Episode 34: Hillel Zidel of Kennet Partners on
Expanding Companies to International Markets 

Episode Transcript

Shiv: Alright, hello, welcome to the show, how's it going?

Hillel: Hey, great. Yeah, going really well. Thanks. Thanks for having me. Very happy to be here.

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

Hillel: Yeah, absolutely. So we're a growth equity fund focused on a very specific category of companies. So we invest pretty much exclusively in B2B SaaS businesses that provide essential mission critical products. And these companies have been bootstrapped. So your typical business has been built to scale with after reliance on external capital. So we love being the first institutional investor in the business. Prior to this, I was doing a similar thing, but with a debt fund. So essentially, financing growth stage companies with debt and equity warrants. And right at the beginning, my career was working in consulting and a number of B2B startups, actually. So yeah, I've been doing this for a long time and really enjoyed it.

Shiv: And you're on your sixth fund like we discussed earlier and talk a little bit about the profile of companies that you're looking for beyond the B2B like in terms of revenue size and anything else that specifically that you look for in companies that you're investing in.

Hillel: So typically, businesses will have north of about $3 or $4 million in annual recurring revenue. They'll be growing, we say, at least 30%, ideally higher, maybe 50%, 60%, 100% plus. These companies will have usually high-gross margins, as most software businesses do. And importantly, they would have been built in a pretty efficient way. So the kind of company that we really love has got to a good level of scale, maybe a bit profitable, maybe breakeven. If it is losing money, it's not losing a lot of money, but really has been developed in a really efficient way with the founders of both capital and sort of used capital efficiently. And then in terms of the type of sectors, we tend to focus on sectors where the products are pretty sticky. So the question we're always asking is, if there's a downturn, if there's a pandemic, if something happens, is the customer going to turn this product off? And if the answer is maybe or yes, then it's not for us. We want to be in the type of businesses where it's really essential to the underlying operations of the company. Then these businesses need to be internationally relevant. So we want to invest in companies that we can help expand into new markets, usually the US. So if it's the kind of company that is really only relevant in one market or one or two markets, it's not going to be for us. And then I think the final point is, do we think that this is going to be a strategic asset in three to five years time? So if we can't identify a group of really logical industrial buyers, that's going to be a problem. If we think, OK, well, another private equity firm will pick it up, that's not going to be interesting for us. We want to feel like, This is going to form part of the stack of this category of buyers in a three to five year period where we can generate pretty attractive returns from that investment.

Shiv: That's awesome. In terms of some of the characteristics you mentioned, I'd like to dig a little bit deeper into this. At a stage of three to four million, it's still early days for a company in many ways. So how do you vet companies or or try to filter through them when at that stage, maybe their sales and marketing efficiency isn't figured out, they haven't fully gotten to like, understanding the full set of solutions and services that they can sell to their customers. Profitability is often not completely figured out either pricing is not nailed down and some of the things that you mentioned about efficiency and things like that It's not at a point where it's completely figured out. So how do you look at companies and try to determine if they're already there or like - because if for them to already be there would just be a very small market of companies you're going after and so I'm assuming that you actually have to build this build this out with the companies that you're acquiring as well.

Hillel: Yeah, so three to four million is the entry level. You know, a number of the companies we're investing in are larger than that. But how do we get comfortable with a business at, you know, four million dollars an hour? Firstly, we want to see a lot of customers. You know, if companies got three or four customers, you know, it's going to be not interesting to us. We want to have, you know, 30, 50, 100 customers. We want to invest in companies that don't have custom concentration. You know, we're really looking to test product market fit. We want to invest in companies that have gone through at least a couple of renewal cycles. So again, companies sold to 30 or 50 customers and a good portion of those have had the chance to renew and have renewed. We spend a lot of time on customer due diligence. This is really fundamental for us. We want to be able to talk to 20, 30, 40 customers. We want to talk to business operators, so we don't want to talk to the innovation department within a large company who's bought the product. We really want to talk to the business unit sponsor, and what we want to hear is, this is why we chose this customer, this company. We like it. We plan on continuing to use it. We have no plans to not use it, and it's key to what we're doing. So that's on the sort of product market fit size, which is where we really, really focused then clearly technology is an area that we dig pretty deeply into. Because these companies have been bootstrapped, they usually have been around for a longer period of time than your VC-backed businesses. So there's enough data and information to really dig into on the custom profile on the tech platform. So management, another really kind of key thing we look at on the minority side, which is the majority of what we're doing. We're really backing management teams. So we want to feel comfortable that they are able to navigate through the next stage of growth. 

