Welcome back to Inside the Mind of an NYC VC, a new series at AlleyWatch in which we speak with New York City-based Venture Capitalists. In the hot seat this time is Mia Hegazy, Senior Associate at Catalyst Investors, a growth equity firm focused on tech-enabled services including vertical SaaS, marketing tech, human capital management, and supply chain management. Mia met with AlleyWatch to talk about growth equity as an asset class, how Catalyst adds value as a board member, the growing pains and common learnings for CEOs as companies transition from venture financing to growth equity, and much, much more.
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Mia Hegazy of Catalyst Investors
Bart Clareman, AlleyWatch: Tell us about your journey into the venture business and how you came to join Catalyst Investors?
Mia Hegazy, Catalyst Investors: I’m from Pittsburgh originally. I went to Brown for undergrad, and I found my way into economics and urban studies. I interned for PNC in Pittsburgh, which was the first finance exposure that I’d had. After interning there I knew that I wanted to do something in finance but I wanted to be in New York.
I ended up at Berenson & Co., which is a boutique investment bank that’s a generalist M&A advisory firm. After a couple of years in banking I felt that I’d gotten the skillset I wanted from that experience, but didn’t necessarily want to stay on in an advisory role. I wanted to move to a longer-term role working with companies.
I found Catalyst through a headhunter, and through the interview process I realized it was the right fit for what I was looking for. Specifically, it was an opportunity to work with companies over a longer term, add value, have a lot of ownership in what I was doing, and be exposed to new sectors in tech.
I liked that Catalyst had a broad tech services focus. What I’d learned about myself as a generalist at Berenson was that I enjoyed ramping up on new sectors and getting exposure to new things I hadn’t previously worked on.
Catalyst provides growth equity – what is Catalyst’s definition for that and what does a company’s positioning need to be in order to be interesting for you?
It’s been an ongoing process of defining the asset class. A couple years ago Cambridge came out with research that said that the growth equity asset class had superior returns over 5- and 10-year periods relative to venture capital and buyout firms, so LP interest in the asset class continues to increase and defining it is very important.
At Catalyst, we think of growth equity as the tail end of the venture capital financing spectrum. It’s late stage enough that you have proof points to inform your investment decisions, but early enough to influence the growth trajectory of the business. Companies here have established product-market fit, they’ve reduced the technology risk as much as possible, and they’ve resolved their unit economics – they’re not necessarily profitable, but they understand how to acquire customers profitably and are in a position to scale on that basis.
I worked with the Growth Equity Group at the National Venture Capital Association to come up with a broader definition that goes to the company profile: a proven business model, quickly growing revenue, breakeven or approaching breakeven, and some level of founder involvement with the business. Often, it’s not so far removed from the venture capital world that the founder is no longer in the picture, it’s either founder-guided still or the founder is on the board.
The other part of the NVCA’s definition is the use of proceeds. Capital raised in this asset class can be for expanding a company’s sales and marketing efforts, product refinement, M&A and international expansion. We also consider secondary investments or liquidity for early shareholders or members of the management team to be an acceptable use of proceeds.
Finally, capital raised at this stage should be able to be the final round of funding. It doesn’t have to be, because many of our businesses will choose to focus on growth rather than profitability. We expect that our round of funding could get the company to cash flow positive if the company wanted to flip from a growth-based to value-based model.
You mentioned the Cambridge study, which showed the returns in the growth equity asset class are superior to earlier stage venture capital. How much of that is a function of avoiding companies that fail outright – a significant aspect of early-stage investing – and how much is a function of having greater certainty about the things Catalyst focuses on – product-market fit, reduced technology risk and unit economics clarity?
I think it’s a mix of both. We have a concentrated portfolio, we don’t expect to lose money on any investment, which is a big difference from venture. Where half or more of their investments may be losses, we expect to generate at least our money back, but typically we expect to do 2.5-3x on each investment. It’s less of a question of, “will we make 10x or 0?” And more a question of, “can we hit our target return?” We won’t invest if we don’t think we can get our target return in a base case outcome.
So I think it’s reduced risk, and with that comes more limited upside while having more stable returns. Catalyst has been consistent through our four funds of targeting that profile.
