BY REZA CHOWDHURY

Welcome back to Inside the Mind of an NYC VC, a highly acclaimed series at AlleyWatch in which we speak with leading New York City-based Venture Capitalists. In the hot seat this time is Kapil Desai, Vice President at Catalyst Investors, one of New York’s first growth equity firms, which was founded in 2000.  Currently investing out of its fourth fund, which closed at $377M in 2015, Catalyst has made investments in names like ChowNow, MINDBODY, MediaMath, WeWork, and WeddingWire with a research-driven focus on tech-enabled businesses.

Kapil was kind enough to join us in our offices in Soho to provide some candid insight into his path to venture from banking, the nuances of growth equity investing, actionable insights for founders that are raising and considering growth capital, ramen in NYC, and much, much more…

If you are a NYC-based VC interested in participating in this series, please send us an email. We’d love to chat. If you are interested in sponsoring this series that showcases the leading minds in venture in NYC, we’d also love to chat. Send us a note.

Reza Chowdhury, AlleyWatch: Please tell us a little bit about background and how/why you started in growth equity.

Kapil Desai, Catalyst Investors: I’m originally from South Jersey (not to be confused with New Jersey).  I went to Georgetown for undergrad where I was enrolled in the business school.  Directionally, I knew I wanted to study “business,” but I had a bit of trouble identifying exactly what that meant.  Not knowing what I wanted to do, I took the tried and true investment banking route and ended up at Credit Suisse in its Technology Investment Banking Group in San Francisco.  While there, I primarily worked with software and internet companies across a host of advisory services, from capital raises and IPOs to M&A.

One of the IPOs I worked on was for MINDBODY, which provides business management software for companies in the health and wellness industries.  Serendipitously, at the same time, a headhunter reached out about a position with Catalyst, who happened to be the largest institutional investor in MINDBODY.  Having had some exposure to Catalyst and its investment philosophy, I knew this role might be a potential fit.  The interview process reinforced my interest as it was clear that this new role would allow me to work with companies at a pivotal inflection point in their maturation, the “growth stage,” and allow me to help talented founders and management teams work towards great outcomes.  More than five years later, I can confidently say that this was the right path for me.

Tell us more about Catalyst Investors.

Founded twenty years ago, Catalyst is a growth equity firm that invests in software and technology-enabled services.  We take a research-based approach to investing and have active themes across several functional and vertical areas, including food, legal, compliance, healthcare and several others.  Some of our representative investments, include Mindbody, WeddingWire, ChowNow, Weave, and Fusion Risk Management.  Our team is up to 16 people, all based in New York.

How has the transition been from banking to startup investing?  What skillsets from banking have been helpful in investing?

The transition from banking to startup investing has been (mostly) smooth.  Banking does a great job of building your technical base with exposure to financial modeling, unit economic analyses, and market sizing.  It also helps you with softer skills such as prioritization and communication as you’re working on multiple projects with multiple teams at any given time.  These skills are immediately transferrable to growth investing, particularly with investment analysis and execution.

The biggest difference between banking and startup investing is the time horizon and immediacy of results.  Banking is often project-based and has a specific goal within a specific time frame.  Throughout these projects, there’s typically immediate feedback and direction that helps you iterate and respond accordingly.  Startup investing has a much longer timeframe and feedback periods are elongated.  You need to be comfortable trusting that the process (thematic sourcing, go-to-market execution, strategic guidance) will lead to results.

Is there a specific investment thesis that Catalyst deploys? Where is the firm’s sweet spot? 

Catalyst invests exclusively in growth-stage recurring revenue businesses.  We focus on B2B software, technology-enabled services and marketplace businesses that have demonstrated significant transaction and product-market fit.  Typically this means we initially invest $10 million to $30 million in businesses with greater than $7 million of revenue.  We usually lead each round and target 12-15 investments per fund, which averages out to three or four new deals each year.

How exactly do you classify growth equity as an asset class? 

Growth equity falls towards the end of the venture capital financing spectrum.  Growth companies have (i) product-market fit, (ii) a statistically significant customer base, (iii) reduced technology / fundamental risk and (iv) signs of a scalable go-to-market.  These companies have enough datapoints to reasonably inform the investment decision but remain early enough to influence the ultimate growth trajectory.  Typically, these companies are raising primary capital to scale their go-to-market, invest in product development and potentially consider opportunistic M&A.  These companies may also seek secondary investment to provide partial or full liquidity for early shareholders and management.  Growth companies aren’t necessarily profitable, but they are unit economic profitable, meaning they understand how to acquire customers in an efficient and scalable way.

How is growth equity misunderstood?

