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Scott Orn

Scott Orn, CFA

Katie Shea of Divergent Capital talks about startup financing

Posted on: 12/07/2021

Kruze Consulting's Founders and Friends Podcast · Katie Shea of Divergent Capital talks about startup financing

Katie Shea

Katie Shea

Co-Founder & General Partner - Divergent Capital


Katie Shea of Divergent Capital - Podcast Summary

Katie Shea of Divergent Capital talks about her background, industries in which she invested, and things she looks for when investing in a startup.

Katie Shea of Divergent Capital - Podcast Transcript

Scott: Hey, it’s Scott Orn at Kruze Consulting. And thanks for joining us on Founders and Friends for another awesome podcast. Let’s give a quick shout out to the Kruze Consulting accounting team. We’re very fortunate. We have a ton of people at Kruze who work on the monthly books for our clients and get them all set up, due diligence ready, rocking every month, answering all the clients’ questions, making all those adjustments. And there’s no better moment for a founder and for us really when a founder says, “Hey, I think I’m going to get a term sheet. Are my books ready for diligence?” And we get to say, “Yes, they are. Fire away. Send them over. Give them access.” That is a great feeling. It’s the feeling that lets us know we’ve done a job very well done. And nothing is better than watching that cash at the bank account. So, if you are a venture backed startup, you’re going out to fundraise, maybe check us out. Check us out at kruzeconsulting.com. We love what we do. At taping here, I think we have 575 clients. Clients raised over a billion dollars this year, so we know what we’re doing. And hopefully we can help you be successful in your fundraise. All right, let’s get to the podcast. Thanks.
Singer: (singing). It’s Kruze Consulting, Founders and Friends, with your host, Scotty Orn.
Scott: Welcome to Founders and Friends Podcast with Scott Orn at Kruze Consulting. And today, my very special guest is Katie Shea from Divergent Capital. Welcome, Katie.
Katie: Hey, Scott. Thanks for having me.
Scott: Great to have you. Well, we talked a couple months ago when you were kind of in the thick of the fundraise for Divergent Capital. And I just really appreciated who you are and where you come from, and so I wanted to have you on the podcast. Maybe you can start off just by telling everyone how you had the idea and the motivation to start Divergent.
Katie: Yeah. So, I don’t know if this resonates with everybody, but I feel like the older I get, the more I think about my childhood. And like everything I think that most people end up doing somehow goes back to their childhood. So, I was really fortunate. I grew up in Queens, New York, Queens, Long Island border. My dad was a firefighter, and my mom was a stay at home mom of four. But over the years, my dad had started this small sign company that basically I had the privilege of watching grow over my entire childhood. And my mom, even though she stayed home, she was always dabbling in something. She had a daycare business and a home organizing business. They would get involved in real estate and rentals and things like that. So, I just had that around my whole life. Because my mom had four kids in seven years, I think sometimes a form of babysitting was like, “You’re going to work with your dad. Get out of here for a couple hours.” And I think in hindsight, that was so hugely impactful because at a young age I knew what a purchase order was, and would pick up calls and deal with customers as a 13-year-old. So it definitely taught me a lot and I think got me really comfortable from a really young age, just being in business settings. That’s my 10 months old banging on the [crosstalk].
Scott: All good. All good. All good. Well, I was going to say I’m remembering now why we hit off is because my dad was a firefighter. I’ve lived a similar life to you. And the cool thing about being a firefighter is you have a lot of spare time to do the stuff you’re talking about like start a business on the side. So, I saw my parents do the same thing. So, we lived parallel lives on different coasts, so I remember this now.
Katie: For me, it was at a pretty young age I think there was just this natural, obvious path for me. I was going to do something entrepreneurial. That took me to go to Stern business undergrad at NYU. I studied finance and marketing with a minor in entrepreneurship. I was completely the dork, the startup dork on campus that ran the entrepreneurship club and launched this café that was for students, by students. I got really close to the dean and actually helped her launch that entrepreneurship minor. My, let’s see, junior year, basically I was interning at Goldman Sachs, I was working on the trading floor. My best friend from school was interning at Citi at their trading floor. We’re both pretty petite. We were in heels all day. We were pretty miserable after work, and so basically spend senior year launching this footwear brand, which was a total departure. I remember going to my boss at Goldman at the time and basically