Don't waste your time on the Vistula, but push into the world!

Scaling technology on the Polish market is like squeezing water out of stone. Don't do it! – warns Marcin Hejka, Partner at OTB Ventures.

The healthiest for success is the revenue generated by a given startup - sums up Andrzej Różycki, Managing Partner of Tar Heel Capital - You think too much about exits, rounds, valuations, and I have already seen many companies that have "drowned" in the money received from investors.

We invite you to read excerpts from a unique debate with the participation of two giants of the Polish venture capital market, managing funds with a capitalization of over one billion zlotys each. The debate was held as part of the December conference "International Business Scaling" - organized in Warsaw by WP2 Investments.

What is it like with the Polish market as a starting point for domestic startups? Is the fact that most of them are starting to develop from the domestic backyard an opportunity or more of a trap for these businesses?

Andrzej Różycki: It seems to me that this is always a very difficult, somewhat perverse question, because almost everyone wants to scale their business internationally. And first of all - not every business should scale internationally. Secondly - this business cannot always be scaled internationally. Thirdly, there are businesses, truly technological ones, that do not need international scaling. They create a technology that has been universal in the global perspective from the very beginning. In fact, from my perspective, these businesses should be divided into those that make real technology, which is in most cases universal. Of course, it fits into some regulatory framework and market and customary situations, and so, for example, Asians use the Internet differently than Europeans or Americans. This is where the example of Allegro comes to mind, which has been very successful in Poland and has recently written off 2.2 billion from its acquisition in the Czech Republic. It turns out that international scaling in this case turned out to be a complete distraction for business and value. To sum up, not every business, not every board is suitable for international scaling and actually not everyone should do it.

Marcin Hejka: I will only refer to the market of these real technologies, I do not know any other market and I am not interested in other investments. To clarify - Allegro is not technology, an app store is not technology, just like a scooter with an app or delivering purchases is not technology either. True technology is by definition global, or... is not technology. 

Coming back to the question, when it comes to the market of real technologies, their development on the Polish market does not make any sense. If someone has real technology and the idea that it will scale in Poland comes to mind, they should consider a cold shower or a long walk. It won't make sense. If we look at any real technology market, we will see that Poland and the entire region are the periphery of the periphery. Trying to develop anything here will only be a waste of time. You must not even try!

Why?

Marcin Hejka: First of all, if we look at the scale, where are the markets for technology consumption? Not in Poland! Let's take a closer look at a simple market, let's say enterprise software. 45 per cent of the global market in this area is one country - the United States. Western Europe accounts for about 30 per cent, Japan less than 10 per cent and the rest of the world accounts for about 15-20 per cent of the global market, including China, India, Russia, Africa and Latin America. The same principle applies to any real technology market. I would say more, the newer and younger the market, the greater the part of this market will be the United States. So developing a technology business on the Polish market is an attempt to squeeze water out of a stone. Why? Because the Polish market is not only damn small, but also quite poor, and the enterprise market consists largely of state-owned companies that will never be early adapters, because it is beyond their perception, or it is a market of foreign companies and their Polish branches will never be a center of innovation, because there technologies will come from above.  

What's more, even if some brilliant start-up comes up with a brilliant solution that will win over the 5 largest corporations as customers, it will still be worth nothing. Because having companies such as Azoty, Orlen or PKP as customers does not make any sense in international expansion, because as a reference it will have zero value.

Is Poland, by definition, also a bad place to test a technological product?

 Marcin Hejka: Yes. In general, I know American corporations quite well and unfortunately I have heard a little about how it works in Poland. The mentality of an employee of a foreign corporation operating in Poland or a Polish corporation is such that they have an advantage and such a corporation crawls and squeezes these startups. Trying to test with large companies in Poland, doing early implementations is therefore often pointless for startups. Even if you check that something works, it will not matter to anyone, it will be of no use later, and it will only be a way through torment. It will be a torture inflicted on oneself.

Why does it look different in the States?

Marcin Hejka: American corporations have a completely different mentality. What's more, they have it written in their DNA as a way of acting. It is completely normal there that we work with startups, that we try to help startups, and it is completely normal that such a corporation, product departments, business units have annual targets written down in their company, that they have to test 10, 15, 20 startup solutions in a given year, check if they work and help them at the same time. There is a completely different way of thinking, not that since I am a big company, I have to squeeze each of my suppliers to the last drop. The mentality there is rather this: "I have a budget for it, we will try whether it works out or not, and if it does, we will do a larger implementation, we will be a reference, we will pay fairly and we will not overdo it". This is ecosystem thinking.

