Building VC strategy

I would like to share how we built the strategy of Innovation Nest.

Building strategy is a long process and very often it is a long and winding road. In our case it began 6 years ago when we started Innovation Nest Fund I. The current strategy, the strategy of Fund II, is a consequence of experimenting that we did in Fund I. Fund I was a sandbox, it was a microfund of €7.5m and it invested in 23 companies from 2012 until 2016.

Fund II begins investing now. The first substantial closing for €24m will take place next week, in June 2017. Fund II will invest in 25–30 B2B companies in Europe and its target size is €30 to €50m.

Before the story begins, here are a few basic facts about Fund I and Fund II:

Innovation Nest Fund I — looking for the strategy that works

Founding thesis

In 2011 I had two observations: (1) Internet markets had become more and more connected with the US market, and among themselves, what made more and more difficult for local entrepreneurs to compete; (2) there were plenty of examples of companies that had a global reach though they were founded outside main tech hubs. Combined with the observation that the tech market in Poland, where we are from, was very dynamic but very local, founders of Fund I agreed to the very clear Founding Thesis:

Fund I invests in early stage Polish companies that go beyond the local niche.

We assumed that there will be a trend of Polish entrepreneurs starting software companies that go beyond the Polish market. Anticipating the ending of this story, I have to say, that we were right!

5 investment hypotheses of Innovation Nest Fund I

In general,

staging execution, setting milestones, making micro-hypotheses are necessary to find a good strategy.

It was so in our case. The Founding Thesis was very general. To make it work we made a couple of investment micro-theses and tested them in the real world.

Three of them were about startups in pre-revenue stage. We started investments with (1) hands-on pre-seed — 2–3 years of direct support for companies that were long before a product launch. These companies usually received a couple of tranches of investments from us. We had the (2) acceleration program — the same kind of support but more structured and with clear time constraints and we invested in B2B software companies at pre-revenue stage that had (3) a hardware component.

We invested also in companies that (4) almost had first sales, that is in companies where there was a substantial feedback from the market, the product was ready or almost ready but there was no proper sales yet. And, last but not least, we invested at (5) seed stage in companies with monthly recurring revenues above €10k.

Gradual roll-out

In each of these groups we made 4 to 6 investments and there was a gradual roll-out and iterations of strategic thinking. Hands-on pre-seed and almost first sales started the fund and after a year we added two variants of pre-seed: acceleration program and software/hardware companies.

After 2 and half years there we made two observations: (1) pre-seed investments were progressing very slowly and (2) there was a new type of companies around — companies with revenues that went beyond the local niche. It made us to stop pre-seed investments (except software/hardware) and start seed investments.

Investment hypotheses of Fund I and the market verification

After 5 years we have the following verification and wrap-up of 5 micro-theses of Innovation Nest Fund I:

As always in life the results were mixed: some micro-theses worked well, the others worked did not.

What we learned

There are the following lessons learnt about the companies:

  • The founding thesis was correct — the anticipated trend of local entrepreneurs going global became real.
  • Seed investments and almost first sales investments were the most successful for Innovation Nest Fund I.
  • It takes longer that we assumed to build a company. Though my personal experience at was that it took 5 years from the pre-seed investment to +€100m exit, but usually it takes more than 7 years from pre-seed investment to +€100m exit.

And we had the following take-aways about how to operate a fund:

  • Good co-investors add value and increase chances for success. It is not a coincidence that most successful companies have a number of investors on board.
  • Focus matters. If an investor has a couple investments in one field, the added value of such investor increases.

The overall conclusion was that

Innovation Nest has reached Product Market Fit and it was ready to scale!

The new adventure was approaching!

Innovation Nest Fund II — scaling after Product-Market-Fit in Fund I

The cycle of innovation makes the world go round. Make a hypothesis, test, think, iterate. We did our homework and we come with the next iteration. The Fund II is based on three claims:

Founding Thesis №1 — Cloud and SaaS B2B Software

  • Lessons from Fund I: Focus matters. If an investor has a couple investments in one field, the added value of such investor increases.
  • Observations: Cloud is making a revolution for B2B software and the revolution will be huge. Innovation Nest has become a specialist in B2B software and most investments of Fund I were made in cloud based businesses.
  • Assumption: It is good to anticipate the trend. We assume that in Europe there will be a need for specialised value add seed investors as it already happens in the US.

Founding Thesis №1: Innovation Nest invests in cloud B2B software. We understand cloud very broadly but usually it is a SaaS business model and a cloud architecture.

Founding Thesis №2 — Seed Stage

  • Lessons from Fund I: First, seed investments and, as I called them, almost first sales investments were the most successful for Innovation Nest Fund I. Second, it takes long time to build a company therefore it makes sense to invest at seed stage instead of pre-seed stage. Third, good co-investors add value and increase chances for success.
  • Observations: First, for entrepreneurs it is often more difficult to get €2m seed round than €0.5-€0.75m pre-seed round. Second, follow-on investments make a lot of sense for companies and for the fund.

Founding Thesis №2: First investment of Innovation Nest and active support is at seed stage but Innovation Nest continues and makes follow-on investments. At all stages good co-investors are highly appreciated.

Geography — Europe

  • Assumptions: First, any fund has a choice to be a generalist on local market or specialist on global market. The choice of Innovation Nest is to be a specialist and therefore Innovation Nest looks at companies and invests in companies in whole Europe. Second, Innovation Nest is based in Kraków, therefore Poland and Central Europe are important for Innovation Nest.
  • Observation: In the main hubs (London, Paris, Berlin, Stockholm) there is liquidity at seed stage but there is not enough liquidity in all rising centers in Europe, therefore there is a space for specialised value add seed investor.

Conclusions: Innovation Nest invests in Europe but Central Europe is important for Innovation Nest. Among all cities in Europe, Innovation Nest focuses on rising centers.

Innovation Nest Fund II strategy

Each of the three claims follows from what we experienced and what we see. Innovation Nest Fund II strategy on a general level is a sum of these three claims. The strategy in one sentence is the following:

The path ahead

We are starting the next adventure. I guess there are many traps and dangers on the way but I know that there are paths to many treasures as well. I will be happy to update you how the treasure hunt progresses.