David Gardner (Cofounders Capital): We have a joke that if we don’t understand something in the first 2 minutes, we won’t invest.
30 Jul, 2021
Dmitry Chikhachev is General Partner and Co-Founder at Runa Capital. He co-founded Runa in 2010 and has led many early-stage investments in deep tech companies, including Nginx (acquired by F5 Networks for $670M; read the story), Capptain (acquired by Microsoft), and MariaDB, as well as many B2B SaaS companies, including Ecwid, Critizr, and Simplifield. He is based in Luxembourg and predominantly focuses on startups from France, Benelux, and the United Kingdom.
Well, that’s a long story starting back in the fall of 2009. I exited my previous project, Uvenco; it was manufacturing and operating vending machines. I took a month off to think about what I’ve got to do next. As usual, I sent emails to my contacts that they shouldn’t write to my corporate email anymore, but use my Gmail account. One of the first who responded was Sergey Belousov, my classmate. Then he called me, saying. “Looks like you are looking for your next gig. Please, come, and let’s talk.” We met in his office in a couple of days, and he proposed to launch a venture capital firm. My first question was, “What the heck was the venture capital firm?” I was doing mostly offline business, while Sergey was in software business since 2000. Sergey told me, “Why don’t you buy a ticket to San Francisco? I give you some contacts over there and they will tell you about venture capital much better.” One month later I was in Palo Alto, where I met a couple of dozens of people related to the VC industry – fund partners, business Angels, startup founders. I had a list of questions about VC, I put together the answers, and I liked very much what I heard. Later I visited Israel, where I have many friends, and I met other people from the industry, asking the same questions. That’s how the business plan of Runa Capital was put together. It turned out that our expertise was quite complimentary, so Sergey and his partner Ilya were from software business, we all have graduated from the Physics department and understood technology well, and my experience as CEO of a startup and work in M&A was quite complimentary too.
I think all of our startups are exotic in their own way because every entrepreneur is crazy to some extent. When people are thinking about disrupting the giants of the industry or starting a new tech venture, they need to have some stamina.
We see about 200 startups every month. I don’t look at all of them – they are screened by the team. Frankly, 90% of them go directly to the bin – not because they’re bad or something, just many of them are not in our focus, or not the right stage, or some other technical reasons. Perhaps, 10% and up are been discussed on our pipeline calls. Every 4 years we raise a new fund and make 25-30 investments out of it, which is less than 10 investments per yearLater we added B2B SaaS and Software.
It is a combination of methods, probably 50/50. About half of the startups come to us, the rest we proactively reach out. Some of those who come to us are sending cold emails, which is not the best way to contact the VCs. It is much better to come through introduction: try to find someone who can introduce you to a partner or even an associate in a firm – that’s an industry standard. It is kind of a VC’s joke: What kind of entrepreneur you are if you cannot find an introduction to a partner? When we reach out for startups, we’re looking specifically at the industries we’re interested in. We look at various open-source startups at GitHub and other platforms, we contact them through LinkedIn or other social media, and ask for additional information or invite to talk.
I think the criteria are all the same for most VCs. VCs look at three components. One component is the team, and I will put the team in the first place. A good, strong team can make a successful venture out of an average idea, but an average team wouldn’t make a good business out of a good idea. The second component is the product – what kind of problems it is solving and how good is their solution. And the last but not least component is the business itself, the economics of a startup: how big is the market, how competitive, what is the business model, how good is the unit economics – all the operational components of the business plan.
Our investment interests are quite broad. We’ve started with DeepTech, which includes a variety of things. Back in 2010, when we’ve just started, Cloud was DeepTech, now it is a commodity, as well as Open Source is. Now DeepTech means AI, Quantum Computing. Later we added B2B SaaS and Enterprise Software; that’s very much mainstream for VCs over the last years, but I think this trend will continue. Finally, we have what we call “regulated industries,” that includes FinTech, Education, EduTech, and Healthcare that have very much in common from an adoption point of view: all these industries are very regulated, very horizontal, and very conservative.
We mainly enter at Series A, when a company is making some first revenues which confirm product-markets fit. We can invest $3-5M in this round. But we also do pre-Series A sometimes, at a late seed or pre-Series A, when a startup needs a bridge round. We can see MVP and some traction already. And sometimes we do later stages, as late as it takes. It doesn’t mean we chase each and every deal, but we look for special opportunities, where we can add significant value or where we can have a very good deal. We are quite opportunistic when we look at the later stages.
North America and Europe. We started originally from Western Europe, then in 2013 we started making investments in North America and opened our office in Palo Alto in 2014. Now our capital is deployed roughly 50/50 between North America and Europe.
Sometimes it takes 3-4 weeks, sometimes it could take up to 1 year: the longest deal closing I remember took us 11 months. That’s not necessarily because we are so slow: sometimes a startup is not ready to close the deal, sometimes we start a conversation, like, 2 months before they are ready to start the fundraising. Actually, I like it when we have enough time to get to know each other, and I think that’s also beneficial for a startup – to get to know an investor for several months, rather than several weeks, prior to signing the deal. The diligence itself takes 4 to 6 weeks.
For Series A that’s typically $3-5M. For pre-Series A or seed stages, it is $1-1.5M. For later stages, it can be $5M as well. We can deploy up to $10M into a single company, so during the initial investments we keep in mind that there will be following rounds, so we have some resources for each company in our portfolio. We also recently established Seed Pocket. It is a small part of the fund from which we can issue smaller checks (in hundreds of thousands of USD) to really early-stage startups – at the seed or pre-seed stage.
