Episode 16: Lauren Bonner of MBM Capital
on the Value of Steady Growth in a ‘Unicorn or Bust’ VC Environment

Episode Transcript

Shiv: Alright, Lauren, welcome to the show. How's it going?

Lauren: Great, great to see you and be here with you.

Shiv: Likewise, excited to have you on. So why don't we start with your background for the audience and we'll take it from there.

Lauren: Sure. So I'm a born and raised New Yorker in all possible ways, I would say. I started my career really at Bridgewater, where I think I kind of got my professional operating system in terms of how I think about performance and obsessiveness about talent. I then went on to be a GP at a fintech venture fund called One Zero Capital. That's really where the idea for what we're doing now in terms of investing in stranded venture-backed companies started. It was an atypical venture fund. It was - we created companies ourselves. So we were kind of early in the venture studio model and we brought founders in. We had a very low basis, obviously, because we were creating these companies ourselves. We had control for a long period of time in these companies, and then it was also all partner capital, which meant that, you know, our money was going out the door every two weeks. So it gives you an owner-operator mentality, let's call it. There is a zero-tolerance policy for zeros in the portfolio.

So we were pretty operationally involved in our companies. We spent a lot of time making sure that every company had a good outcome. Maybe not a kind of 100X-er, right? But a good outcome. And so as I reflected on that experience, after a couple of years, my takeaway was - and this really comes from some of my Bridgewater training about having a reliable, repeatable process for operating, for investing. And I just didn't have a playbook for unicorns, despite being involved in quite a few of them

I felt like too much magic over too long a horizon - and some people have that playbook, it just didn't feel like something I could take away and run again over and over again. And my now business partner, who I met at this venture fund - he was the turnaround CEO of one of our companies, he and I turned around one of those companies together - he felt the same way. And at the same time, I thought, okay, what do I have a reliable, repeatable process for here in venture? And it was really taking companies that were in kind of the middle tier of a venture portfolio. Companies that had established product market fit, had real customers that loved what they were doing, but they weren't really able to hit that escape velocity. And taking those kinds of companies, getting them to profitability, getting them to sustainability, getting them to a good exit to a strategic - that's the thing I felt like I could do over and over again. And so that was about a decade ago. And over the last decade, my now business partner and I, Arun Mittal, and I spent a lot of time meeting founders and founders who were stranded, who were saying, ‘I have this company, it's valuable. We're providing real value to our customers. We're not growing fast enough, and we're not worth hundreds of millions of dollars, but we belong in this world, we belong in this ecosystem.’ And so we just kind of built conviction, and at the same time, looking at the data, 88% of companies that get early-stage venture capital fail to get to a Series C. That's a huge opportunity set. And so we got really just compelled by the opportunity and the lack of capital markets that are organized to support these kinds of companies. And so we decided to launch a fund in 2021, really just focused on these kinds of companies. And so we invest five to 15 million into formerly venture-backed companies that have a real product, are revenue generating, typically kind of 3 to 25 million of revenue. And we help them to get off that venture path, which sometimes feels like a hamster wheel of fundraising for folks, and get them onto a path of profitability with more reasonable and achievable growth rates with an expectation they will exit in three to five years

Shiv: Right. And maybe you can expand on this concept of stranded venture-backed companies, because a lot of companies do raise money and it's celebrated to raise a series A or raise a series B. But the dirty secret is that a lot of those companies don't necessarily have either the best business models or maybe aren't capable of growing to the level that VC investors want them to grow to when they put in those dollars. And so is that the idea, is identifying the winners between that subset to find an alternative path for those investments

Lauren: Yes. I would say we still like to see companies that have a solid business model. They may not be on a business model that makes sense from a venture lens perspective. Apropos of this podcast, I think there are a lot of companies that want to be a SaaS company and they call themselves SaaS companies because they feel like that's where the multiples are and that's what sells. And I certainly understand that instinct. But if you're not trying to kind of attract venture investors, you're not trying to grow it 100% a year, 200% a year, you can reduce your sales cycle, you can bring in cash a lot faster if you just move to a transactional model. And that can be okay. You know, that - we think that's a great path for folks. And so we do look for companies that have a real solid product, but oftentimes their go-to-market doesn't make sense. And that's where we like to step in.

