Connect Ventures, the London-based seed-stage VC that was an early investor in Citymapper and Typeform announced a new $80 million fund last month to continue investing in “product-led” founders.
Launched back in 2012, when there was a shortage of institutional capital at seed stage in Europe and micro VC was a novelty in the region, Connect Ventures invests in B2B and consumer software across Europe, including SaaS, fintech, digital health and “future of work.”
Running throughout the firm’s investment thesis is a product focus, with the belief that product-led — or “product-first” — software entrepreneurs are the kinds of founders most likely to transform the way we live and work at scale.
Connect Ventures does fewer deals per year than many seed-stage firms, promising to place bets in a smaller number of early-stage companies. It recently backed scaling startups such as Curve and TrueLayer. Keeping a compact portfolio lets the shop throw more support behind its investments to help tip the scales toward success.
To learn more about Connect’s strategy going forward, I put questions to partners Sitar Teli, Pietro Bezza and Rory Stirling. We covered what makes a product-first founder, the upsides and downside of “conviction investing,” and the next digital product opportunities in fintech, health and the future of work.
TechCrunch: Connect Ventures positions itself as a pan-European VC investing in “product-led” founders at seed stage. Can you be more specific with regards to check size, geography and the types of startups you look for?
Sitar Teli: Of course, I know it can be hard to differentiate seed funds at first glance, so it’s worth digging in one layer down. Connect is a thesis-led, seed stage, product-centric fund that invests across Europe. I know we’re going to dive into some of those parts later, so I’ll focus on our investment strategy and what we look for. We lead seed rounds of £1-£2 million (sometimes less, sometimes more) and make 8-10 investments a year. Low volume, high conviction, high support is the investment strategy we’ve executed since we started eight years ago.
As for what kinds of companies we’re looking for, we’re looking for companies that have an original product idea in a potentially large market that either already exists or that they’re going to create. It’s worth digging into what we mean by product, since not everyone has the same definition. At Connect, we’re looking for high-margin companies that have internationally scalable solutions to problems and opportunities, so when we talk about product, we mean software. It could be front-end, infrastructure, B2B, B2C — there’s a wide breadth, but the core of the company is software. We’re looking for companies where most, if not all, of the value is captured and delivered by a digital product and the digital product is the critical factor in the user experience.
As a counter-example, if you’re a food delivery company, the digital product is how a consumer accesses the service, but if you don’t have any restaurants they want in your network, they’re not going to use your service. In that example, the product is necessary, but not sufficient — without desirable restaurants in the network, the product doesn’t have value. What we look for are companies like Typeform or Second Nature — the digital product itself delivers all, or most of, the user experience.
Many companies claim to be product-first these days, and arguably every company now needs to become a product-first company in order to survive and keep up with consumer trends and expectations. How do you define a product-first startup and what are some of the lessons you’ve learned from backing product-led founders over the years?
Sitar Teli: Yeah, so lots of companies talk about being product-first and I think it helps to define what we mean by it. Even though the phrase is used a lot, I’m not sure there’s an accepted definition of it. We took the time to develop an internal definition that has been really helpful in helping us filter through opportunities and identify what we think are the most compelling ones, so I’m excited to share our thinking on this front.
What we’ve learned over the years is to identify product-led founders and a product-first mindset. Product-led founders are not necessarily founders that have built a product in the past or are product designers or product managers themselves. This is a misconception we commonly deal with. What we’re actually looking for are founders who have found a problem or opportunity they want to tackle, have an original solution for it and have conviction that product is the best way to build that solution. They care deeply about user experience and put it at the center of what they do. This in turn means the companies they build put product and user experience at the center.
A product-first mindset is something we’ve learned about from some of the founders we’ve backed over the years. It’s taking the approach of building great product — hypothesis testing, MVPs, iterative building, user centric design — and the advantages of building product — rapid testing, scalability — and applying it to all aspects of the business, like distribution, marketing and community. Not all product founders have this mindset — some just like building great products and don’t really enjoy building and scaling a business. A really important lesson we’ve learned over time is to differentiate between product-only and product-first founders.
Connect Ventures does fewer deals per year than many seed-stage firms — so-called “conviction investing,” as it is often referred to today, although I think it was part of your strategy long before that term came into vogue. This is the opposite to a spray-and-pray approach that favors greater diversification and means not only placing bigger (and therefore riskier) bets in a smaller number of early-stage companies, but also throwing more support behind those investments. What are the upsides and downsides of conviction investing and how are you attempting to mitigate the downsides?
