1Mby1M Virtual Accelerator AI Investor Forum: Heriberto Diarte, Co-Founder and Managing Partner at Catalyzer Ventures (Part 4)

Sramana Mitra: In other words, you’ve structured the funds to play the small exit game as opposed to just mindless unicorn chasing.

Heriberto Diarte: Yes. We want the unicorn. Don’t get me wrong. We want the big company. So we’re going for that, but for all of our companies, we have an intermediate stay, but they are going to get the option to be acquired earlier for hundreds of millions of dollars.

Sramana Mitra: Well, I think the problem that we see is this. The difference between mindless unicorn chasing and being more judicious about how you play your cards is how much money you raise in those companies. If you raise too much money, you price yourself out of small exits. If you keep yourselves capital efficient and focused on profitability and focused on, as you said, free cash flow and all of that, then the option of going for small exits remains.

Heriberto Diarte: That’s exactly right, and we give them that option. Let me give you an example. You have no idea how many entrepreneurs we’ve met who want to boil the ocean. They want to do everything in-house, have the factory, build it, sell it. And then part of our value-add to them is to figure out the right growth strategy where they can be capital efficient and fast. And we say, “You know what? Let’s say you’re building a computer. Don’t build the battery, the casing, and whatever. You’re just going to build the processor because that’s the key part that you need to have in-house. And then everything else, outsource it to somebody else.”

So we help them figure out, can they license the whole technology and let a Siemens or a Flextronics or a Nestle, if they are in reactors, build the product for you, or do you need to keep something in-house? We figure out what is the best way to grow fast, to invest less amount of money, and to get to cash flow positive and scale the fastest possible.

Many of these entrepreneurs don’t know the industrial ecosystem that we have in this world and which pieces you can bring to bear to make your company successful and faster. So the first thing we do is sit with the entrepreneur, and even before we invest, we go to them and say, “Look, we have a path for you to grow, which is this, which is slightly different than you were thinking. Are we aligned on this? Do you think we can go in this way?” And if we agree, then we make the investment and we help her or him to achieve that path. Because if you grow fast and get to profitability quickly with less capital, you’re going to be golden at the time you’re selling. And that’s what we want.

Sramana Mitra: How is vertical AI going to play out in your assumptions? For a while, vertical SaaS emerged either as its own IPO-worthy category. One of my favorite examples has always been Veeva. They just raised $4 million and they built this fantastic company that still continues to be an independently successful vertical SaaS company.

And then many other vertical SaaS companies were acquired by private equity. But now a lot of these are sitting around within private equity portfolios and are unable to find exits. How do you see vertical AI playing out?

Heriberto Diarte: That is a very good question because you’re trying to extrapolate the experience of SaaS into vertical AI, which is a very relevant comparison because basically vertical AI is the new SaaS. The key thing is, as we kind of discussed before, if you have a company that has three things; first of all, it’s embedded in the network. It uses proprietary data. It uses, for example, rules and things like that that are difficult to codify. I call it AI in a box. When you need to design a sub-station or build something, there are some rules. If you are able to put your AI in that box that follows the rules and has proprietary data, that is a moat. That is a real differentiation, that’s the first thing.

The second thing is, if you’re in a big market that is growing; once you’ve proven the model and you have a big white space to go after and continue to grow, then you reach the third point, which is growth and cash flow. You will have positive cash flow, and you will be growing this cash flow through time as you grow. Then you’re going to go IPO or you’re going to be acquired. So, what changes with SaaS is that these companies can be much more frugal. We’ve invested into one of these companies.

We gave them $2 million. It turns out they’re going to need only half of that. They’re sitting in plenty of cash because they’re using AI a lot to develop their solution. And instead of having a team of 20 people that we thought, at the most, when they are selling hundreds of millions of dollars of ARR, this is going to be a six to seven people company because they don’t need more.

Sramana Mitra: That is really where my thesis on Vertical SaaS versus Vertical AI is ending up. Vertical SaaS became a very big money game. A lot of capital went into Vertical SaaS. Vertical SaaS became the favorite of the venture capital industry, and they just flushed those companies with capital. And I think Vertical AI can be bootstrapped or built very capital efficiently with small amounts of capital and become sustainable companies. And then they’re not dependent on raising more money and all of that stuff. So I think there’s a huge opportunity in Vertical AI on the bootstrapped side as well.

Heriberto Diarte: I agree 100% with you. We’ve seen it in this company. As I said, we gave them $2 million. They haven’t even spent– They’re going to start becoming profitable with $400,000 spent, something like that. It’s incredible.

Sramana Mitra: Yeah. That points to the fact that these companies are very bootstrapable. You don’t really need capital to build these companies.

Heriberto Diarte: I thought you were advertising to your entrepreneurs! Yes, but you need somebody like me to tell you how to play the market. So get my money in, and my advice.

This segment is part 4 in the series : 1Mby1M Virtual Accelerator AI Investor Forum: Heriberto Diarte, Co-Founder and Managing Partner at Catalyzer Ventures
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