AlleyWatch: Inside the Mind of a New York VC: Mia Hegazy of Catalyst Investors
By Bart Clareman
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.