Pietro Bezza: Yes, you are right. Since the start of Connect, we have been strong believers that in venture capital less is more. In building our portfolios, we have always chosen conviction over volume; and high ownership over diversification. We aspire to be an engaged partner for fewer founders over “I don’t have time for this.”
In each of our three funds we have employed with consistency the same “low volume, high conviction and high support” strategy. Low volume for us means to build a curated portfolio of 25 companies per fund. As a perspective, consider that seed funds with a different strategy do over 40 or 50 or even 100+ investment per fund.
As you say, adopting this strategy presents upside and downside. The upsides are multiple. First and foremost, it empowers our focus. We have multiple filters we apply when it comes to pick the companies we want to invest in. We are thesis-driven, we want to back category defining products with the ambition to transform the way we live and work. Companies with the potential to be outsized fund returners. Honestly there are not so many opportunities out there that fit such filters. In fact, each of the partners does 2-3 max new investment every year.
Secondly, high conviction gives us an edge. It enables us to move fast, to take risky and contrarian opportunities where others don’t. Driven by our conviction, we always take the lead position, write a significant cheque without compromising on the round size. We want to give the companies we back the right amount of capital they need to achieve their goals. We don’t invest small option tickets.
The third advantage of this strategy is bandwidth. We want to devote to each of our companies the time they deserve. The best and most ambitious founders require us to be engaged, to stay connected with their products, businesses and industries. Keeping a low-volume strategy enables us to commit real time to portfolio companies.
Conviction is at the base of our binary value. We are all in or we are not.
The downside of this strategy is that mathematically we have fewer shots on goal. But we don’t mitigate this by design. We know in fact that the best returns in venture are determined by the magnitude of the outcomes and how much ownership you have at exit, rather than from the frequency of being right. As said before, less is often more in venture.
Eventually, the size of the fund and portfolio strategy define who you are. Our low-volume, high-conviction and high-support strategy feels right for the kind of VC we have always wanted to be: focused, specialist, thesis-driven, and with a very high level of ambition to back the best product companies globally. Ultimately, [we are] passionate about working closely with the founders and being an active part of their journey.
Backing fewer startups per year also means it is even more important to have exposure to the most promising early-stage startups and then convince them to take your money. With a small team — only three founders — how do you approach and optimize deal-flow?
Rory Stirling: Yep, there’s no doubt seed is the most challenging stage for deal-flow because by definition you have the biggest funnel of opportunity, combined with smaller fund and team size. This is the same challenge for all seed funds. At Connect we’ve made a few strategic decisions over the years that impact how we tackle this.
Firstly, we’re a partner-only investment firm; we don’t have a team of more junior investors being the first line of defense on deal-flow. We think this is good for founders and efficient decision-making. It also means we don’t spend time managing a big team.
Secondly, as you’ve already mentioned, we’re unashamedly a low-volume, high-conviction investor, which means each partner has a lot of time to spend with each portfolio company and also on new deal-flow.
Thirdly, we’re a pan-European investor but, by design, we have chosen for all partners to be based here in London together. Again, we’ve optimized for the quality of our partnership communication and decision-making, but it does make covering deal-flow across Europe more challenging. The answer to this is a lot of time spent on planes and trains whilst building great partnerships with the best local angels, accelerators and pre-seed funds.
Fourthly, and I would say the most important point in relation to deal-flow, is how we choose to focus our time and effort. We’re a thesis-led investor and I didn’t realize the power of this until arriving at Connect. A lot of people think about an investment thesis as an external marketing tool for attracting deal-flow. That’s probably right but we’ve been pretty crap at that. The real magic is how we use our thesis as an internal tool to quickly filter opportunity and make better investment decisions.
Then, finally, beyond our firm investment thesis — which we think of as a horizontal tool that can be applied to most areas of tech — each partner develops their own individual specialization areas. These can be sectors or themes and they can evolve or change over time. Right now, Sitar spends most of her time in consumer software and digital health. Pietro loves SaaS and is obsessed with the future of work. And I’ve become a fintech nerd.