Shiv: And so can you describe some of the characteristics you look for inside those companies - when you say solid business model, is a net revenue retention is a profitability? Like what are some markers that are interesting to you?

Lauren: I would say, first of all, the product itself has to be a quality product. So that has all kinds of implications about churn. You want to see low churn, and you want to have, to the extent that there are great NPS scores, you want to see that. You want to see a real love of a product.

I would say there are always issues with a business model, so I can't say a company with a perfect business model is going to be one that shows up at our doorstep necessarily. But we do like those companies that have really that established strong product, but oftentimes the pricing is wrong. Oftentimes they're trying to be subscription when they should really be transactional or vice versa. Or there's just a different approach, or the sales strategy doesn't make sense. Less applicable, I think, for SaaS, but certainly we see in consumer all the time. Companies that have, I would say, a bad business model is one where the customer acquisition costs are just insurmountable, right? They don't get paid back for 12, 18 months, right? That's just insurmountable customer acquisition and either that means your go-to-market strategy is wrong and there's a better path, in which case we would be interested and we would be invested. We might invest because we could help carve that path and give the company the runway to make that change or you're just not going to be able to get there.

Shiv: Right, right. And so assuming those characteristics, why do you think those kinds of companies with better fundamentals, where maybe, yeah, maybe their go to market is off, maybe they haven't fully nailed down their pricing model, but they still have happy customers, there's some growth, maybe they're profitable. Why do you think just structurally those kinds of companies get to a point where they're not able to raise more venture capital or miss their growth projections?

Lauren: Well, I think if you think about the venture model, which has resulted in just extraordinary innovation, and has fueled just leaps and bounds of technology growth in this country and all over the world. But that model fundamentally is based on moon shots. So before a venture fund raises a dollar or deploys a dollar, they know - and the data tells us that 70% of the companies that they invest in are going to return between a zero and a one, right? And it's really that kind of one portfolio in the company that's going to be the massive fund returner. And so if you're a rational and thoughtful venture GP, you have to constantly be optimizing your own portfolio. You have to be willing to walk away from companies that are not on that 100x track. And so that just sort of sets up companies who don't have that kind of a growth path to automatically be cut. And so a company that could be somewhere in the kind of like 3, 4x - or maybe depending on the valuation that the venture investors got in at, right, if they come in at 100 million valuation for a company-

Shiv: Mm-hmm.

Lauren: and it has 10 million of revenue, and really the value of the company should be 30, and in five years it could be 100. For that venture investor, it's not going to be a good winner, but for another investor with a different lens it could be a great winner.

Shiv:  Mm hmm. Do you think a lot of these companies are being set up to fail in that venture model?

Lauren: I'm not sure I would go that far that they're set up to fail, because I genuinely believe that most of these founders have big aspirations. And that's wonderful. We should support that. But I do think there has to be a space for companies that establish themselves with a really solid product that isn't going to be at that scale, but still has value in this world. And there has to be kind of an off ramp, right? There - it can't be - right now we're living in a world, for the most part, of a unicorn or bust. And we have to live in a world where there's, there's another pathway and that's what we're trying to do.

Shiv: I think this concept of an off-ramp is a good one in that, yeah, either it's unicorn or bust. And if you're not a unicorn, you suddenly stop getting funding and you're kind of stranded at that series B point where you don't have anywhere to go. And if you don't have a good business model or you don't have the cash to sustain you through, the business can potentially go under. So that's what you're providing is that off ramp for businesses.

Lauren: Yeah. And not just that, you know, I think - look, every single company, every company - big, small, early, late - is making mistakes, right? Everybody's making mistakes all the time. And the reality is there's quite a bit more luck and timing to these things. That, you know, if you make a mistake at the wrong moment in the market, or you, you know, hire the right head of sales, but you've hired them 12 months too late, and you only have four more months of runway left. Like those mistakes that everybody makes, for some, for some companies can be near fatal.