And so I'd say the red flags at $4 Million are, you know, customer concentration is a big one. I mean, that just is a risk that you cannot do diligence and one that we think you shouldn't take. Small number of customers closely linked to that. Retention or churn issues. If you have an efficient customer acquisition model but you lose half of those customers 12 months later, that's deeply unattractive to us. And then finally, a founder or management team that we don't think that we can work with. But there is a huge number of companies at this scale that we think we can invest in and support to get them to the 20, 50, 100 million.

Shiv: Right. Do you find that there's a lot of competition for assets like these? Because I find that a lot of PE investors have this profile of net revenue retention, 100% or greater, you know, having certain EBITDA margins or rule of 40 as a benchmark. And very quickly, you know, the profile of company that you're going after is being searched for by many PE firms. And so you get kind of get into this competitive race and an increase in valuations of the underlying asset. How do you see that?

Hillel: It's a great question. So we were talking in our team meeting earlier today about something what we see is there is more competition for US assets than there are for European assets because in the, you know, in terms of businesses focused on B2B SaaS companies that have been bootstrapped, you know, we're probably the only firm in Europe pretty much exclusively focused on this category at the size that we invest. Whereas in the US, I mean, they're not, you know, tens of firms that are doing it, but there's probably a handful of firms that are doing it doing that. And because the availability of data means that it's now easier to find these companies, you know, we're seeing more competition and more price, put price impression in the US. In Europe, it's very different. In Europe, you know, firstly, you know, the overwhelming majority of our deals are proprietary deals, right? We are using technology to identify these companies, we're spending a lot of time building relationships with them, demonstrating that we can add value to them. And we're investing typically outside of a competitive process. And so, you know, we invest about 70% in Europe, 30% in the US. And we're not seeing a huge amount of competition for what we're doing in Europe. And I think really what it comes down to is the focus on bootstrapping. So, bootstrap companies have very particular characteristics that you have to be geared up to address. And so, your typical bootstrap company, they won't have a very broad management team.

You know, VCs are looking for a complete team, you know, a typical bootstrap company, it's got a founder, a CEO, but the second level management team isn't developed, typically isn't a board, you typically don't have systems and processes in place, you know, the financial reporting is usually, you know, pretty rudimentary. There's often some technical debt in these businesses because, you know, they haven't invested a lot in the latest technology. And so, we look for companies that have the challenges that we are geared up to solve. And this means backing a founder with no management team around and building the management team six months into the deal. Investing in scalability on the technology side to fill up any, to deal with any technical debt gaps. And we really like it when companies want to be able to provide very detailed analysis in terms of acquisition costs and LTV and all that kind of stuff. Because if they've got great customer logos, good growth, good momentum and are growing efficiently, the other stuff is very easy to solve. The problem that's hard to solve is if you're not growing or if you have very bad gross margins or you're very high burn. And so, when we're engaging with bootstrap company, they typically don't need capital. They're making a choice to raise capital and they like to work with us because we only work with bootstrap companies. If it's us and a more sort of traditional VC or more traditional private equity player and it's a bootstrap B2B SaaS company, we're already well positioned to do those deals.

Shiv: Right, right, totally. And do you see that in the markets that you're investing in, are you leaning more towards Europe and there's less competition there?

Hillel: Yes, so we, you know, we have an office in London and an office in California, and we invest the majority of our funds in Europe. So we invest about 70% in Europe. But we're also investing directly in the US and our US team, you know, is playing a really important role in supporting the expansion of our European companies. So you know, the majority of European businesses aspire to expand to the US. And we do this with real investment professionals on the ground. And so they can support in the diligence phase, they can help vet, you know, general managers and, you know, country managers and all that sort of thing. And in a number of cases, you know, European businesses become a US business over time and has really benefited from multiple arbitrage because, you know, like for like businesses in Europe and the US, the European business is just going to trade at low multiples. So if you can expand it, create an international US business, you know, you get a nice, increase in multiple along the journey.

Shiv: Right, right, right. And on the European side, do you find that certain companies that have a good presence there that might have some of these fundamentals, does it translate well when they move to North America? And the reason I ask about this is on our side, we definitely have clients that are global, clients that maybe are headquartered in the US and try to expand towards the EU and also vice versa. And it doesn't always translate. So I'm curious about your experience on that and then what has helped you make that transition work.

