1Mby1M Virtual Accelerator AI Investor Forum: Heriberto Diarte, Co-Founder and Managing Partner at Catalyzer Ventures (Part 3)

Sramana Mitra: So you talked about the stage at which you like to come in. What check sizes are you writing?

Heriberto Diarte: $2 to $5 million. We can go up to 10, but we normally do $2-$5 million, and then we reserve 40%.

Sramana Mitra: And so $2-$5 million is in seed and Series A, and then you have follow-ons after. You do follow-ons as well?

Heriberto Diarte:  Absolutely, yes. And on the follow-ons, the plan is we are happy to lead the follow on also – to price it and to lead. And we have LPs who would like to co-invest. So the ability to do follow-ons with a company that we know well goes beyond the $100 million fund that we have. So we can put more money in a follow-on in a company we know well and we have conviction in.

Sramana Mitra: You mentioned that you’re doing investments all over the United States, including in places where there isn’t a lot of venture capital locally. And of course, the industrial and energy and all that is not really Silicon Valley’s business. So those types of domain expertise comes from elsewhere. Are you restricting yourselves to the United States, then?

Heriberto Diarte: That is a great question. In practical terms, yes, because we’re a small fund and a small team. But if we find a great opportunity internationally that is really compelling, we’d go ahead. We looked at a couple of companies in Europe, one in Israel. So, the opportunity has to be really compelling, and we have to have an edge.

If I’m trying to compete for a deal in Berlin versus the local ones, I’m probably going to be without money, so I don’t want to do that. It has to be an edge. For example, we know the entrepreneur. The entrepreneur knows us and would like us to invest. He or she knows what we can bring to the table and  wants us, then that is a special situation where we have an edge because of the relationship. Also, if we think we can help this company, we can really open doors, help them to sell, or organize a partnership with a big company that is going to build the product instead of buying so that they can be asset light. If we are convinced that we can help the company go from zero to one, and they want us, we have an edge, then we would consider an investment outside the United States.

Sramana Mitra: Right. Okay, I’m going to get into something that is extremely hairy right now in the market. And the venture capital market has shifted to these whales. You have a bunch of companies, a handful of companies that are sucking up capital like crazy. The Anthropic, and the Space X’s, and the OpenAI’s, and so on. And they are obviously chasing trillion-dollar valuations and so on.

And then there are the unicorn chasers who are also sucking up tons of capital, hundreds of millions of dollars of capital. And I look at all that, and then I look at the statistics of how many zombie unicorns are sitting on the sidelines. They have raised tremendous amounts of money. They’re diluted to the hilt, and they cannot find an exit because they’re too overpriced, right? They’ve priced themselves out of reasonable exits. And the exit equation is really complicated, right?

96% of industry exits are sub $100 million, and the vast majority of exits are sub $50 million. So the amount of VC capital chasing the very small number of exits out there that are billion-dollar exits or $500 million exits are minuscule. How are you thinking about the exit issue? Our philosophy is entrepreneurship equals customers, revenues, and profits. Financing is optional. Exit is optional. However, if you raise venture capital, you have to exit. You have no choice. The only way you make money after raising venture capital is through an exit. So how are you thinking about the exit issue?

Heriberto Diarte: That is a great question, and we could have a whole podcast talking about this bifurcation of funding and whether all this money going to these big elephants with big dreams is going to pan out. And we have the historical answer to that. We’ve been in situations like this before, and this one is even bigger, the amount and the speed at which things are going.

Remember, everybody overestimates the first wave, which is where we are now, and everybody underestimates the second wave. There’s going to be a handful of big winners; Amazon was one of the big winners of the dot-com, but many went away. It’s going to be exactly the same thing this time. But I’m not going to comment on that. I’m going to comment on what we’re focusing on.

So, I mentioned to you that valuation is very important for us because of the way we underwrite an investment. Let’s say we are going to help this company succeed, and at some point this company has to generate cash flow. This is the whole thing. Cash flow, free cash flow is the thing that everybody wants. So based on these cash flows on year seven or year five or whatever, how much is this company worth based on the multiples of the space they’re in? Is it a 15x multiple or 30x multiple given their profitability, their trajectory, and so on. Based on that, we bring it back and underwrite the investment where we have to make money for our LPs.

So you asked something very important. For the shallow wrapper companies, what is the future and whether they can have an exit. So we’re looking for companies that can have a venture type of outcome, and to do that, we look for a big market, a company that can be really big and generate hundreds of millions of cash flow profit. That’s what we’re looking for, and there’s many of them.

So the second thing is that the generating cash flow is the reason to exist of the company. Then the moat is this access to proprietary data, to being embedded in the workflows that once you’re in it and everybody’s using your platform and you have a network effect, and the more people use it, the better, that is a moat. So when we find those, and we find them often, then that is a good investment. Now, because of our entry point, we are investing in companies at low double-digit valuations.

So if a company sells in five years, Siemens comes and buys them for $100 million, we’re going to do 5X. Or Schneider Electric comes and buys them for $300 million, we’re going to do 10X. I think about half of our companies are going to end up being acquired by a big corporation for cash in a very short amount of time because they are disrupting some of those larger businesses.

So when they get to the point that they have $50 million in ARR and EBITDA or cash flow generation of $20-something million, that company is set. They have a good trajectory. But then the big company is going to come and say, “Oh my God, these guys are eating my lunch,” or, “I want this technology.” And they’re going to put an offer on the table. And then as we’re on the board, we have to decide. Do we take this cash now? Is everybody happy to go home with this return? Or do we have, in a short amount of time, the capacity to keep growing this really significantly and do an IPO? That’s a decision we will take. But many of our companies, the great majority, are going to have the option to exit to a trade sale relatively quickly.

This segment is part 3 in the series : 1Mby1M Virtual Accelerator AI Investor Forum: Heriberto Diarte, Co-Founder and Managing Partner at Catalyzer Ventures
1 2 3 4