In terms of sectors you’re targeting, although not necessarily an exhaustive list, four that you cite are SaaS, fintech, digital health and the future of work. Let’s delve into a few of them.
If I were to sum up the current state of fintech, I’d say that the first phase is largely done — the unbundling of various consumer and business financial services, such as foreign exchange or savings or credit — followed by a number of companies, such as challenger banks or money management apps and platforms, having emerged in an attempt to rebundle these products in a way that puts the user in control, i.e., the elusive financial hub strategy.
Arguably the next phase is so-called embedded finance where nonfintech companies put fintech features into their products. Is this an accurate summary and what are the open spaces in either consumer or B2B fintech that currently excite you?
Rory Stirling: Spot-on. I see the market evolution in exactly the same way. We spend so much time looking forward it’s easy to forget how far we’ve already come in fintech. There’s a lot of things you can do now as a consumer that simply weren’t possible until very recently. The unbundling started post-2008 and over the past few years some of these challenger fintechs have achieved the scale where they inevitably need to start rebundling to make their customer economics work. They’ve built their distribution channels and now they’ll push as much product through them as possible.
It’s exciting to see what’s been possible but I’m even more excited for fintech 2.0. The rebundling will continue to happen but it’s not a winner-takes-all. As you say, we’re in a new phase where the user continues to have more control. Financial infrastructure will continue to get built and rebuilt, and we’ll see more outlier companies being built in the really valuable segments, Truelayer in our portfolio is a great example. But we’ll also see more pure product companies being built on top of this new infrastructure. Curve in our portfolio is a good example. In 2009, the future of personal finance was a better bank. Today the future of personal finance doesn’t need to be a bank at all. A software layer can sit between financial infrastructure, consumers and their financial products. The user can choose which software tools they trust to provide them with the best choice, experience, automation and advice. My prediction is that the largest fintech in the future won’t use a balance sheet.
Most of this relates to the consumer market but I’m equally interested in the new breed of products being built for business users, as is the case with Soldo in our portfolio. It still feels like there’s so much to be done here and we continue to meet some very strong founding teams. New current accounts is a start but there are power users within every size of business that require a much broader and deeper set of financial tools. And the best bit is that they’re willing to pay for them.
You asked about embedded finance as the next phase. I’m pretty bullish on this. With the way a lot of financial infrastructure has now been built, it’s not only possible but inevitable that we’ll see a much broader set of financial products embedded into nonfintech propositions. In the same way that plug and play digital payments is now the default, we’ll see the same evolution for insurance, credit, escrow, savings, etc. I’m excited about the companies building these embedded propositions but I’m also excited about what new market opportunities and business models we’ll see enabled by this shift. There are many offline markets that still don’t function at scale online because of the friction or lack of trust between parties; embedded financial services will help solve many of these use cases.
Digital health is another, although this feels a lot earlier in the adoption curve, perhaps due to having even greater regulatory burdens and fragmentation than fintech. How do you see digital health developing over the next five years and what are the most immediate opportunities?
Sitar Teli: This is such a tough one! I think it’s one of the hardest sectors to predict trends for because of the regulatory and cultural aspects of the industry. The value of technology in health care has been apparent for years, but the sector has resisted adoption for so long, many predictions feel more like wishful thinking. There’s a few reasons for that. First, the health care industry is conservative for good reasons. They’re dealing with highly confidential data, serious or deadly outcomes and complex economics. They’re not going to adopt MVPs or trial software in real-life situations, so the mainstream approach of tech doesn’t resonate in this sector. Second, the regulatory burdens are pretty heavy and tech firms need to make sure those are addressed as well. It actually really increases the cost of building a company in the space, which has probably deterred funding in the sector. Third, I think very few startups have fully addressed the needs of the sector, like understanding how clinical trials for electronic products could work, calculating economic outcomes as part of the sales pitch and understanding who the different buyers within a health care system are and what their motivations could be.
Luckily, this is really starting to change. We’re seeing some companies really scale up in a few areas right now. One is the application of artificial intelligence to areas where humans struggle to perform as well as software, like vision. One of our portfolio companies, Kheiron Medical, is using deep learning and computer vision to identify cancer in mammography scans, which superpowers radiologists to do more and better work. This resonates in the market because radiology is a strained sector, with not enough staff and an overwhelming amount of work. Another area is drug discovery. The cost of developing a new drug is several billion dollars, and technology can do a lot to speed up the process, potentially shaving years off the development of a drug. Companies like BenevolentAI and HealX are interesting ones in this space.