like, Hey, give me an offer.” And they were like, “Are you going to take it? And I was like, “Can I try to start this footwear business and get back to you in six to 12 months, probably with my tail between my legs?” But we were really fortunate we never had to do that. So even at that point, I did not know what venture capital was. I had grown up surrounded by small business owners that didn’t take on debt. And so, we bootstrapped the business. This was 2009 to 2013. We grew it to multi millions in top line profitability. We factored against our [inaudible] to grow. We sold product into Neiman Marcus and Macy’s and Bloomingdale’s. I just really look at those years of where I kind of earned some founder stripes. It wasn’t a sexy, tech unicorn exit. But hiring people, firing people, figuring out warehousing and 3PL systems, trying to hit super, super aggressive revenue targets. That’s what we did for a couple years.
Scott: And in some ways, when you don’t have the venture capital, you actually learn those lessons harder and faster than someone who has the kind of venture capital cushion.
Katie: Yeah, 100%.
Scott: Because there’s nowhere else to get money. You either figure that problem out or you’re out of business.
Katie: Right. I think I was lucky in a way I didn’t know too much about that world because it forced us to go for profitability right away because we needed to pay ourselves. And we sold the business in 2013. And I think if we didn’t have EBITDA, that transaction never would’ve happened. And for me, it was interesting, my partner, Susie Levitt, she still works for that company today, the business that we sold to.
Scott: Oh, wow.
Katie: And what she realized in those five years building this manufacturing company was she was really the designer at heart. Fashion and design run through her blood. I don’t have a fashion bone in my body. I was more of the sales and marketer. I just loved building. I loved the zero to five million, zero to ten million stage. And so, we were really lucky because selling the business, I wanted to leave, she wanted to stay. I realized that I loved that starting point. I was a big more sector agnostic, and she realized she loved the industry.
Scott: Well, that would be one of those lessons that sticks with you for a long time though in VC because I think one of the hardest things for venture capitalists is to make the call on when to sell the company, but then also be able to call back on that experience you have with the founders and be like, “I’ve been there too. What do you want? Here’s what I see. I’ve been through this.”
Katie: Totally. I think it’s more of the latter, especially in a really competitive financing ecosystem right now. Don’t get me wrong, there’s brilliant career investors out there. But founder to founder empathy is, you can’t really fake that. Right? You can’t talk in the same way if you haven’t been through that experience as founder operator yourself. I spent, from there, basically spent my career moved into the venture backed tech side of the house. I had gotten really interested in retail technology while I was running a manufacturing business that sold into retail. I could not believe I was getting purchase orders via fax machine for $700,000 purchase orders in 2013. I was dealing with EDI systems that were built in the 1960s to manage all of our warehouse processes. So, I ended up going to a retail tech company called Ordergroove, super early. You could think of them as Amazon subscribe and save for everybody that’s on Amazon, so this white label, [inaudible] subscription commerce platform. They’ve done exceptionally well. I was their head of marketing. From there, I joined a company called Homejoy, rest in peace. That was a bittersweet experience. I was the GM of New York, so oversaw all of our head count in New York and 300 plus independent contractors. That was my first lesson of things not going to plan. I would join [crosstalk].
Scott: Yeah. Yeah, yeah. I saw that. It was kind of like a high-profile company, and then it caught people by surprise when it came crashing down. So, I’m sure you’ve kind of learned a lot of lessons both on the upside then the downside.
Katie: Even like being in the business, now so many lessons that apply to my investing world, which is they’ve raised too much, too fast. They had to basically scale to 30 cities in six months because they had raised so much, quality of the product went down. I think at the end of the day, it was a home services marketplace, but you’re still dealing with people, people that had to show up at other people’s homes. So, I think a lot in hindsight, it wasn’t just as easy as, “Hey, this is a super scalable tech platform.” Right? And the growth was fueled on at the time, people were still using Groupon to get off the ground and to get [inaudible]. And there’s a lot of conversion data and no engagement and retention data. So, obviously, that’s something now I spend way more time looking at from the investing side. So, fast forward, I started angel investing shortly after I sold the business, which made my first angel investment in 2014. And