Shiv: Right, right. And having a way to come back from a mistake like that, where it's not punitive to the point where the company goes under is necessary.

Lauren: That's right. That's right. And it's a way of preserving value, preserving jobs, preserving value, and continuing to kind of push innovation forward. Cause a lot of these companies do have products that really provide a lot of value to their customers and clients.

Shiv: Mmhmm. Yeah, I know a lot of venture-backed companies that maybe haven't broken through to that unicorn mark, but they've created something that is valuable and they have customers and they're delivering and it's sticky and there's retention and all of that. But just because they're not able to break through, it's kind of like, well, I don't know what to do with this investment now. So yeah. Yes, it's a matter of finding those. How much of this do you think has been created by the macro environment up until 2021 where valuations just kept increasing and increasing?

Lauren: I think it has certainly amped up the magnitude, but I would say this cycle has been around for a long time. One of my mentors, advisors, or investors is a guy named David Nierenberg who ran this strategy in the 1980s. So I think as long as there is venture and there is a kind of moonshot mentality, there will always be fallout from venture.

And so we've seen it definitely, you know, the cycles over the last 40 years or so. But for sure, I mean, cheap money has certainly fueled a lot of growth of these companies. And so the venture industry itself has just gotten huge.

Shiv: Right. And with the way the market has trended over the last, let's say, 18 months or so, with interest rates climbing and valuations coming down, has that led to a lot more pipeline for a firm like yours where there's a lot more distressed assets out there in the marketplace?

Lauren: It has. It definitely has. We've continued to see more and more companies kind of ending up at our doorstep because it is - the dollar, the venture dollars available have just really contracted. And, you know, if we had talked a year ago, I would have said, you know, the data on previous cycles would tell us that this is a ten quarter pullback. That's what the data from kind of the 2000 crash, the GFC crash, that's what the data would tell us. I think what we're seeing now is it's going to be more prolonged than that. 

Just because, to your earlier point, there have been so many new investors and so much more money that was poured into venture over the last five years. In 2021, 70% of the dollars going into venture were from non-traditional venture investors. So that's from hedge funds, private equity funds, corporate VC. Almost all of that has, or at least a big chunk of that has gone away. And so the magnitude of it, I think, is going to protract. The venture pulled back pretty considerably, I think we're gonna be in this for another 12 to 18 months.

Shiv: Yeah, it's looking like at least another one to two years, maybe three even. And so when you're underwriting potential investments, what is -what is your process? I think that would be a good thing to dive into just to understand how you're, one, identifying - and I think you touched on a little bit earlier - but then also once you've acquired that business or invested in it, how are you going in terms of optimizing it to the point where now it is a more healthy entity?

Lauren: So I'd say, you know, when we're looking at companies, we like, you know, as I said, kind of that product market fit, that product that is really kind of beloved by its customers. We like to see a company that is growing - it may not be growing at kind of massive, massive month-over-month numbers, but that is growing - that is in the path of consolidation, that has a business model or could have a business model that fundamentally makes sense. And then of course, ones that are in our wheelhouse of sectors that we care about - fintech, HR tech, SaaS, a little bit of consumer. And as we do that evaluation, a lot of what we do is basically put together the plan of what we would do to get it on the right path.

How do we get it to profitability in six to 12 months? How do we - what does the team need? Who does the team need to be? And how do we really focus the team on the absolute must-haves if you take off the table some of the assumptions that you would have to have in venture, right? Things like having a really expensive engineering team, having to show growth beyond your vertical, right? Having to shoot for sort of a 2 to 4 to 5x growth on an annual basis. If you take some of those assumptions off the table and you say, okay, I just want to run a sustainably growing company, what does that look like? And so usually by the time we actually close a transaction, we're on the same page with the management team about exactly what those changes are. So we can start to implement them day one.