We’re control agnostic in growth equity. We take both minority and majority stakes. We typically invest in sectors that have already attracted venture activity. The returns are a function of the business’s growth, rather than leverage, which is an important distinction from the later-stage buyout firms.
From a company’s perspective, growth equity is compelling because it’s legitimacy signaling. To the extent the growth equity mandate is to not lose capital, for companies that raise capital at that stage it shows you have a proven business model. We also generally have deeper pockets with larger funds so we can follow on as needed. We are well aligned with the founders because of our return profile target; we’re not trying to generate outsized returns, and we try to be on the same page with management in terms of vision for the business.
Is that to say then that it would be unusual for Catalyst to make an investment and then change the management team? That’s more the province of later-stage buyout firms?
Yes – we don’t do that. Management is a big part of our investment decision. We see certain recapitalization opportunities where management is looking to leave, but we are not one of the firms that has a bench of CEOs ready to step in once we make an investment. That’s not to say that we don’t make management changes as the business matures or reaches a key inflection point, but it isn’t part of our investment thesis.
Catalyst invests in less than 1% of deals you see each year, so there’s quite a lot of pruning that takes place. What does it take for a company to make the grade at Catalyst?
From a quantitative perspective we’re looking for businesses with high single digits of revenue – $7-10M depending on who their customer is. For SMB-focused businesses we’ll go much earlier because they have many more customers and there’s more statistical significance to a lower revenue number, but we also do a lot of midmarket- and enterprise-focused businesses, where you might have just a handful of customers, so being at the upper end of that range is more important.
In terms of profitability, generally we’re investing between negative $5M and positive $5M of EBITDA and focusing more on the profitability on a unit economic basis than what the business is doing as a whole.
We’re looking for really good management teams in sectors where we see an opportunity to be a market leader – that’s probably the most important aspect on the qualitative side.
For us, feeling like we are going to partner with a manager that is strategic but also amenable to getting what we call our “professional board guidance” is important. We’re not operators at Catalyst, all of us have finance backgrounds, so our level of involvement is generally at the board level. We get involved to a greater extent because we have 10-12 companies in a given portfolio, so it’s a manageable number. But we’re not doing what the early stage guys do and helping companies find office space or whatever else.
One other point: we’re looking for mission-critical solutions. Especially over the past couple years in SaaS, where we do a lot of our investing, there’s a lot of marginal vitamins versus painkillers so to speak. We’re looking for something that demonstrates a real ROI and has an easily communicated value proposition.
What makes a value-added Board member, in your or Catalyst’s opinion?
There are three main things: it’s strategic guidance, establishing governance, and ensuring performance excellence.
On the strategic side, we work with companies to refine their value proposition. A good test here is, when we’re doing our diligence, we’ll talk to the CEO, the Head of Sales, and newer employees, and we’ll ask them, “What does this company do?” It’s amazing how often that response varies across those members of the team. We want to make sure everyone’s aligned around a core strategy and that the messaging is clear.
We’ll work with companies on a mission statement. Culture is really important for growth stage companies, because often we’re investing when they’re going from 50 employees to 100 and they’re doubling departments and there can be a lot of growing pains. Having a clearly defined mission is really important at that point. It may be a lower priority early on when you’re trying to build the ship, but it’s critical so we’ll work with companies to refine that.
Part of the value we add there comes from having looked at dozens of companies in the space before we invest. We’ve often talked to their competitors or clients of their competitors and have a good understanding of the competitive landscape. We’ll leverage that into doing market maps with our companies, we’ll do “the world according to our portfolio company” exercises to see how they’re fitting into the broader landscape. Those sorts of exercises will also inform exit planning.
On the governance side it’s setting up Board committees that earlier stage investors may not have instituted, like an Audit Committee or a Compensation Committee. We also bring in really great independent board members. We have a great network in our Catalyst Advisory Group, which includes former CEOs and other functional experts. We’ll leverage them to either sit on the board themselves or make referrals for good independents.