Another interesting trend is consumer-first approaches in some areas of health. I was skeptical at first whether venture scale companies could be built in consumer health, especially in Europe where most consumers are used to excellent public health systems and have not historically paid out of pocket for health care. But I’m finding there are some areas where consumers are willing to spend for data, insights or treatment. Mental well-being, nutrition, sleep tracking, exercise and menopause are some of the areas I’m seeing health startups take a consumer-first approach and getting to interesting scale. We’ve made two investments in this space so far, Second Nature and Fiit, and I’m regularly meeting with more.
On a longer-term horizon, I’d like to see more industry adoption of technology because I think it’s critical to getting affordable, high-quality health care at scale. One of the positive events during the COVID crisis has been public health systems very rapidly turn to technology solutions like telemedicine to deal with remote patient demand. I’m hopeful that this experience has helped both sides understand how to work well together and the benefits of doing so and we’ll see more of it in the future.
Let’s talk “future of work.” Obviously, the coronavirus pandemic has reignited interest in tools that help people and teams work from home and collaborate remotely. However, I’m guessing the category is much broader than that? Perhaps you can share how you view the future of work and the startup opportunities that could arise from it?
Pietro Bezza: Future of work is a theme we are very passionate about. To back products that improve the way people work is a core part of our mission as a firm.
And your guess is right, Steve. The future of work is bigger than remote work. We see two macro themes. Both represent a formidable opportunity for creating a new layer of innovative products.
The first revolves around the impact of artificial intelligence on every job and how it changed our role as workers. In short, we believe in augmenting us versus replacing us. This thesis has guided our investments in companies such as Kheiron — as Sitar said above — or GenieAI where machine learning algorithms work alongside human professionals (e.g., radiologists or lawyers) to augment their abilities and performances.
The second theme is around the profound change in the structure of work. It is a real revolution with multiple categories. Remote working is of course the one that is now top of mind to everyone for obvious reasons. But it is here to stay, permanently. It is the inevitable change necessary to empower the next 50 years of global growth. While this is not controversial, less obvious is the lack of purpose-built products that empower companies to work in a remote-first fashion. We believe there is a lot of room for deeper innovation. For original products that are not just a virtual replica of real-life but rather rethink the entire user experience for a remote-first perspective. In multiple areas: collaboration and communication; training and leadership development; coaching and mental health; employment and payroll. For example, every company now wants to hire anyone anywhere. But today remote hiring is still fundamentally broken. This view led to our recent investment in Oyster, a SaaS HR and payroll product built for the remote world.
Another big structural change is the rise of the freelance generation. With the shift to decentralized work models millions of workers now operate as freelancers outside the conventional employer’s perimeters, with no access to a full range of software and services. Hence the opportunities to create a new range of products designed around the freelance needs, ranging from communication and training, to career management, to payment and benefits.
Lastly, we see the need for more platforms for the creative class. The so-called passion economy. Chefs, mental health coaches or surf instructors seek to turn their expertise and passion into scalable business but they lack the software, the tools and the distribution. Here there is opportunity for tools that empower entirely new forms of work.
We have already backed several companies building the future of work. We’re excited to find and back the new generation of purpose-built products that create new categories in work tech.
Finally, although Connect is a very small team, it is already more diverse in terms of gender and ethnicity than many VC firms. What are you actively doing (if anything) to ensure you back diverse founders, including relating to gender, ethnicity and socio-economic background?
Sitar Teli: I think one of the most important things we’ve done is exactly what you pointed out: Built a diverse team. We’re diverse in gender, ethnicity, socio-economic background, sexual orientation and geography at the partnership level and across the wider team. This diversity means we challenge each other on how and what we think, view investments from different perspectives and are more likely to be aware of individual biases. Venture capital is a series of decisions — to invest or not, deciding whether a company is reaching escape velocity or needs course correction, should we invest more money into a business or not. Several studies have shown that heterogeneity leads to better decisions. There’s a lot of warranted conversation in the startup world about the lack of funding for minority founders and female founders and what to do to fix it. We think one of the most impactful ways to change that is to create diversity of all kinds at the capital allocation level, so that’s what we prioritize.