We're pretty actively involved in our companies. We don't do a ton of deals per year. We do a handful of deals per year. And so for the first three to six months after investing, we're working very, very closely with the team to get the company on a good path. And once we feel like the right team is in place with the right cost structure, we start to step back and kind of let them run with it.

Shiv: You - that's great. And you mentioned engineering there. What are some common areas where you find optimization is required? And just for some context, like we - in the work that we do with private equity firms and investors, we find a ton of efficiency, inefficiency on the go-to-market side where CAC payback periods are often inflated and it takes, in some cases, north of two years to break even on spending a lot of those areas. So is that common? And what are some other areas that you've seen opportunities?

Lauren: Yes. Yes, for sure. I also think, you know, oftentimes as we're looking through these business models, we're finding that cost of goods is like not particularly - like it's not exactly properly calculated, right? And so if you're really kind of staring hard at it and being honest with yourselves, COGs are a lot higher than you may have thought, right? And so kind of making sure that you are calculating it properly and then actually making the right cuts that make sense. I think there's a lot on the pricing. We see pricing and packaging as a big problem. I think actually one of our smartest investors recently said to us, for all the time they spend on product, the company spends like 1% of the amount of time thinking about the pricing, which is so true.

Shiv: Right. 

Lauren: And we see that all the time. So the pricing and the actual sales team, making sure there's - you know, I would say common sense stuff. You know, we're not - we're not doing a lot of rocket science over here. You know, we're making sure the team is data driven and has real process in place. And I think, to your point, we do find, tend to find quite a lot of fluff in go to market teams.

Shiv: Mm-hmm. Yeah. On the pricing and packaging thing, one thing that we have found is that there's often a mismatch between the business model and the pricing and the ICP that a company is going after and their actual go to market, their messaging, their positioning. And it's just like fundamental work that is not done. And so then when they go to market, they're not able to find the right person or the right type of customer. So if they're more enterprise, they're finding a ton of like SMB type of leads that aren't a good fit or vice versa and you seem to have like this essential problem because they haven't really nailed down who they're going after.

Lauren: That's exactly right. And that throws everything off, right? That's how that throws your sales cycle off. It kind of throws everything off. And so having a go-to-market leader in place who knows how to really do that work is absolutely critical for us. I mean, that's one of the things that we start with, with most of these companies is just getting that right leadership in place.

Shiv: How much of the work that you're doing on the operational side, like - are you spending in terms of sizing the market correctly, right? Because that's another thing where your price and your TAM kind of go hand in hand and then making sure you have the right number of accounts or targets defined that would be in your ideal set. Because one pattern that I've seen with venture-backed companies is because they need to grow at such accelerated growth rates, they keep trying to go to adjacencies that is not their core market. And now it looks like they're everything to everyone. And that's obviously not true. And so you kind of have to re-narrow that focus to come to a target segment.

Lauren: So look, I think you have to do that work and you have to be thoughtful about it. But for us, again, that's sort of one of the core constraints of venture that - or I should say, constraints, assumptions of venture that we don't have to live by. We take a company that has 15 million of revenue to 40 million of revenue. That's great. We can exit there. There are plenty of other buyers who can kind of take it to the next stage.

And so for us, the TAM doesn't have to be enormous. We don't have to bend over backwards and contort ourselves to make the case around a huge TAM. And we're okay kind of taking a - you know, not having enormous market share as long as we feel like we can really achieve true growth towards that kind of marker that we have in place for us o an exit value and an exit valuation. So, but - but I think your, your point is well taken that you absolutely have to do the work to size the market, right? But it starts - it really starts with who is your, you know, ideal client profile. How are you selling into them? How do they think? How do they operate? What is their sales cycle? And really understanding where they are to be able to kind of back into a TAM that is actually achievable.

Shiv: Yeah. Also, I think your approach kind of gives you a bit of an advantage in that you can be - your growth rate can be slower and you can take a longer period of time to get to, you know, 40 million if you're a $5 million company or whatever it is, and so every year the amount of new customers that you need to add doesn't need to be as aggressive as in the venture model. So, having a smaller time in a way is a good thing because you can be more meticulous and focused and you can get really good at doing one thing instead of trying to be everything to everyone.