The last part is about guiding performance excellence. We do a lot to establish KPIs and a regular monitoring system – monthly reporting or quarterly reporting. We’ll get involved in helping with their budgets and longer term projections, as well as analyzing the unit economics. They often appreciate having another set of eyes to work through this stuff with them.
Because we invest broadly in different industries but always at the same stage, we have a lot of great benchmarking information from companies who have been at the same stage – for example, this is the Sales & Marketing cost as a percent of revenue that other companies at your stage have spent. Most of our CEOs and CFOs are craving that benchmarking information.
Part of what you’re describing is the process of a company growing up, of going from a messy early stage startup to a mature business. I imagine that can be a tough transition for some companies – what are the things companies struggle with when managing that transition?
I think part of it is the discipline required as you scale. You can patch up a lot of stuff with rubber bands when you’re really early stage, and you can get to $10M without necessarily figuring out the real operational efficiencies your business needs to have. When you scale, you need to make sure you don’t have a lot of variable expenses that continue as you grow.
Culture is a big thing. I think it’s Dunbar’s Law that says you can have meaningful relationships with 150 people, and then after that it’s really hard to maintain meaningful relationships. Our companies are often scaling past that 150 mark during our investment period, and there’s a lot of self-reflection among managers at that point. They’ll ask questions like, “Am I the right person to take this business from $10M to $25M and beyond?”
That’s what we really diligence in our initial screen of management – are they the right leader to take this company to the next phase of growth. What do we need to do to give them the right coaching to be the leader of a bigger organization?
The other thing is that, when you’re really early stage, I think CEOs in particular but also members of management as well can be involved in almost every aspect of the business. As you get larger, part of the growing pain is learning to delegate and find that next level of leadership, so recruiting is really important.
Say more about the coaching these in-transition CEOs need – are there certain gaps you see routinely?
Prioritization is one. Things can move really quickly when you’re small, but you can’t move as quickly when you’re larger, so drilling down on a couple of key initiatives for the year is really important.
Part of it is conservatism in some cases, because the venture funding cycle is much quicker than the growth funding cycle. Early on you’re fundraising pretty consistently every year or 18 months, so there can be a need to recalibrate your mindset to be more efficiency driven and thinking how you’re going to deploy capital over several years rather than go from financing round to financing round.
Another thing is building relationships with potential acquirers or future investors. We do a lot to set up our CEOs, which means going to conferences, including industry conferences that maybe they weren’t attending previously because they were earlier stage or banker conferences where they can build relationships there as well. That’s not top of mind when you’re first building a business, but it becomes more important as you approach an exit.
Finally, being connected with independent board members can be really helpful as I said earlier. It’s all about finding someone who has done this before. Many of our CEOs are first-time CEOs; one of my partners jokes that for some of our CEOs, every day the business they manage is the largest business they’ve ever run. They need a sounding board at points, and having a peer-to-peer relationship with another CEO who has been there before can be really helpful.
At Catalyst you’re responsible for deal sourcing and identifying new trends – tell us about the process for finding new trends. How do you identify them and, once you identify them, how do you diligence them and decide it’s a space Catalyst should play in?
Our research initiatives are largely driven from deal flow that we’re seeing. About half of our deal flow is outbound, and the other half is inbound either from entrepreneurs or companies reaching out or bankers sending us opportunities. As we start to see businesses in areas where we don’t have an active thesis but think are interesting opportunities, we’ll decide to pursue a research effort there.
An example is food tech. We were seeing a lot of deals there but didn’t have a framework for how to evaluate them. We’ll see deals and think they’re interesting but we’ll really need to come up with what our lens for evaluating those opportunities will be.
Once we’ve determined there’s support internally in a research report on a sector we’ll start to do diligence. We’ll look through Salesforce to remind ourselves the companies we’ve seen in a given space, and we’ll reference research that we’ve received through teasers for those companies. We’ll do our Google research and we subscribe to GLG, so we do a lot of calls with their expert network and all of that helps us refine a thesis.
From there, we’ll put together a white paper that will define the market that we’re researching. That will cover the market size and the growth rate, and it will also drill into the most interesting trends that we’re seeing. We’ll also put together a market map to frame the landscape; this is where we’ll identify companies we think are interesting candidates for growth equity investment.
