I’d suggest seeing John Hodgman’s talk.

Personas are models. Those models get used in user-centered design to personify patterns in the data. The idea is to understand the needs, experiences, behavior, and the driving factors behind it. It’s a composite character in a story and is an imperfect approximation of reality.

It’s this approximation that might mislead decision-makers. Or, to quote Taleb, to be fooled by randomness. It includes survivorship bias and all the ‘silent evidence’ of founder stories that could have been good bets. Such as the archetype of the introverted nerd. The one that enjoys vintage arcade games, Magic: The Gathering and Warhammer 40K — or so I hear. Think of a founder story that has not yet demonstrated a pattern of achievement. They might have lacked the opportunity to do so.

I listened to thousands of these kinds of stories during the past decade of coaching founders. As a result, I had to bring up a few that had a Pareto-like influence on the ecosystem during the 6th minute of the episode.

Story patterns

The first case is from Gerri Kodres, the Founding Partner at United Angels VC. They are an early-stage fund with €16 million under management.

My favorites are the teams that have worked together previously in another company where they have solved a specific problem. They’re very good domain experts, and now they’ve left the company and want to solve the same problem for the whole industry.

Examples of these teams are led by Taavi Tamkivi of Salv, Kair Käsper of Klaus, and Andrus Purde of Outfunnel.

The second is from Marko Oolo, the Investment Manager at Superangel. They are also an early-stage fund with €16 million under management. Marko’s comment echoes the same pattern but adds a caveat.

We’re looking for exceptional founders who have worked in the field long enough to become experts and found a problem to solve. Ideally, they have the track record, know-how, and achievements to go with it. The exceptions to this happen when an early-stage founder has shown hunger and ambition to spend the next 5 to 10 years, scaling the company to a global level.

Their portfolio features several such ambitious founders. They include Martin Kristerson of UpSteam, Kaarel Kotkas of Veriff, and Markus Villig of Bolt.

The latter just raised €100 million in a period of several months that started in January — this year. Now their valuation stands at €1.7 billion if TechCrunch is to be believed. Markus pitched over 200 investors all around Europe from 2014 to 2016, getting almost as many no’s. The process got ‘easier’ as they grew and became the leader in Europe. His take is that the original no’s had to do with the mental models those investors used. Likely, those models didn’t allow for anyone going against an established player like Uber. The investors were too risk-averse to imagine a different outcome at the time.

Bolt’s competitor raised $24.7 bln in funding. They did this, in part, thanks to the ‘winner-takes-all market’ narrative. Now, it’s turning out to be fallacious. The new story in town is that it’s a ‘city-by-city’ game.

In hindsight, chances are it had something to do with the analogy of comparing the company to Amazon or Facebook. John Pollack explores this seductive, yet destructive power of faulty analogies in his book.

Story of failure

Yrjö’s take on the pattern brought forth by his peers was the following.

What you described before — is an ideal. These guys work together, and then they realized that there’s a problem. The boss […] won’t listen to us, so let’s do it ourselves. Let’s do some of this creative destruction, start our start-up, innovate and be that much more successful because our solution is 0 to 1 better. Sure, that’s one story, but there many, many stories of how they’ve gotten there.

He goes on to state that many of the successful platforms have come out of failure. The pattern highlights a challenge that comes with picking a leader for companies born out of such cases. The specific example he brings up has to do with Stewart Butterfield, who has made two attempts at building games. Both of them failed. One became Flickr, and the other transformed into Slack. You could think of him as a modern-day ‘Cinderella’ man. The one that if asked about the reason for his app’s success answers — ‘I have no f–king idea’.

On my end, I first heard this story from the ex-Creative Production Manager and one of the first hires at Tiny Speck (Slack), Märt Lume. It was during his Start-up Grind interview with Joao Rei in Tallinn in 2018.

In 2012, Tiny Speck, a game called Glitch at the time, had $5.5 mln (out of $17.5 mln in funding) in the bank. They had enough for a year of operations before pivoting to Slack.

They could have modified the game and made it work, yet it would not have been a ‘10x’ project. The ‘proto’ features of Slack were the internal tools of game developers at Glitch. They had been in use for three years by the time of the pivot. The solution got developed because Skype’s search feature wasn’t good enough. The vision of the internal tool that would, later on, become Slack went straight into a pitch deck. It still took six months of validation and a complete technical makeover. The media relationships that they built up over the previous years didn’t hurt either.

Slack made a bold move to focus on a completely different product. This decision under conditions of uncertainty, in turn, got Yrjö and I talking. During the 8th minute of the episode, we got closer to home. We discussed layoffs, runway, and the effect of market conditions on Change’s portfolio.

Portfolio, valuations, and unit economics

Slush surveyed 260 start-ups and 140 investors. The findings revealed that the average runway for over 50% of the companies in the region is at around 5–6 months.

For many companies, this means letting people go, cutting payroll and other expenses to preserve cash. It can be in preparation for the long-term when markets come back — or for the next round of financing. For others, the period is an opportunity for growth.

Portfolio

Change Ventures has both types of companies in their portfolio right now. It’s a time when business models go through rigorous testing. The result of this test is whether the product is a vitamin or painkiller.

It’s also a time when a laggard can experience several hundred percent growth month-on-month. Or, it can be the moment a high-performing team adapts its business model to keep its customers. Others might leverage the opportunity to grow even faster.

One of several examples Yrjö has provided includes Interactio — a company I got to train in Copenhagen a while back.

Here’s one portfolio company that, of course, benefits significantly […] from social distancing because they provide remote interpretation. So the EU and the United Nations and all these other organizations don’t have to be face-to-face. You don’t have to bring in these interpreters that have to sit there and listen to people from a booth. Instead, you can drop in an interpreter from anywhere in the world. They’ve had many […] hundreds percent per month growth, brand new clients, and they can barely keep up with all of the requests.

Valuations

The topic of growth brings us to another fact that came out of the Slush survey. It has to do with a question dreaded by many founders during Q&A sessions — what’s your valuation? Over 70% of investors that responded to the survey are expecting at least a 20% decrease in company valuations. This drop will likely put many early-stage start-ups in a much weaker negotiating position in 2020. In this regard, Yrjö had the following to say.

In good or bad times, the same points are significant. In bad times, revenues are more important. If they’re down, so is the valuation. What’s the right valuation when you have half the users you said you’re going to have?

Unit economics

Regardless of the times, the good old unit economics define the efficiency of the investment. Now, it’s coming back in style when it comes down to talks about company valuations.

Companies will develop at different rates. They will also develop differently across various segments. In some areas, it will be […] less challenging to grow early on, but then you hit sort of a glass ceiling, and it becomes tough to get larger orders. In other cases, […] you can start out making lots of sales cheaper, but then keep leveraging them into larger clients.

The takeaway is that folks are scrutinizing customer acquisition costs and lifetime value. They are asking whether the fundamentals will make sense in the long run.

People

Some of you might think of WeWork, Theranos, or even the long-forgotten case of Boo.com. The predictable irrationality and exuberance are cyclical. The valuations might go up or down, yet the part that makes us human doesn’t change.

The fact led me to ask how Change Ventures deals with human fallibility. Both in its founders and the decision-making process of selecting them.

On the 24th minute of the episode, we go beyond the plugs. We get into a real conversation about resilience, burnouts, and vulnerability. It explores some of the behind-the-scenes processes that guide the selection of exceptional founders. There’s mention of the right type of cup in meetings, centipedes, and Tarantino pitching Robert De Niro. Towards the end of it, we touch upon the humanity and realities that underpin the long-term game of venture capital. Tune in to hear the rest in the first episode of Pitch Confidential.