Lauren: That's right. I think that that's what we try to focus on. And that's what we spend a lot of time with our teams, getting them to focus on, which I think it comes as a bit of a relief oftentimes to management teams. Right? You don't have to be everything to everyone. You don't have to launch in four more verticals that we all kind of quietly know there's no way you know how to launch in htese verticals, right? You can just say, okay, this is what we're going to go after. These are the like three to five most important things that we have to achieve this year. And here's how we're gonna do it. We're just gonna steadily chop wood.

Shiv: Right. Yeah. And we found that - and now we're just discussing it, but we found that, you know, there's only three or four key things that if, you get right, you're going to be growing anyways. Like one is just improve your conversion rates, improve your opportunity to close rates. If that's like under 30%, get it above 30%. Right? That's an easy, quick win that you can get in the door. Number two is like get the right type of lead at the top of the funnel. And if that's not right, change your programs, make it more efficient, cut out the stuff that isn't working. 

Lauren: That's right.

Shiv: That's an easy one. And then you mentioned pricing - just increasing your average deal size or how long somebody's staying with you by having the right package in front of that type of customer so that they're growing with you over time. So a lot of these changes are pretty fundamental things that even though companies are raising money because they're having to grow fast they don't actually slow down to do that work. But in your model, they're actually able to do that.

Lauren: (That's exactly right. You know, I think we're, we're focused on kind of selling the product we have. Obviously there, you always have to invest in kind of enhancements and bells and whistles, but we're not fundamentally trying to kind of rebuild something new every 12 months on the technical side, right?

Shiv: Right.

Lauren: We invest in a product that exists and works, and just trying to increase the sales against it while making sure that it maintains its stickiness, it maintains its value.

Shiv: Yeah, that's great to hear. I think, I think a lot of companies - it's kind of sexy to say, we're going to add another product line or increase another offering, but each new thing that you offer needs its own set of sales tools and go to market things and product roadmap items and customer service requests that come along with that. And before you know, you're running an entirely new line of business and nobody's really done the math around the economics of that. And whether it's practical to add that on to whatever you're offering currently. But you kind of have to do that in certain environments versus when you're being more profit-focused or being more laser-focused on a particular market, you don't need to do those things.

Lauren: For sure, and I think there's a kind of, call it distraction or complexity cost there, right? That it's just - it's more to manage, it's more for everybody to do. And I believe in the power of focus. You know, if everyone is really kind of just focused on a handful of things all in the same direction, you can just get a lot farther faster that way.

Shiv: Yeah, yeah, I think the distraction risk is just so high. It's very understated that. 

Lauren: Absolutely.

Shiv: We get caught in it all the time. We have so many ideas to grow this business. Like, sometimes we want to become a private equity firm and sometimes we want to launch our own software. And there's all these different ideas. And you the deeper you get into it, you're like, whoa, one second, we haven't fully optimized what we're really good at either. We need to maximize that. That first. There's a good book on this is by, I think it's a Bain guy or BCG guys called Profit from the Core. And it's all about maximizing your core business before you go to adjacencies. And I think that's a principle that companies violate all the time. How much do you... 

Lauren: I think you're right. Thank you. Give me some holiday reading.

Shiv: Yeah, I'd say it's one of my top five business books worth reading. In terms of profitability, like how much of a focus you bring to that, and looking at your path to break even, like what is the expectation there after an investment?

Lauren: I would say extreme. Not just because from a financial perspective, it kind of makes sense, but because it is a real discipline, right? About making sure that the things that you are doing really kind of - the math works, right? They're sort of the - like the gravitational pull of profitability that you kind of can't fight. And so we're extremely focused on how you get to profitability. Because it also helps us really understand the business, right? When we're evaluating these companies, you know, what are the core drivers? What really needs to happen for a company to hit profitability? And if each of those levers and how far you have to pull them just feels a little too magical, you know, that that's probably where we step off. We need to feel like it's quite achievable. 