it was not, I’m not institutionally trained and my partner, Lucy, is. I’ll tell you more about her in a minute. But it was very organic for me. We had been lucky enough to win some of those 25 under 25, 30 under 30 founder awards. I just got to know other young founders and they became my friends. And when they had angels that were much better than my own, I was like, “Hey, can I put some money into your company? I just sold mine. And [inaudible] liquidity for the first time.” And that really snowballed. I got really lucky. I ended up investing in some incredible companies very early. And the word kind of spreads from there. And about four years ago now, officially came over to investing. I love when you say officially came over to the dark side. I had made 20 angel investments at that point. It was my favorite part of the day. These are small personal checks, but to be able to sit with founders, hear their story, I just have so much respect for what founders are doing. They’re putting everything on the line for this idea. They’re putting reputation. They’re putting income, getting their partners on board for what they’re about to go through. So, once I realized venture was an industry, I was kind of hooked on that idea. I can do this for a living potentially, and kind of knew that I was never going to look back.
Scott: And that led you to Divergent. That’s when the moment you were like, “Hey, I’ve got to start a fund to do this.”
Katie: It actually led me to a small fund here called Kairos, which is where I was a general partner for a few years before starting Divergent. And honestly, I love that team so much. They’re more consumer and consumer tech. The Divergent story I’d say in a way starts eight, nine years ago, although I don’t think either Lucy or I knew it at the time. Lucy and I first met in New York at a tech conference. She was a deep tech investor. She was institutionally trained. She was at Greycroft and then 11.2 Capital. She was previously at Bridgewater. And she was investing in stuff that seemed crazy to me, like robotics, space tech. And it was really refreshing because we connected immediately I think from an ethos perspective, both of us kind of felt like we were underdogs coming into the venture community in New York. Lucy emigrated from Wuhan, China when she was 12 years old.
Scott: Oh, wow.
Katie: Her mom got a job at John Hopkins. I was raised by entrepreneurs and small business owners and she was raised by scientists and academics and technologists. And our paths are so representative of that, even to this day. So, the foundation for Divergent was again really organic. We actually found it refreshing for those first couple years of the friendship that there wasn’t a ton of professional overlap. Sometimes the world can seem a bit incestuous and insular in New York. Any time Lucy was talking about something, I was like, “Oh, I’ve never heard of that before,” and vice versa, which was so different than some of my other conversations, which is like, “Oh, yeah, of course you’re chasing that founder and talking to that founder and investing in the company.” I think that was the first aha moment of, “Wow, our worlds are really different.” Is there a key thing?
Scott: Which is a good thing.
Katie: Good about that. Right?
Scott: Yeah.
Katie: And so, a couple years ago, we noticed something was starting to change. And we were calling each other a lot more on the professional side of the house. So, we were seeing founders and getting excited about companies that they didn’t perfectly fit in Lucy’s deep tech portfolio. They didn’t perfectly fit in my consumer generalist portfolio. To us, that was twice as exciting because these are founders that want to take on big tech or science risks and big go to market or commercialization risks. And our thinking was like, “All right, there’s no such thing as too much risk.” Right? If you’re an early stage VC, that’s kind of the job. As long as you prize that risk appropriately, there’s still huge [inaudible].
Scott: Yeah. That’s good the way you’re saying that.
Katie: We talk about Tesla. We’re like, “Okay, obviously there’s innovation on self-driving cars, batteries at the beginning.” And but along with that, Tesla was like, “Hey, we’re also going to sell cars direct to consumer.” And a lot of people that missed Tesla in the beginning were like, “No, we buy cars on parking lots. That’s how we buy cars and that will never change.” But if you now look at the market cap of Tesla, that’s clearly a great example of where kind of taking risks on both sides have paid off really well and created a ton of defensibility. So, we started angel investing out of a shared LLC. We just put some personal capital in a couple years ago, not really with an end goal in mind, just to kind of see. Hey, are there enough companies out there that we both get excited about, given how different our backgrounds are? Can we find these founders? Can we either get excited and help create the round for them, or get into a round if it’s competitive? Generally, we’re more interested in the former. And we invested in five company’s