Each startup we invest in we expect to make at least 10x at the best scenario. I think that’s the minimum because the venture math works this way: you always expect 10x, the best-case scenario. Then the risks kick in – the execution risks, the technology, etc., – all those reasons why this 10x would not happen. Those risks lead to a situation when just a small fraction of the startups actually generate 10x: some generate 3x, some only pay your money back. But if not all of the startups in your portfolio have a high potential for big returns, then the venture math is broken and risks of not even returning your fund are still there.
The dilution of ownership is happening at each round, usually, it is 15% to 25%. To generate some meaningful return on our investment, we have to have a sufficient stake in the company.
We looked at Open Source and DeepTech, and as the latter includes infrastructure software, which is everything beneath an application layer, we practically looked up different Open Source projects in infrastructure. Nginx is one of the most popular Open Source projects, it had amazing traction by the time we started to support them. Actually, by the time the founders decided to stop raising money, it already had very significant traction. MariaDB was a slightly different story. It was founded by the team which developed MySQL, it was acquired by Sun Microsystems, which later was acquired by Oracle, which was the worst enemy of MySQL. The team behind MySQL decided to restart it, that’s how MariaDB started. My partner knew Monty – Michael Widenius. And he invited us to join the Series A round.
It’s a combination of a few things. One thing is competence. It is especially important for DeepTech projects, but not only that: you need to have the expertise, otherwise, you will never achieve good results. Number 2 is commitment and energy. Teams need to be dedicated to what they doing, need to be all in, and commit all their time to make a startup while having sufficient energy to do a lot of things. They need to be committed and hard-working. These 2 qualities are the most important, but then there is a number of other factors which are also quite important. Members of a team need to be complementary and coherent, need to work together. Finally, the team should be mature enough to work with investors, because this work requires both maturity and humbleness from a founder, as well as an understanding of mutual interests. Founders may have various interests, values, and reasons to do what they do, but when they decide to partner with an investor, they have to put the interests of shareholders in the first place, while all other interests should step back. This is very important.
Statistically, the best performing teams consist of 2 or 3 founders, but we have supported solo founders with teams, of course.
There is a variety of red flags for us. Any backside of the qualities that I mentioned, like the founders are not hard-working or not competent in the area or not committed – it is a red flag. Every red flag may expose itself in a number of ways. If, for example, founders ask for very high salaries for themselves, that probably shows the lack of commitment, etc., etc. These kinds of details signal future problems. And you should look for such signals, because nobody will tell you, “ I’m not committed to this startup, just want to get some fast money.” So, the signals show you that a problem may exist, and there are lots of those signals.
I don’t remember cases when we’ve rejected a startup and then realized that we’ve made a mistake. But there were cases where we didn’t pay enough attention and missed a good deal. When you reject the startup, you have some good reasons to do that, and in most cases, it doesn’t become something great. But there are many cases when you have some doubts, you’re not convinced, you’re hesitating, don’t make a deal – and it becomes a really great company. This happens now and then.
I wouldn’t say it has changed completely, but it highlighted certain sectors of the economy and certain trends, that we try to take into account. For example, remoteness is becoming the new reality. And, I think, the recession is becoming the new reality too. That creates whole new markets for startups, For many years we invest in online education, but lately, it became super hot. Medicine is becoming super hot. Some industries have got a boost, but I wouldn’t say that the landscape has changed completely.
I don’t think it’s a threat, because what VC is doing, we are buying risks, this is a part of the game. And one risk more or less doesn’t change the situation dramatically. It’s neither threat nor opportunity, this is just another risk to take into account.
There are all old names that come to my mind, but let’s name Hewlett-Packard, Intel, and Microsoft as a software company that really disrupted the ecosystem.
I’m not only satisfied: I’m extremely happy with what I’m doing. It is a hardly rewarding job, and I literally think that during all my previous career I was coming to do what I do now. It combines 3 things that I like. I have to exercise my brain because I’m at the very edge of the tech world. I am meeting extremely impressive people because most entrepreneurs are extraordinary people, with extraordinary competence, extraordinary energy, and by far are very strong people. Finally, I like variety, I’m not someone who can be in operational business doing the same things for years. And VC provides ideal variety in tasks and people. We work with different regions and different people from all backgrounds.
It’s actually a combination of two things: you need to like people and you need to like complex problems. It’s not often when people like both of these. When I’m recruiting for Runa Capital, there are people who are stronger in solving complex problems and some people are very good at social interaction. But you need to be good at both.
The venture business is sort of Poker. You may consider your portfolio as a number of deals. You can lose with any given deal to a complete beginner because the cards in your hand won’t be good. But in a series of deals, if you know the math and know how to play, you are very unlikely to lose.
Number 1: Solve a massive and painful problem. When you develop a product or when you start a company, solve a real problem, the one that people have, not the one you think they have. Many startups are solving some hypothetical problems. If it’s not massive, then you will never scale the startup, and if it’s not painful, it’s not really a problem. Number 2: Time is your most valuable resource. You can raise or borrow money, but you can not raise or borrow time. You can buy yourself some time with money by hiring more people and doing some things faster, but you have to remember that money is just a resource and time is a unique substance you cannot waste. Number 3: It a consequence of #2. Bring only the best people to your team. Don’t hire B-people, hire only A-people, because they can do things fast, and that’s, actually, how you win. Your team is the most important component, make it the strongest in the market. Because the best teams win, not the best ideas. Ideas are a commodity, the good teams are scarce.