Now look, every time you do one of these things, you know something will go wrong and you don't know in what way. And so you have to - you have to kind of build in some, some real buffer and time there. But that discipline around getting to profitability and having a clear-eyed ROI discussion about any dollar out the door that puts that at risk is just absolutely critical to managing a business really well, I think.

Shiv: And hand in hand with that, a lot of these companies I would imagine have a decent amount of debt on the balance sheet, right? So how do you manage situations like that where you're now trying to get to profitability and laser focus this business and at the same time, you kind of have this debt that's hanging over the business that needs to be serviced. So how does the prioritization work between those priorities?

Lauren: We work very closely with lenders. Oftentimes when we're coming into a business, we're having very direct and open conversations with lenders. Often lenders are the ones that bring us into these situations because they're looking - they believe in the investment, but they feel like there might be some changes needed or they're looking for some operational expertise. And so, we work with lenders all the time and it has to be a real partnership to say, look, here's what we think the path forward looks like for us to get to a good place with this company. Push backs, you know, tell us where you disagree. How would you do this differently? We're, we're quite open with them because oftentimes they have a lot of history with the company that we don't, and can share some real insights. But at the same time, that's how you get aligned incentives. And that's how you get to, you know, restructuring of that debt that is good for both sides.

Shiv: Right. Yeah. I was going to ask about that because you would need to restructure the debt for it to - for you be incentivized to even take over the asset in the first place. So how much of that is a piece of the puzzle that you're figuring out prior to fully acquiring the business?

Lauren: Well, we don't always need to restructure it, but that evaluation is always a big part of - and those conversations with the lenders are always a big part of the investment discussion.

Shiv: Mm-hmm. Right. And then as you're acquiring these businesses, do you often put on more debt onto the balance sheet or are you using purely equity to buy them out?

Lauren: We're using equity to buy them out typically. I would say that that's mostly how we're doing it. We're not looking to kind of lever up and buy these companies. That being said, you know, we are creative capital. And so depending on kind of the nature of the situation, we might - we might structure the deal in a variety of different ways. I'm not trying to be coy about it, it's just there's a multitude of ways that we could do the investment. But typically it's a straight equity check. And then sometimes we're bringing on some debt partners along the way if we think that that's the right tool and the toolkit to use to help with growth.

Shiv: Gotcha. And one metric that I did want to come back to is, you shared earlier, like 70 to 80% of VC deals don't really end up working out. And within your model, I believe that win ratio is 80 to 90%. You want to talk about that a little bit?

Lauren: Sure. Yeah, I mean, we target something in that kind of 80 to 90% in terms of getting a good outcome for our investors. And that's in part because we're doing fewer deals, we're more operationally involved, we are pricing the risk very differently, we're often valuing the companies pretty differently. And so our threshold for the price that we need to get out at for us to at least return capital is often pretty low. Right? So my partner comes from 20 years of credit investing. And so we really come to the table with a more of a credit lens.

Shiv: Got it.

Lauren: In terms of evaluating these businesses and planning for that downside. And planning for that downside helps us avoid some risk. And it also helps us structure the investment in a way that makes the most sense for us in case something - you know, things go wrong and we get it wrong.

Shiv: Mm hmm. Well, I think that's awesome. And I think your model is purpose built almost for the market that we're in. So I think that's great to see. It is also a good place to end the episode. But before we do, if there are founders or VC firms that are looking for an off ramp, like yours, if you will, how can they find you and learn more about you?

Lauren: You can reach out to me directly. My email is [email protected] You can find us on Twitter. You can find us on LinkedIn. We respond to any cold inbounds that we get. So we're always keen to expand the network and talk to folks. So please don't be shy about reaching out.

Shiv: Awesome, that's great. We'll be sure to share that in the show notes and all the links for the episode as well. And with that said, Lauren, thanks for doing this and sharing your wisdom with our audience.

Lauren: Thanks so much for having me. Great conversation.

Shiv: Appreciate it. Thanks.