In a capital-rich environment where venture funds have increased their AUM and/or have raised opportunity funds, there’s been some grey area as to what constitutes growth equity.  Venture-backed companies that raise additional capital aren’t necessarily growth equity investments.  Many of these companies are still associated with the binary (0 or 10x) outcome risk of many earlier-stage venture investments; they just happen to require and/or raise significant growth capital to execute on their plan.  Rather, growth equity should still be defined by the business and risk profile and not just the aggregate capital raised.  Growth companies are stable, faster-growing businesses that have demonstrated statistically significant traction and (typically) aren’t as susceptible to outright failure.  This asset class is often underwritten against execution and go-to-market risk rather than necessary transformational or fundamental shifts in industries and technology.  As such, growth equity investments are underwritten to a 3-5x ROI with a reasonable expectation to avoid complete capital loss.  In baseball terms, growth equity aims to hit consistent doubles and triples rather than swinging for a home run every time.

What does your day-to-day role entail not that any day is typical! 

My role has evolved over the last five years at Catalyst.  When I initially joined as an associate, my role skewed more towards sourcing new deals and investment analysis.  Now as a vice president, more of my time is spent supporting portfolio companies at the Board level.  I’m currently a Board Director on two companies (BrightFarms and Clinicient) and a Board Observer on two more (ChowNow and eSUB).  In these roles, I work with each management team and Board on overall strategy, budgeting/forecasting, KPI and performance benchmarking, capital formation and team building as well as joining and assisting Board committees.  We’re fairly active investors at the Board level and try to help our companies as often as appropriate and necessary.

Can you please walk us through an instance where you were involved from sourcing to exit?

While it hasn’t exited yet, we developed a relationship with ChowNow and its CEO and co-founder Chris Webb almost two years before our initial investment in 2017.  ChowNow provides a digital ordering platform that allows restaurants to offer direct online ordering and delivery.  We had originally identified the company through our Food Tech research and subsequently received a warm introduction from the CEO of Mindbody.  After initially connecting with Chris and the team, we had quarterly/semi-annual check-ins, tracking the company’s progress as it scaled into our investment mandate.  We tried to be helpful with introductions and feedback along the way, leveraging our experience in Food Tech and SMB-focused vertical SaaS.  When it came time to raise their Series B, we worked quickly with Chris and the team to close, having already built the relationship and trust over the last two years.  Fast forward another two years, we’ve closed a subsequent Series C and remain enthusiastic and supportive of the business and its mission to help local restaurants thrive.  It doesn’t always happen this way (though we’d like it to!), but we try our best to meet and stay on top of companies well in advance of them raising growth capital.  Shameless plug – if you’re considering an upcoming growth round, let’s talk!

How does Catalyst work with its portfolio companies?  What are the resources that Catalyst offers to its portfolio companies?

First and foremost, Catalyst offers availability.  We intentionally take a concentrated portfolio approach so that we can dedicate the right amount of time and attention to each of our companies.  Therefore, we try to limit the number of active portfolio companies each of us has to five or six at any given time.  We lead most deals and are active investors at the Board level.  We won’t tell you how to operate your day-to-day business – that’s not the nature of our business.  We will, however, lean on our experience investing exclusively at the growth stage to help you with challenges that we see many growth companies encounter.  We outline our approach to value creation across our four P’s framework:

1. P­eople – Your team has found success from $0 to $10 million of revenue, but do you have the right talent and structure in place to scale from $10 million to $50 million revenue?

2. Purpose – Is your mission statement and value proposition clear and consistent, both internally and externally?

3. Process – Have you professionalized the organization to make sure it has the right infrastructure and governance to scale?

4. Performance – How are you operating against your peers and competitors and where do you need to be to have a successful outcome for all shareholders?

While we’re with you every step of the way in answering those questions, we know what we don’t know and lean on the entire Catalyst network and other trusted resources, internal and external, to help in situations where an operator or a different skill set is more relevant.  One of our internal resources that helps in these situations is our Catalyst Advisory Group – about 30 operators and investors across various backgrounds who we leverage for different sector and functional expertise.  When there’s a great fit with a portfolio company, we have some members fill independent board director seats.  For example, John McKinley, who was previously the CTO of AOL, is an independent board member for our portfolio company, Reputation Institute.

Given that you are investing in the late stage, after product-market fit has already been established, do you find that founders may be set in their ways and not necessarily be willing to shift strategy or take advice readily?

We haven’t really seen that.  The average hold period for one of our investments is five to seven years – that’s a long time.  Considering that hold period and our activity at the Board level, a big part of our diligence is our relationship with management and more specifically, management’s openness to feedback and advice.  We find that our best founders and entrepreneurs all have a point of view but seek to refine their thinking and build consensus around the larger strategic decisions.  We won’t have a definitive answer to every question, but we aim to add value in the areas we do have relevant experience and guidance.

I’m sure you have seen instances, where founders took on too much capital early but did manage to figure out the formula.  How do you approach opportunities like this where the cap table may be less than ideal when considering an investment?