American corporations understand that they, as corporations, are not innovative in themselves, and if they want to be competitive in this respect, they must cooperate with the startup market all the time. This is a bit of the other side of the coin, why most American corporations are creating their venture at this point. Because they understand that as corporations they have no chance to be innovative. American corporations have decided and praise them for the fact that making any innovation in a corporation will not work, because if a corporation gets down to something and starts doing something in accordance with procedures, etc., it will suddenly turn out that it costs 10 times as much as expected, and takes 10 times longer. And in the end, it is not created at all. Or it arises in the form of what was not intended at all.

If they understand that they are not able to do it, it is natural that they have to work with the startup environment, they have people to do it, it is in their strategy and they have budgets for it. And this is the mentality that allows you to scale up the easiest way in the US.

It is a nonsense and harmful myth that it is easiest to scale on a local market such as the Polish market.

Today, we are in an era of deep digitization. The question is, what defines business scaling today?

Andrzej Różycki: If you have technology in the way Marcin said, then it is global simply by definition. On the other hand, among startups, 95 percent of businesses, if not more, are businesses that are not purely technological businesses. Of course, this definition of technology is changing, of course. Something could have been a technology in the past, but today it is a complete commodity. In their case, we are talking about winning the market, customers, marketing, operational excellence. And not about technology development. Now, depending on what kind of company it is, the question is, is the market on which you operate sufficient and good? You have to ask yourself: why are you building your startup - some people do it for money, others do it for glory and others for something else. If you do it for money, you have to think about who you will sell it to one day? It is often the case, even sometimes from the point of view of a strategic investor, that if you are present on 5 markets with a low market share, it may be better if you were on 1 market, but had a large market share. So as if this does not mean that scaling is unambiguously good and always makes unambiguous sense.

Marcin Hejka: I think that a very good example is Israel, where there is practically no local market for technology consumption at all or it is so small that it does not make sense. The situation is similar in Poland. Only we live in the illusion that this is not the case with us at all. How does it work in Israel? In such a way that when a company is established and has two founders, on the first day one of them gets on a plane and flies to the States and starts talking to customers there, often selling on the basis of "trying to sell shit that doesn't exist". He tries to talk to these enterpis, push something on them, and at the same time try to build it. And this model works, and the engineering talent there is no better than in Poland.

Most of these engineering brains in Israel came from our part of the world. In fact, it could be said that Israel and Eastern Europe have similar technical DNA. And what are the results of the global from day one approach? If we compare the scale, the entire Polish VC market, with annual records combined with champagne opening, is roughly 10 weeks of VC market in Israel per year. When it comes to exits, it's even less and it shows a bit the way and effectiveness of that model.

What can be the "driver" of the exit?

Marcin Hejka: There are 3 exit drivers. There are only 3 reasons why a company can be bought, and these are the so-called 3Ts, i.e. Traction, Technology, or Team. Traction is market share and revenue - the buyer simply buys revenue or market share. This is often applicable and crucial in private equity transactions. From the point of view of technology companies, it is probably a few percent of the weight in exits, but probably more than 90 percent are the remaining T's, and the absolute majority is the value of the technology. Where is a company bought not because it has revenue, not because it has a market share, but because it has an important technological element that fits into some larger puzzle of a potential buyer, i.e. let's say, for example, a security software company that offers an antivirus and has 100 million customers, buys a startup with an additional feature, e.g. whether Internet links are safe, or we store some passwords additionally, and this is a simple decision - time to market and that,  what matters to them, not what revenues the purchased company has. What's more important is what revenue I, as a buyer, will have when I buy it, because if I add this element as a premium option for my existing subscribers and I charge $5 more for the top version next year, then if half of my customers buy it, then I will earn an additional $250 million. And that is why these multipliers on technological exits are often so high.

Andrzej Różycki: I look at it from a slightly different perspective. We had a company in our portfolio called RemoteMyApp, which was bought by INTEL a year ago. What did the company do? It streamed games installed in the cloud to your computer and a lot of such solutions appeared, although this business in a nutshell did not work out for anyone big and with today's technology costs and the cost of buying IP, it has no right to be profitable. And we have been building it for years and there was a buyer who, unlike his competitors, simply did not have it yet. From an investor perspective, when we talk about development, we can find ourselves in a trap that there will be no buyer for it. 