pre-product, pre-revenue. They’ve all done exceptionally well and raised [inaudible] capital and fueled growth. And Lucy and I spent a lot of time asking ourselves, “Does the world really need another venture fund?” Especially since I was super pregnant with my second, it was the middle of COVID. There were all the reasons not to do it, so I think we really took the exercise really seriously of: Does it make sense to turn this angel vehicle side hustle into an institutional strategy and a firm that will hopefully be around for decades? And so our founders are really the ones that got us over the ledge there. They were the ones that were like, “Hey, you met us the earliest. You put together the memo. You shared it with 17 of your friends. You guys made this round happen. You did all the work and gave up all of the value because you’re not rich kids.” And they were like, “More than that, you’re a really unique partnership on the cap table because there’s both a deep tech expert and a consumer commercialization expert.” And usually what our founders saw is whoever was on the cap table, they were one or the other. And they were like, “You actually understand both sides of this business.”
Scott: Do both, yeah.
Katie: Yeah. We set out earlier this year to raise a debut fund-
Scott: If I may, also, selfishly, you said earlier it was your favorite part of the day. There’s a little bit of: Should another venture capital firm exist? Yes, probably. But selfishly, you also have to … It sounds like you listened to yourself and what makes you happy. I think there’s a lot … Sometimes people, they go through life not taking that leap because it’s too scary, even though they know that’s what they want to do. And so, kudos to you for taking that leap. Hey, it’s Scott Orn. And we’re going to take a quick break from the podcast to give a shout out to the Kruze tax team. Gosh, it’s so nice to have an in-house tax team, I can’t even tell you. We have some really amazing professionals on team. It’s over, I think it’s 13 people now. And we do everything from your federal and state income tax return, state franchise tax filings, R and D tax credits. Those are pretty popular these days. And guess what, they’re there for you when you go through diligence. A lot of people don’t know this, but you actually go through tax diligence, not just operational kind of financial diligence. But you do go through tax diligence, so it’s nice to have Vanessa Kruze on the phone with your VCs and with the accounting firm they hired to diligence all your stuff, and the law firm they hired to diligence all your stuff. Vanessa knows what she’s doing. She’s done this a million times. And it’s not just Vanessa, we have a really great team of tax professionals that will do those calls too. It’s kind of sometimes the difference between getting your round closed or having it take another two weeks because something was disorganized and the tax compliance wasn’t done correctly. We hear those horror stories from clients that come to us. So, hey, if you want Kruze’s tax team on your side, we’re here for you. Check us out at kruzeconsulting.com. Thanks.
Katie: One of my early angel investments was into Bombas socks. Founder was a good friend, Dave Heath. And I remember talking to him about it. We’re fortunate he’s also a backer of Divergent. They’re on the IPO track. They’ve done exceptionally well, one of the most capital efficient teams I’ve ever met. And when I was talking to him about, “Should we do this? Does the world need another venture fund?” He’s like, “That’s not the right question.” He’s like, “The right question is: Do you love it? Do you think you can be top [inaudible] at it?” And I was like, “Yes, I do.” He’s like, “So we’ve got to do it.”
Scott: That’s great advice, great advice from your friend.
Katie: Yeah. So that was the very long version of how I got here.
Scott: Well, first of all, it’s great that you have probably that angel track record to show prospective investors because they probably got a lot of comfort out of that. And you kind of live the life of a seed stage VC. And there’s something else you said in that, which was you helped create the round or make the round happen, which for some of these early investors, or early companies you invested in, but that is really the role. People don’t always know that. That is the role of the lead in a seed stage deal. By signing Katie Shea to that term sheet and pricing the deal, you’ve given the founder not only money, but you’ve given them a reputation boost and something to show other people-
Katie: Right, some clout.
Scott: Who come into the round, that is actually I think that is one of the biggest services a seed stage investor can provide a startup, making it okay, or creating the social proof for other people to get behind the company.
Katie: Yeah, I couldn’t agree more. One of the things that Lucy and I always bonded over, and we don’t think it’s a coincidence, when we look at our unicorns, our soon to be unicorns, they’re not the Silicon Valley cool kid founders. They were the young visionaries with no proven track record to underwrite. They’re the PhDs or the scientists that didn’t know how to speak VC. That to us is where we get the most excited. There’re enough funds out there chasing those founders. But we don’t think it’s a coincidence that those have been where our outliers are coming from.