Once we have a report we’ll discuss it as a group. Often there are still questions as to how we as Catalyst would enter this new space. With food tech there was a lot of that because part of it is B2C, and on the restaurant side a lot of it is selling to really low margin businesses that tend to be more focused on revenue growth than margin improvement.
Once we resolve some of the key internal questions, we’ll write a blog post and publish the research on our website, and we’ll use that to reach out to the companies we’re excited about. We’ll go to industry conferences to gain visibility, and also to continue to learn from industry leaders and the companies in the space.
It is very competitive in growth equity, so the research is a good way to show we’re not just tourists in a space, but rather that we actually have an interest in a space and are actively seeking an investment there.
We have a regional strategy as well because we are focused on investing across the US. We have investments in New York and San Francisco, certainly, but we also look to build relationships and deploy capital in some of the less-ventured regions.
I spend a lot of time in Pittsburgh, which has a burgeoning tech ecosystem. We also will go to Indianapolis and Austin and Portland, we spend a lot of time in Denver and other areas across the US where we’ve found there’s a level of pragmatism and capital efficiency that you’re not seeing in the venture hotbeds. Especially at the growth stage where we can write larger checks and do a recapitalization of a founder-owned business, that’s a really exciting opportunity for us.
What can cities that need innovation or revitalization do to make themselves a city that Catalyst would be interested in?
Support at the institutional level is important. Having entrepreneurial programs at universities is key, and then having jobs for students after they graduate is essential, so they don’t have to leave the city. In Pittsburgh you’re seeing companies like Uber and Google opening offices and hiring talent right out of the college. That will create potential future founders who want to stay in the city.
The other thing that’s essential is having early stage investors. For example, we have great relationships with Pittsburgh and Denver VCs who have spent time to nurture that ecosystem, and we are working on developing those relationships in other regions as well.
Back to trends that are interesting to you – what trends are you watching now beyond food tech?
Business process outsourcing, which is very broad. A couple of years ago we were seeing so much in SaaS and we found with many we just weren’t excited about them – they were marginal solutions, not mission critical solutions. Also, valuations were beyond where we could be comfortable that we could achieve our target return.
We started thinking about other areas where enterprises or SMBs were spending money. The services side was interesting to us, too. If you can establish a tech enablement element to it and create a recurring revenue model that’s scalable, there’s a huge market opportunity there.
Education has been an area of interest. We were initially focused on K-12, but we’ve gotten excited about continuing education more recently – in particular, vertically focused training solutions, that is, honing in on specific skill sets for corporate or vocational learning. We haven’t made an investment in continuing education yet but it’s of interest. On the K-12 side, we invested in PresenceLearning in 2015. The Company provides speech language pathology and occupational therapy to K-12 students via telemedicine platform. This is an example of a company we met through sharing our research pieces – I sent the education thesis to the founders and one of their investors who happened to be from Pittsburgh.
Some of the other sectors we’ve looked at more recently are travel technology, non-profit SaaS – not to be confused with unprofitable SaaS businesses! – and we looked at solar. As we see deal flow, we’ll reinvigorate areas that have maybe fallen by the wayside if we didn’t see a lot of activity after publishing our report.
You mentioned everyone at Catalyst has a financial services background rather than an operating background. Do any companies you speak with express concern about that?
We’ve not really heard that. Part of the reason is we’re supplemented by our Catalyst Advisory Group, which is all operators. The other thing is that the skillset for a growth equity investor is a bit more skewed towards a finance background, vs. early stage VC.
Also, it involves a lot of pattern recognition.The partners who have been here have worked on 60-70 transactions. Because we have a small portfolio that’s highly concentrated, we’re all up to speed on the whole portfolio. We talk about each portfolio company every Monday morning and across the firm, everyone is expected to be knowledgeable about each company. I think that helps with the pattern recognition, which is, I think, the important part of what an operator would bring to the role.
That said, we try to know what we don’t know and we leverage other resources in cases where an operator would be more helpful than we would be.
Say more about the Catalyst Advisory Group. How big is it, who are those people, and how did they come into the Catalyst family?
