Batch brew #4

How to play VC in a downturn? Our Boring Biz Thesis & How to Build Your Own!

GM, this is The Caffeine Capitalist. We tell you what opportunities are brewing in Central Europe, what is hot & what's not in VC & Boring business spaces.

Estimated read time: 12 minutes and 14 seconds (longest ever btw)

Here’s what we got for ya today:

  • ❓ How to play the tech and VC downturn? Is there any in the VC early stage?

  • πŸ’Έ Our Boring Business Thesis, Value Creation Companies and Enabler Companies

  • πŸ‘€ Our recent investments in the VC and Boring business world 🍐

Before we kick-off, special thanks to 112 new subscribers since last issue πŸ™πŸ»

Department of Venture Capital

In our second newsletter Batch (here), we looked closely at what was happening in the public markets and more closely in the public tech markets, their valuation drops and what could be the possible impact on venture capital space.

Every VC was for sure internally discussing how would the market evolve, how to play this downturn, whether to wait or invest as previously. At we also looked closely and discussed the situation during the last weeks.

After some time, we have additional data which might help us to understand the effect of public market crash and economic downturn on early stage and late stage VC investments.

One positive message for founders and start-ups, according to Pitchbook-NVCA Venture Monitor (download here), the size of VC funds raised in Q1 2022 was higher than during the whole year 2019, 73.8 bil. USD in Q1 2022 compared to 70.3 bil. USD in 2019.

One could argue that raising funds from LPs takes a lot of time, therefore the fundraising size is rolled over from previous discussions with LPs, even during the peak times of end of 2021 and we might see a drop in the coming months. Nevertheless, currently there is a lot of dry powder and cash, at least from US based VCs to be invested.

But where it will be invested is another discussion. The implications for late-stage and early-stage investments might be different.

The late-stage problem

The IPO window of opportunity is basically closed for now. The top 10 VC-backed IPOs in 2021 felt the downturn impact (Rivian, Roblox, UiPath, HashiCorp, Coinbase, Toast, Aurora, Marqeta, Ginkgo Bioworks, Robinhood). From their post-money valuations at exit to their current market cap, those 10 stocks were all down 18% to 68%.

The US VC exits in Q1 2022 dropped severely and the biggest drop is in the Public listing part.

Valuing companies at 20-50x revenue multiples was not an exception during last two years. It's hard to imagine how this could be sustainable, but the market sentiment was basically that everybody dances until the music stops. Adding to that, late stage investors thought they will see a short time-to-money by getting the company quickly to IPO in or to another megaround calculating with the same valuation multiples as before. And the music stopped. We see a huge market correction. Valuations of last rounds compared to expected IPO valuations now are in many cases uneconomic for the last investors. So there are only two ways how to play this:

  1. Cutting costs, extending the runway and hoping there will be a better opportunity for exit in the coming months or years as the market comes up again;

  2. Raising a down-round to extend your runway (or debt). But given the anti-dilution clause, this harms mostly the founders and lowers their equity stake in the company, not the previous investors.

Funds are holding a lot of cash right now. So where is all the money going to flow when it might not be the right time for the late stage given the IPO window is closed?

Where do we see the VC allocation opportunities nowadays?

  1. Earlier investment stages - Pre-seed and Seed

  2. New opportunities given the new problems we are facing

  3. Buyouts of failed VC backed companies

1. Early-stage investment market 🌱

Activity and valuations of late-stage deals might be down and more correlated to the public market situation, but what about early-stage deals?

Surprisingly, not. Or not yet. At least in the US, the median and average Post-money valuations in seed are still increasing also in 2022. But VCs are for sure more cautious now.

The size of overall early-stage investments is also not falling.

The explanation of increased activity and interest in early-stage deals is straightforward. The younger the startup, the less it has to worry about public markets. A seed-stage company might be a decade away from an IPO or exit. So in 2022 VCs are pouring more money into earlier stage startups and hope that the public market sentiment in 5-10 years will be more favorable for an interesting exit.

And many late stages VCs are starting to invest earlier as they recognise this opportunity.