Hillel: So, I mean, what has helped us make it work is we've just done it a lot of times, right. And we've developed a number of playbooks, which significantly decrease the risk associated with the US expansion. So if you just, you kind of go about it, you've never done it before, hiring in the US is challenging, customer expectations are challenging, the market is huge, and so that creates benefit, but you also probably not known if you've got some customers on the East Coast and customers in the West Coast. So, you know, we've developed a playbook model, which is about supporting a business which is primarily European, transition to the US, ultimately, you know, develop most of the revenue in the US. And, you know, the aspects of the playbook are, you know, firstly, it's kind of the cultural element, which is really, which is really key. You know, you've got to avoid creating two separate companies and a whole bunch of new people building out different business in the US. So how do you start, particularly those first few hires, how do you ensure you maintain the DNA of your European business? We encourage founders to ideally move or at least spend a lot of time in the US. It is a key aspect of that. Finding those first key hires is fundamental and then supporting with things like initial customers, partners and ultimately, you know, gradually morphing into more of a global business. And so, you know, the more times we've done this, you know, the greater, you know, the more successful we are at doing it.

Shiv: And what would you say are some of the most common ways that you're leveraging to enter new markets? Like obviously hiring salespeople jumps to mind, expanding digital marketing efforts comes to mind, but I'm just curious, like, are those the most prominent ways that you're entering new markets or are there other unorthodox ways that you're leveraging to expand current business operations?

Hillel: Well, I mean, when we're choosing investments, we're obviously looking for the lowest risk possible. And so how do you get the lowest risk possible? You get companies, European companies that are already selling to the US. And so we've done a few deals, actually two of our recent deals, where notwithstanding the fact that the teams are based in Europe, more than 50% of their customers are in the US already. And for us, that gives us a really high degree of confidence that we can create a huge business in the US. That's really about team building and using the existing client references to scale out. And so that's probably our favorite way because it's...

Shiv: There's existing demand and an existing base of customers that you can build upon.

Hillel: Exactly. Now, if you don't have that, what we have seen is you're selling to global businesses in, but we're selling it in Poland or in the UK or in the US using their international operations as a kind of trojan horse into new markets. That's a way that we've been able to do and have been successful. If you demonstrate that you're really good in the UK, then you're able to expand and maybe get the North American, you know, the North American aspect. You know, fundamentally, a lot of this is driven by just by team, you know, and it's what are we doing well in the UK or in France and Germany? And how do we replicate that in the US market? I mean, I think one of the one of the most challenging aspects is moving from kind of an inbound sales models and outbound sales model. And, you know, we feel that you want to do this incrementally. In the VC world, companies that raise a bunch of capital and they're going to very aggressively hire, we want to start expanding with maybe some customer success people, some salespeople who are based in France, move them to the US. Build slowly and then start to double down on experienced North American hires once it's clear that we have a start and we're able to meet customer needs in that market.

Shiv: Do you find that product market fit sometimes is problematic because there can be specifics in a country like the UK or France or Germany that when you move over to another market, they don't necessarily have the same compliance rules or legal regulations or market dynamics that makes it harder to sell into the same types of customers?

Hillel: Yeah, and this is where due diligence comes into, right. So in our due diligence process, we're really spending a lot of time figuring out, are we really, do we have a really high level of conviction that this model is going to work well in another market? And so there's certain categories that we're skeptical of. So education is one, because each country can have a different education system that can have different, you know, buyer motivations and, you know, maybe there's some government intervention involved. And so that's a category that we would be skeptical of unless we're comfortable that you weren't impacted by those. Your health care is another area. Different markets are different and you may not be able to apply one thing to the next market. And then there's certain companies that just really serve some local problem really well. It's always going to be a French company, it's always going to be a UK company. And so we kind of debug that in the diligence process. And once we're scaling, it's pretty uncommon to invest and then figure out, okay, this is not going to work in another market. What we have found is in the accountancy area, for example, the markets that you go after are a bit different to what you would go off to in a HR software market. But in the plan, when we're investing, we put that together and go off to those markets. So not every software company is relevant to international expansion. And you've got to pick the ones that you're comfortable with.

Shiv: And even if, let's say, and totally get that like certain markets like accounting, their gap standards are different in different countries and there's different regulations. So in those cases, it makes sense. What about in cases where, like that or other markets, where there is a presence or you're making your, you see a path during diligence to expand into other geographies, but product work is required in order to get there. So how much are you directing the product roadmap in order to fill those gaps?