The Group is about 30 people. It’s been growing since the firm started. There are a variety of different roles. Some people were CEOs of former portfolio companies, who, once we exited the business wanted to maintain the relationship with Catalyst and we with them.
An example is John McKinley, who was the CTO of AOL. Catalyst has a longstanding relationship with John, and we recently appointed him to an independent board member for our portfolio company, Reputation Institute.
It’s generally informal, what we ask of the advisory group. We’ll ping them if we see something in their sectors or areas of expertise. We have an annual meeting that they all attend, and we’ll introduce them to our portfolio. Then we’ll have calls with them quarterly to share research and get their ideas on where we’re looking.
VC continues to be a male-dominated industry. How do you assess the progress that’s been made in terms of evening the playing field?
It’s definitely not where it needs to be, but I think there are really great initiatives to drive improvement. I’m a member of the Women in VC group that was started by Sutian Dong at Female Founders Fund and Jessica Peltz-Zatulove at KBS Ventures – it has grown to something like 200 or 300 women and is a really good network of women to trade notes with.
Catalyst has always been really good at recognizing that there aren’t enough women in the venture capital ecosystem. The firm has been supportive there as well, they make sure to give me equal exposure and have the opportunity to work closely with management.
There are a lot of events focused on bringing women in venture together, which is a good start. You need to have a strong support system, but more importantly you need to understand the necessary skills, specifically as a woman, to be successful in the field.
Negotiating skills are different for women than for men, so it’s important to skill up there. If you’re the only woman in the room, which is often the case, how do you make sure to add value and voice your opinion? When you’re in meetings with other women, how do you amplify each other?
Paying it forward is important as well. The number of women decreases as you move up the ranks. Part of addressing that means supporting junior people who are early in their careers to ensure they have a positive experience and want to stay in the business.
No matter the challenges, I’ve always thought it’s great being a woman in venture capital; you’re different and have a unique perspective and worldview. I’ve generally enjoyed that differentiation.
What advice would you give to an aspiring VC?
Building relationships is so important. A big thing is understanding how you can be helpful to somebody without expecting anything in return. I recommend going into meetings thinking, “what can I do for this person, where is there overlap, who can I introduce them to?” As you talk, there are other things that will come up, so after the meeting find a way share research or an article that would be helpful to them. Leaving someone with something meaningful from a meeting is a really helpful way to start establishing connections.
It’s the same for Catalyst as a firm. We’re really focused on meeting companies before they’re at our stage of investment because we like to add value before we’re investors. We’re serious about getting to know companies and entrepreneurs; we’ll actually introduce them to people in our network and will keep them informed as we see M&A opportunities or other opportunities.
The other thing is, there’s no substitute for hard work. When you leave fields like investment banking where it’s all about logging hours and you get to the point where you’re ready for a change, just make sure to hit the ground running when you’re in a new role. One of my partners sent me this article that was the two tiers of success. One is, you work really hard, and a lot of people can achieve that level, because you’re focused on yourself and improving yourself.
The second level is continuing to do the things you’ve done to be successful after you’ve experienced some level of success in a field. Often what that means is working with others and 10x thinking, and thinking bigger than what your individual goals were. That influenced me early in my career.
Favorite book and why?
Sadly, I mostly read nonfiction now. I liked Adam Grant’s Originals. The concept of avoiding “pre-crastination”, if you start a task too early without giving your mind time to work through the problem you’ll have less creative answers on how to deal with it. When I have tasks that require more thought I try to put them in the back of my mind, keep them marinating, and it makes for a little more stress maybe, but also better ideas as well.
What’s the most under-hyped part of the tech ecosystem?
Under-hyped is probably the services side of technology. People get really focused on very high margin SaaS businesses, but from an investor perspective I’m excited about services and how to deliver them efficiently to the SMB market that now has access to more technology and more outsourcing than they did before
The world in 2027: what one iconoclastic view do you have about how tech will change the world in the next 10 years?
This is a little idealistic, but I am hoping that increased connectivity will drive people to be healthier over time – from their individual decision making to being able to really quantify the self, hopefully driving more people to exercise more regularly. I’m optimistic about innovation in medicine and treatments for illnesses.