Scott: Yeah. And they’re grateful for life because you helped them get on the journey to start their dream.
Katie: When you give that term sheet. When you give that term sheet, Right? We’re fortunate we have been doing this for a decade plus. We’ve literally only been in the early stage tech communities our whole lives as founders, angels, investors. We’ve never done anything else. We literally just gave a term sheet last week to somebody, and introduced them to 25 potential co-investors and now their [inaudible] oversubscribed. Right?
Scott: That’s amazing.
Katie: As a founder in Boulder, Colorado, he’s brilliant. His CTO right now is in Europe and he was a machine learning software engineer at Google. But they just didn’t have those networks. They didn’t know that they could get the [inaudible] show to [inaudible] funds. So that’s one of my favorite parts of the job is betting on people before it’s obvious to everybody else that you should bet on them.
Scott: Yeah, I totally agree. Well, maybe talk about Divergent’s strategy and also the type of founders you’re looking for and are looking to meet.
Katie: So, when we think about founders … So, let me take a step back. I would call us, it’s a $25 million fund. It’s a micro fund by every definition of the word. We’re looking to back about 20 to 25 of the next world’s changing, pre-seed companies. So, what that means in practice is we’re usually investing $250,000 to $750,000, in really the first round that they’re raising. There’s a lot of nomenclature now. But let’s just call it the first 500 K to $2 million that this founder is thinking of taking into the company. We’re hoping to come in and institutionalize that really painful angel round that some of these less “connected folks” are putting together to get this thing off the ground. In a dream situation, we’re going to lead or co-lead that round. We think of ourselves, [inaudible] portfolio companies. They think from afar, it looks pretty generalist. As people get to know Lucy and I, it all starts to make more sense. It’s usually a matrix of technology [inaudible], Lucy knows really well, or gets really excited about, so that’s robotics, AI, machine learning, biotech, and a market or sector I know really well. So, we’ve done logistics, commerce tech, ed tech, digital health, so a variety of different business models, founders, and geographies. But it really comes down to we think there’s a real tech or science innovation and a really unique insight about the customer, commercialization, or go to market. We are looking for founders who are literally obsessed with what they’re doing. I feel like that word has a negative connotation, but I always come back to it because the founders we’re biased towards, they haven’t been thinking about this idea for days, or weeks, or months. They’ve been thinking about it for years or decades, and somehow a lot of pieces of their lives have brought them to this point. We definitely have a bias towards founders that are solving some problem that they’ve experienced on their own in some way, either as a consumer or as a professional if it’s a B to B company. And they just have a unique perspective about what the market is missing. We call it the difference between the bottoms up sales pitch and the top down sales pitch. When we get on an intro call and a founder is immediately going into, “Hey, it’s $100 billion market. If we get 1% of it, blah, blah, blah,” it’s like that’s not how … The founders we gravitate towards, they’re like, “I interviewed 300 customers. I had this hypothesis. I was actually wrong. What I realized from these 300 interviews is this is the unique insight, or this is the problem,” and I’m the best to do this because of X, Y, Z. It’s more of a bottoms up analysis of how they’re thinking about the opportunity. It tends to focus a lot more on product and customers than it does on market size.
Scott: Also, when we talked off camera before we turned the mics on, you also talked about how kind of concentrated … Maybe explain the difference between a typical seed stage fund and how they invest versus what you’re doing.
Katie: Yeah. We’re going to invest in 20 to 25 companies over the course of the fund. We’ve already invested in five of the 25. Most early stage funds, at least what I’m seeing these days, are investing in anything from 35 to 50 companies per fund. And literally, you can be an amazing investor either way. But I think this high concentration, high conviction route is just more aligned with Lucy and my personality. We look more to the Union Square Ventures of the world, IA Ventures of the world, where we’re doing one investment per partner, per quarter. And so, one, that means we can actually be smart and due diligence too. We can actually get our hands dirty with these founders for a couple months post that investment. That tends to be where we’re the most helpful anyway of like, “Hey, you have money in the bank. What should your go to market look like? How should you prioritize the tech science team? Where does budget go? How do you measure it? What’s the dashboards like?” So that I think really differentiates us in the market to get to founders, especially when we are competing with other firms or other term sheets to say, “Look, this is not a spray and pray strategy. We’re very intentional and we’re trying to go as big as we can on these companies.” We actually just sent an LP update last week. And I’m going to botch numbers here a little bit, but it was like we basically saw over 800 opportunities come through the pipeline either inbound or outbound last quarter.