Btw. how does the European and EMEA market look like? πŸ‡ͺπŸ‡Ί, The state of VC in 2022, 31.5.2022

Slow decrease of investments in almost all stages but most drastically in the "megarounds".

2. New investment opportunities? πŸ‘€

The world is changing, the macro trends are shaping the need for new solutions for new problems we are facing. War in Ukraine, inflation hikes, supply chain problems, semiconductor supply shortage, sustainability push, agriculture. These are all problems more pressing than before. And therefore we might expect new opportunities and investment interest in agritech, defense tech, supply chain, sustainability tech.

Solutions in these increasingly pressing problems acting as pain-killers and not only as vitamine pills might be a good bet to focus on when thinking about new opportunities in building a start-up.

3. Buying out failed VC backed companies πŸ“‰

This is the most interesting opportunity from our perspective. Some companies are not able to provide expected VC returns but they can still be a solid long-term cashflow generating business. And there are many cases when the fast growth and expansion strategy of start-ups did not end up well - pushing the founders to burn too much cash, not getting to their revenue goals and sliding into near bankruptcy.

The play:

1. Buy out VC investors at discount (instead of taking a 100% loss) and if needed also the founding team OR buy just the most important assets in liquidation.

2. Restructure the company, cut costs, focus on the main revenue drivers and stabilise. Slower but stable growth towards positive cashflow.

Operator led Private Equity model.

This is a really interesting inspiration. Enduring Ventures buying out legal-tech marketplace Upcounsel.

We will see a lot of VC backed companies in troubles in the next months. Cut through the noise, find the valuable ones with recurring revenues, buy them out with full-time focus.

Department of Boring Businesses

Rainy days in the market are good for two things (among other stuff), falling valuations & we finally get to see who forgot to buy an umbrella. Yes, more companies will be up for grabs, cheaper, perhaps a little bit distressed & definitely more human capital. Don't go out shopping just yet!

Today we want to talk about the importance of having a clear portfolio strategy and the importance of knowing why you invest in these particular types of companies. Since boring business portfolio can be anything but boring, it's good to distinguish between company types.

Power-law vs Normal distribution

Venture Capital is driven by the power-law distribution, out of 100 companies, you would expect 3-5 to do very well, the other will die, some faster, for some it's gonna take a longer painful death. In the Boring world we expect each company in our portfolio to be profitable, we don't expect unicorns, but we want to pull levers and make these companies grow. To achieve this, we need a well laid out set of principles, or a thesis to follow. Rather than telling what it should contain, let us share ours & feel free to comment/copy/adapt it to your need. βœ‰οΈ

We are on a search for profitable small companies, in fragmented regional markets, under-digitised industries, with recurring revenue where we can pull various growth levers.

Boring Business Thesis

If we take this lovely little investment thesis apart you can spot a few important elements (for us), let me break those down in more details below:

  • Profitable: Yup, making profit is still a thing! On a more serious note, we are not looking for 10x increase in value in order to sell it off, we want yearly dividends.

  • Fragmented regional markets: We don't want to see a monopoly or a situation where one player can take the whole market, we are interested in companies serving their local markets.

  • Under-digitised: Super important, especially with owners who are older, if the industry/company is under-digitised you can pull few levers right away if you have right enablers in place (read on for an enabler example)

  • Recurring revenue: We believe it is easier to work with companies that have regularly flowing cash from a stable portfolio of customers. You can focus on increasing customers value & other portfolio strategies.

  • Growth levers: The final party piece, you must be able to actively change the company & for example execute a rollup strategy (just picking the first one from top of my mind)

These five principles making up our investment thesis are the basic filtering criteria when looking at the swath of opportunities out there. What are your? What would you add/remove?

In the next issue we would like to explore the acquisition process & search process a bit more, so you can see this in action. In the mean time, you can read more about what defines a boring business in our first issue of the caffeine capitalist > click here.