When assessing any investment opportunity, we first focus solely on the team and business.  We need to first decide that this is a business and opportunity that we’d like to be a part of.  After that determination and based only on the merits of the business and opportunity, we determine a valuation range.  Only then, do we turn to the cap table to see the best way to structure an investment.  Unfortunately, not all capital creates value, which can lead to bloated cap tables, something we’ve seen more often than we’d like.  While the last round sets a post-money valuation and potential expectation, we simply put forward what we’ve determined is the fair market value for the business.  Then it’s up to management and the Board to determine the right course of action for the business.

When assessing any investment opportunity, we first focus solely on the team and business.  We need to first decide that this is a business and opportunity that we’d like to be a part of.  After that determination and based only on the merits of the business and opportunity, we determine a valuation range.  Only then, do we turn to the cap table to see the best way to structure an investment.  Unfortunately, not all capital creates value, which can lead to bloated cap tables, something we’ve seen more often than we’d like.  While the last round sets a post-money valuation and potential expectation, we simply put forward what we’ve determined is the fair market value for the business.  Then it’s up to management and the Board to determine the right course of action for the business.

In these situations, it’s not easy but our general advice is to reset and take the capital you need from the right partner.  It’s definitely a bit disheartening for a team to right the ship only to encounter the reality that their current value hasn’t grown or has even declined against a previous mark; however, letting a legacy cap structure dictate the future will ultimately lead to a worse outcome.

What do you need to see from teams, both qualitatively and quantitatively, in order to invest?  Which metrics are most important? 

Qualitatively, I need to see a thoughtful and self-aware understanding of the company’s current and future market position.  It’s easy to stick a logo in the top right quadrant or fill in every Harvey ball against very intentional criteria; it’s a lot tougher to be clear about the company’s current strengths and deficiencies and line up why or why not each matter.  It helps cut through the noise to the company’s real value proposition which helps inform the longer-term vision and strategy.

Quantitively, I need to see a clear understanding of key unit economics informed by the fundamental levers of the business.  This is more than simply calculating generic SaaS unit economics; rather, it’s an understanding of how specific decisions impact the metrics and tying it all together in a decision-making framework and strategic roadmap.  The general approach of growth equity is to analyze available datapoints to assess the health of a business and then reasonably project how investments in specific areas and initiatives will return value.  Having that clear understanding demonstrates a data-driven approach to growth.

The metrics that are most important are the metrics that are most relevant.  For example, a SMB-focused SaaS company may focus on gross margin payback period, whereas an enterprise-focused software and services business may focus on net churn.  Not all metrics are necessarily relevant, so knowing which to measure and track is crucial.

At the growth equity stage, what do you think should be in a CEO’s top 3 company priorities?

1. Not all of the employees that got you to $10 million of revenue will get you to $50 million. A CEO’s primary role should be ensuring that each department has the right leadership, often those with deeper functional expertise, such that they grow efficiently with the right systems, processes and people in place.

2. A CEO must be able to clearly define and communicate the vision for the business in a way that allows everyone to understand how their contribution is advancing the company’s mission. This needs to be clear and consistent across all stakeholders.

3. Culture is the personality of a company and defines the work environment. This creates that intrinsic buzz that goes a long way in attracting and retaining talent.

Turning the tables, what makes a good investor?

Creativity and conviction.  Particularly at the growth stage and in a world where SaaS metrics and other analyses are widely available and accepted, it’s not enough to force-fit every investment through the same rigid analysis.  Just as we expect of our CEOs, a good investor will take the time to understand the specific, fundamental drivers of a business and learn how to incorporate that in the analysis of the overall opportunity.  After that, make sure you’ve built conviction about the opportunity.  A good investor has a defined thesis, probability-weights the risk-reward and is genuinely excited about partnering with management to go after the opportunity.  It’s going to be a long partnership and things won’t always go well; make it one you want to see through.

Who do you admire in the startup world and why?

He’s now technically in the startup world, so I’ll stretch and say Sam Hinkie, former GM of the Philadelphia 76ers.  He took an exaggerated, data-driven approach to turning the 76ers around.  Though wildly unconventional and unpopular at the time (and still with many people today), he was steadfast in his approach and laid the groundwork that rebuilt the 76ers into current contention.  Trust the process.

When you put on your headphones and need to get head down in something, what are you listening to?

I have a “Jams” playlist that is exclusively early to mid-2000s R&B and hip hop.  My taste in music hasn’t matured in the last decade and a half.

What’s your favorite restaurant in the city?

Ivan Ramen in the Lower East Side.  Always consistent and delicious.  The spicy red chili ramen is incredible (and legitimately spicy).

What’s your favorite fall destination in and around NYC?

Sitting in Washington Square Park and enjoying the sensory overload.