Scott: That’s amazing. That’s a lot. That’s a lot.
Katie: It’s too much. We engaged with 30% of them, so that like we had a first caller, first meeting. We gave two term sheets and we ultimately invested in one company, so that’s a sub .5% investment rate. So that appeals to I think our LPs, and more importantly, that’s just how we like to operate.
Scott: Yep. I think you said this, but borrowing Union Square’s high conviction, high focus. But as I told you before we started recording, I followed them for 15 years, or I don’t even know, maybe 18 years on the blogs. And they’re doing very well. There’s something we talked about also before we turned the mics on, which is just the overall energy. You’re in New York. And it feels like entrepreneurial energy and the city’s on fire.
Katie: I’m so [inaudible].
Scott: Maybe talk about that for a second.
Katie: Yeah. I’m the only lunatic that moved back to the city with two kids under three years old. I’m just hopelessly addicted to this place, I think because I went to undergrad here, it’s even more entrenched. It’s not just like I’ve been here for 17 years, my entire-
Scott: Is Stern at NYU?
Katie: Yeah.
Scott: Okay, yeah. I lived in … I did a summer in West Village, I worked for Beck and Dickinson, a big company, but I lived in the West village. And I can see how I was right next to NYU. I can see how you being addicted to it, and it could put kind of that blueprint or print on your life. But the cool thing is you deserve a lot of credit for … I think one thing that’s coming up in just this one conversation is you have a feeling about something and you act on it. That’s actually what really, moving back to New York.
Katie: [inaudible].
Scott: Or taking the leap to start the venture capital fund, or that actually is one of those character traits that really when you look back on your life, if you do that and you listen to yourself, you tend to live a happier life.
Katie: Whenever I have big decisions to make, personal, or professional, or investment, it’s really an analysis for me of: What is the worst-case scenario? And what is the best-case scenario? And can I handle both? I can usually handle both. And so just what do you want to do? And if you can’t handle both, don’t do it. Right?
Scott: Totally.
Katie: So, it’s a pretty easy decision-making framework for me.
Scott: Wow.
Katie: But yeah, I think the thing about New York, I mean, I’ve been doing this for so long, I feel like I have some really strong West Coast communities and East Coast communities too. And there is a difference. One, I mean, the funds here are just younger and smaller by definition. But I think I’ve just found Silicon Valley, West Coast, it’s a bit more intellectual, heady, vision, big visions. New York, I think is just still, it’s still a little bit, it’s scrappier and more resourceful. It’s more analytical I think because we’re kind of like a finance Wall Street city at the core that just trickles into the types of founders and the types of pitch decks. And over 50% of my investments are in New York, so I’m pretty-
Scott: That’s good. That’s good. Well, this has been amazing. And we have to wrap it up here. But can you tell everyone how to reach out to you if they want to pitch you, or introduce you to a founder, or an LP? Or how do they get ahold of you and how do they reach out?
Katie: Yes, absolutely. Our website is divergenthq.com. D-I-V-E-R-G-E-N-T-H-Q.com. It’s very light, basically we just let our portfolio companies do all the talking, so it’s literally just the job boards of all of our portfolio companies that are hiring right now. And you can send us an email at hello@divergenthq.com. That’ll go to Lucy and myself.
Scott: Beautiful. Katie, thank you so much. Congrats on starting your firm. It’s so hard to start a venture capital firm, and so congratulations.
Katie: It’s a labor of love. We’re pretty proud. We did our first close literally in April, so I feel like seven months start to finish for a debut micro fund during a global pandemic fundraising on Zoom, it could’ve been worse.
Scott: It could’ve, but you did it, and huge congratulations.
Katie: Thank you.
Scott: And best of luck.
Katie: All right. Talk to you soon. Thanks for having me.
Scott: Thank you. Bye.
Katie: Bye.
Singer: (singing). It’s Kruze Consulting Founders and Friends with your host, Scotty Orn.

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