Hillel: So we're really only going to meaningfully adapt the product roadmap for a US expansion. So, you know, it's kind of the US market is big enough, relevant enough to really justify, you know, investment in product to localize. I think, you know, if we're going to we're probably not going to do that for every year for every market. It's typically.

Shiv: Is it just because there's more opportunity there, so it's worth the effort? Yeah.

Hillel: Yeah, it's like multiple of the size of most other markets. So there we would do that. And it's not uncommon to do that. I mean, what we'll typically find is that maybe the company's got inbound interest from US customers and we really want to double down on that. And that maybe involves some product expansion, which we're comfortable to do.

Shiv: Right. And I also imagine there's like smaller changes that are much easier to implement, right? Like regulation oriented changes are harder, I guess, but cosmetic changes, like making software available in different languages, for example, becomes a little easier. But then even that comes with its list of complexities, because if the product is in a different language, then your marketing has to be in a different language or your help articles need to be in a different language. You need support reps in a different language. So that holistic cost is a lot higher.

Hillel: Yeah, and again, when we're investing in businesses where if the main language isn't English, even if it's a European business, or if English is not an important language, it's going to be challenging. You're asking yourself the question, is this business that's very local going to be able to expand? And so English as the primary language means that we don't have to localize that much in terms of the US. I mean, it's more about building customer success in the US as opposed to having people in Europe working very late hours and providing, it's about providing a sort of a more all encompassing solution for US customers.

Shiv: Yeah, and so talk about that, which is, let's say you are going to the US or any other country. What are some of the key elements that you're putting into place? Like you mentioned the management team, but just more specifically, what are some critical roles that you've seen and critical aspects to the team that you need to build to enable the expansion?

Hillel: So I think in the early days, you want to export the DNA, which is taking people from Europe to the US. You want to ideally have the CEO or founders based there. And then you want to essentially kind of build out your teams. And so that means you're identifying most likely a US general manager. And again, this is not on day one, right? This is once we've probably got 15 or 20 customers in the US, and now we're ready to expand. And then we're going to build out. We like keeping technology in Europe because the cost is lower. We're going to typically build sales and marketing in the US and then customer success is sort of a hybrid of both. And ultimately, if you get that right, yours will start to be a sort of majority proportion of your overall revenue.

Shiv: Right. Do you notice that as you're expanding into other markets, do you find that finding localized partners and or channel partnerships are a good way to enter a market?

Hillel: It's fundamental. I mean, it's really important. And, you know, the market for selling software has changed over the last 18 months or so. And what we're finding is positive references are just much more important than they ever have been. So, you know, building out your community of influencers, positive finger pointing in your direction, channel partners, relationships, it's really, it's always been important, but I think in 2024, you know, it's really, really important. You know, more referenceability.

Shiv: And how do you recommend that companies entering into new markets build that? Because in those cases, you really are starting from zero, unless you have an existing customer base there, but let's assume you don't. How are you building that referenceability? 

Hillel: It's hard. I mean, it's really tough and you know, we do it, right, that's what we get up to do. Some of you know, my partners in the US, Javier and Eric, you know, they've been investing in the US market, you know, 20 years plus. And, you know, they and we know who the right partners are, we have the relationships with them, we have the referenceability. And so we can support a business in doing that. I think it's really tough. If an entrepreneur just go out there and try and figure it out. I think it's a catalyst for companies choosing to work with us, building that bridge, developing those partnerships, making those kind of key introductions to channels, integrators, employees.

Shiv: Yeah, I think the place where we've seen partnerships work the best is where the partner has a vested interest in helping you succeed with a particular customer. And it's not just like a nice to have like as an example, in our case, we go to market primarily with private equity firms. And so they're like our channel partners and they bring us into their portfolio companies. But the PE firm is incentivized because they want to grow their portfolio companies and marketing just happens to be one of the primary ways they can do that. So whenever they see that as a problem, they'll reach out to us more so than us constantly pushing them to bring us in. But in a lot of cases when we've seen partnerships fail is that that underlying motivator is not there for the channel partner to actually even consider you or refer you or that channel partner just has too many options.

Hillel: Yeah, no, I agree. I think, you know, our view on partners is having 100 partners doesn't make sense, right? You want to identify those partners that are most, you know, where there's the strongest commercial logic, you know, the incentives are most strongly aligned and really invest in those relationships because people want to sell their own product, but they're not looking to sell other folks' products. So, you know, rather than going very wide, you know, it's more about going narrow with a smaller group of really strong potential partners.