To apply this, let me share an investment we closed just this week, a digital performance agency called 🍐 (sorry SK only for now) is a case worth exploring in this perspective. When we are looking at our portfolio, we look at two functions that companies can fulfil:

  • Value creator company: Targets where we pull various levers, execute a rollup & we expect these companies to cashflow heavily and perhaps get sold sometime in the future once they are bigger πŸš€

  • Enabler company: These companies help us execute these levers in the value creator businesses. Think of digitisation of digital acquisition channels, building a customer relevant brand, improvement of processes etc. 🧰

The digital performance agency is a clear "enabler company" for us. Considering we are making moves in the accounting industry & looking at property management business, we believe that apart from needing a relevant and up-to-date brand, these companies need high quality digital customer acquisition. This is where Birne comes into play. By the way, if you are in the market for new digital agency, speak to Jakub. 🍐

Yes, we cannot omit our thesis, so let's run it through a quick check. Profitable? Yes βœ…. Fragmented market? Yes βœ…, there are hundreds of marketing agencies & there are thousands of SMEs needing their services. Under-digitised, nope but considering this is an enabler company, we can skip it. Recurring revenue? Yes βœ…, most performance agencies work on a long term monthly retainer, and this is what we like. Growth levers? Not so many, but nevertheless it is an enabler to pull growth levers in other portfolio companies.

All in all, 3.5/5 on the criteria list, good for an enabler, worth an investment. Of course this is not the exhaustive list of criteria, but I will share the other aspects in another issue, let this be our starting point, or a starting sip should I say. β˜•

What to do with this information?

  • Check and/or review your boring business investment thesis. Don't have one? Don't invest.

  • What are the key industries that you want to populate your portfolio with? What levers do you want to pull?

  • What steps do you want to take? What companies will be enablers and which will be value drivers?

  • Inspire yourself with other investment companies from the US. Osceola is an interesting example, especially their thesis & Chenmark is worth exploring too.

Dept. of Twitter Thread Research:

In the last week we have spent quite a lot of time on Twitter so you don't have to, these are the threads, which are standing out for us:

#1 Codie Sanchez as the boring business queen shares a bit about how she runs multiple companies, what are some of the KPIs she is following & how she keeps it all together. Don't just read it, give her a follow!

#2 Heard of Celsius? I bet you did, especially in the recent days. Some argue that the recent crypto "dip" is also due to this little company. Totally worth investing 10 minutes into this one.

#3 Two issues back we discussed the variety of levers that you can pull when investing into boring businesses. This thread covers the exciting story of executing a rollup strategy (buying up multiple companies and stacking them together, like a blend in coffee terms).

Dept. of Visual Research:

We feel ya πŸ‘‡

News from our portfolios & where to shake hands:

  • We had really active last months at and closed several deals. Two weeks ago, we invested in Supliful a US based private labeling company for influencers propelled by an impressive Latvian team. Thinking about creating your own brand of coffee or supplements? Forget about all the hassle with creating an e-commerce store, finding your own unique product, buying it in bulk from manufacturer, labeling it, getting all of the needed certifications and setting up the fulfilment. Supliful covers all of this for you.

  • The other investment to share from ZAKA's portfolio is an app called Sorwe. They focus on employee satisfaction by focusing on growing companies for which, this topic is coming up due to their growth. It's a London & Istanbul based company & if you are challenged by the current workforce market & wellbeing of your team, you should definitely speak to Emrah, Sorwe's CEO.

  • As depicted above, we made some moves in the boring business portfolio too & acquired a share in digital performance agency Birne 🍐. As said before, we see this investment as a strategic building block and an enabler in our portfolio. Digitising customer acquisition (1) of our portfolio companies & building audience relevant brands (2) while being invested in a profitable business is a win-win-win.

  • On the coffee portfolio, after thorough research, Slavo allocated his capital into a new little helper to prepare his daily filter, if you're in the market and looking for inspo, search no further.

Do you enjoy this type of content? The best way you can help us is to share The Caffeine Capitalist in your community using the button below:

Enjoy your coffee fresh, allocate capital, repeat! See you in two weeks πŸ‘‹

What do you think of this issue?

DISCLAIMER: None of this is financial advice. This newsletter is strictly educational and is not investment advice or a solicitation to buy or sell any assets or to make any financial decisions. Please be careful and do your own research.