So what needs to change in Poland?

Andrzej Różycki: In my opinion, a whole generation must roll. Today's 40-50-year-olds are the generation that in the vast majority earned and still earns money for their first apartments. And this startup volatility, the entire ecosystem, funding, etc. is so capricious that only people who enter the labor market have enough imagination and ease to do these things effectively. 

Marcin Hejka: I thought that this process was happening very quickly. We see what is needed to "surprise" it. Let's pay attention to the fact that in every country of our region, sometimes a company will come out with one shot, an example is the Romanian UiPath, which was a revelation. An example is also the Estonian Skype - it generated a group of people who knew "this is how it's done".

Andrzej Różycki: A lot of people made money on it.

Marcin Hejka: And then it started to spin and suddenly Estonia looks like Israel. And a similar situation is in Romania, a country that previously dealt with the development of software houses and bodyleasing, after they got UiPath and suddenly the rash began. The problem is that we have not seen anything like this on a similar scale before. Why is a country that is the largest in the region, which has wise people, behind others? The Czech Republic, which had more unicorns, and even Belarus or Ukraine, which already have several unicorns.

Andrzej Różycki: That's true. This cannot be explained by volatility. 

Marcin Hejka: And why? Because local startups often live under the illusion that they will scale something locally here. We have to start from the same assumption as in Estonia or Israel, that our market is too small, and we will not be able to scale anything effectively here. I am convinced that great technologies can be created in Poland and I have evidence for this. But I am also convinced that no technological business can be scaled up here. This is currently impossible.

Andrzej Różycki: Or maybe this is not a generational issue, but we need one or two successes, and we will also have a flood of such companies. This is how it worked in Romania or Estonia and today they are in a different place. 

Marcin Hejka: I once asked one of the Romanian founders: "What made you decide to start this company?" and he replied: "I know Daniel Dines, the founder of UiPath, and he's not smarter than me." And this is a great approach! Such healthy greed, healthy business hunger. Unfortunately, we have such Daniel Dines "as few as possible".

What are the non-measurable criteria that make you want to invest in a given market or company?

Marcin Hejka: We don't look at geographic markets at all, but at technology and what it looks like on the global market, which comes down to the fact that we analyze the American, Western European, Japanese-Singapore-Asian markets. Of course, we verify the technology - whether it really fits into a certain evolution of market development. So it is known that timing also matters whether a given segment has not already become a "commodity", and on the other hand, whether it is not too late for a venture investment. Contrary to appearances, a very common reason for failure in deeptech investors is that the market will not develop enough for the life of the fund to generate any exit. So it is a matter of evaluating the technology and the market. When it comes to the team, technological competences are crucial. Generally, the earlier you invest, the less you can verify objectively, so probably at the earliest stage the only thing you can do as an investor doing due diligence is to look the founder in the eye and ask yourself if "these guys are able to do it". Later, of course, when this company already has customers, revenue, product, you have to verify it, talk to customers. But there is still this element of trust - do I have it, that the founder has enough competence to fight, that he is able to effectively use our support. These are not just numbers, it is sometimes intuition and the desire to trust. 

How it all looks from the perspective of the exit - as a fund, you have to think about it when investing. How do you look for some kind of compliance, what is most important to you when planning an exit?

Marcin Hejka: In general, we do various types of exit simulations. We try to identify potential development paths, but in fact you have to implement a product plan, a plan for building a business, sometimes it helps that the company is on someone's radar, that it is mentioned in market reports, that a nice customer wins - and getting a few reference customers can make a huge difference. As long as the company is not noticed, it will never be considered a target for potential acquisition. Corporations that scan the market for potential acquisition will take the company into account when a good investor, a decent customer appears, or when the company appears in a decent report.

Andrzej Różycki: It's good to be recognizable and visible, because then it's easier to catch the timing. You never know what, when, who will need it and who will come up with the idea to buy something. But once it buys your competition, it won't buy you! The more motivated the buyer, the better the exit, the more expensive you sell. If you have two or three predefined buyers - you will probably get a worse price, but more certainly that you will get it at all. It all depends on the type of investment. Most people think too much about exit, about rounds, about valuations, about raising money and do not deal with what really builds the company's value - product management and customers. There is no better money than that generated from real revenues from core operations. They validate the business and give more actual, business value. I have already seen a lot of companies that have "drowned" in the money received from investors.