Shiv: What about M&A as a form of entering a market where with an add-on or bolt-on acquisition, you have the opportunity to cross-sell, upsell, and then you also get access to that company's assets, including partners in that market, and that allows you to enter that market with a more steady approach.

Hillel: So it's interesting. So we've sold a number of companies to do that. So where we're selling a business that's maybe strong in Europe to a US buyer, and that enables them to enter a market. In terms of our own bolt-on strategy, that's not something we've really done. Where we have used bolt-ons is in a very targeted way to build out our product stack. So if we know for sure that there's a couple of areas that we can cross-sell as the base, a company now called Dext, previously called Receipt Bank, they did a number of acquisitions. The company had 10,000 plus accounting firms as customers with a single product. And so there, we're doing bolt-ons to add more and more, increase the kind of the potential revenue per customer within our base. That's the strategy that we really like.

Shiv: Right. Yeah, Dext is a good example. It's used by a lot of firms. Can you give an example of a firm or a company that's been acquired by a U.S. company to enter the European market?

Hillel: Sure, so probably a good example of that is Rimilia. So Rimilia is a business that does robotic process automation around cash allocation and credit forecasting. You're a really nice business, very strong in the UK and Europe, acquired by BlackLine for two reasons. The first reason is because they wanted to add cash allocation to their financial close product. And secondly, because it just provides them with access to a whole lot of European customers. It's sort of a nice deal, right? It makes sense. When we can really understand the buyer's logic, that gives a lot of comfort to proceed with the transaction. Obviously, the value becomes more interesting.

Shiv: Yeah, I think that's great. And then I guess the last question I'd ask is just, how do you look at this type of expansion approach internationally, just either from Europe to North America or vice versa, or APAC and other regions? How do you balance that versus the core business? Because the core business obviously always has room to grow. And within the current markets, there's probably a whole list of things that you can do to grow that core business. So how do you balance those priorities?

Hillel: Yeah. You have to be doing well in your local market. It's very difficult. If you're challenged in the local market, say, okay, well, the US is going to save us. I think that's really unrealistic. I think you've got to feel like we've done well in our market. We've got a good level of market penetration and we can kind of bend the curve upwards by expanding into the US. And I feel like this about most new initiatives, your product or what have you, you know, you've more chance of succeeding in the new thing if your existing thing is doing well. And frankly, we would only encourage companies to expand internationally once the core business is doing well in the local market.

Shiv: Yeah, I think that's such a key point because you can easily get into a place where you're expanding geographically, but your core business suffers and then you immediately have to withdraw from the markets that you've expanded to because you just don't have good fundamentals in place.

Hillel: Yeah, you need critical mass in each market, right? If you're a $50 million business but spread extremely wide, you know, you don't have defensibility in your market. You need to have critical mass in order to be kind of before you move on to the next one.

Shiv: So are there metrics or numbers that you look at to try to figure that out? Is it based on penetration or profitability? Like how do you think about when is the right time to go for that kind of an expansion?

Hillel: So I mean, again, the most obvious is when they're already selling into that market, but from Europe. And then it's sort of pretty clear. If you're not doing that, we want good test cases. We want to have done some research. We want to know that we've got the balance sheets to be able to do that. And then we're not going to risk the core market. And one of the reasons we don't do it straight away is because we don't want the founder to now have to make a whole lot of change in the local market. And then, you know, you've got to have a stable base, you've got to have a team, and then you can double down on the international expansion.

Shiv: Yeah, I think that's a great way to kind of think about it and how to actually prioritize at what point you kind of go after that expansion. I think that's a good place to end the episode, but before we do, Hillel, what's the best way the audience can learn more about you and your firm?

Hillel: Yes, so I mean, Kennet dot com is our website and you're all on there and we have a bunch of info about our deals and what have you and then I'm on LinkedIn. Feel free to connect or message me. And yeah, we'd love to chat, particularly to any kind of B2B or bootstrap software companies out there.

Shiv: Awesome. And with that said, really appreciate you doing this, Hillel. This is a great, great episode. And I think it'll help a ton of firms and founders and entrepreneurs that are thinking about expanding internationally and into different markets. I think there were a lot of great takeaways. So appreciate you doing this.

Hillel: Fantastic, it's been fun. Thank you.