Marcin Szelag Interview - Constellation Software in CEE

Gustaf: Hey Marcin! Great to catch up. I'm excited to combine my interest in Constellation Software and the CEE region with this interview. And, while you don't have Mark Leonard's beard – just yet – I do get a Leonard vibe from your background.  

You were a VC and noticed that quality firms were being passed on because of TAM limitations. But you saw an opportunity to fund these niche firms over the long term.

Why don't you tell us a little about yourself and what made you start Orbit with Constellation Software?

Marcin: Gustaf, first of all I would like to thank you for giving me the opportunity to share my thesis for software acquisitions in CEE. I think this is the first time I will be publicly sharing my thoughts on the topic - which makes it even more exciting to discuss.

My story is quite simple and all about “connecting the dots”. I got started in tech around 2004, so close to 20 years ago. I was doing my master’s in Finance and Banking, but I was drawn to everything related to software, startups, and the new thing called “The Internet”.

At the time, I was involved with a few different initiatives. I was part of one of the first incubators in Poland focused on tech startups. We had no money really, but we were passionate. We were trying to incubate some of the ideas people brought us. Looking back, these ideas were terrible, and we didn’t really know what we were doing.

After two or so years of experimenting with several projects, I decided to join a local startup. It was, at the time, a very popular social networking site. I quickly transitioned into product management, where I had a chance to work on monetization and growth projects. The company got acquired around 2010, and I started looking for new opportunities.

In 2011 I joined one of the first VC funds in Poland, Innovation Nest, as the 4th team member. The fund was focused on Poland and was fairly generalistic with a tendency towards B2B Software. After the first 2-3 years, we decided to become thesis-driven and concentrate exclusively on B2B SaaS. We have invested in some of the first SaaS companies out of Poland.

Around 2015 we decided to raise a second fund with a mandate to invest across Europe, and off we went with a €42 seed fund to invest in the most ambitious B2B SaaS teams across Europe. I personally made investments across several countries like Portugal, France, Germany, Slovenia, and Hungary. Fast forward to 2022 - the fund has closed its investment period and built a portfolio of more than 30 companies, with more than 50 across the two funds.

Having spent almost 20 years in tech and the last 12 years in VC investing in B2B software companies, I witnessed many ups and downs. Many of these experiences shaped me as an investor and influenced my way of thinking about investing and the software market in general.

The turning point for me came with the pandemic. In the last two years the VC market in Europe has exploded. Competition increased multifold. It used to be that there were investors focused on stages, geographies, or markets. Now it seems everyone is investing everywhere at every stage. Rounds are closing in days at “crazy” valuations and multiples.

Early 2021 I reviewed my performance as a VC, and I asked myself some hard questions. I knew I had built a solid portfolio with some companies already exited with good cash-on-cash returns. What constantly bugged me was that my portfolio didn’t fit the typical VC narrative of hyper-growth. I have invested in great B2B software companies with strong fundamentals but in markets that didn’t allow them to scale exponentially. I was frustrated that even though my companies had solid growth, they could not raise funding to scale.

This built-up frustration led me to the founding thesis of Orbit. I knew that CEE was full of great Vertical Market Software (VMS) companies, with nobody to fund or acquire them. It seemed like an excellent opportunity to start a buyout firm.

The last dot to connect was Constellation Software (CSI). Over the years, my portfolio would receive inbound interest from various CSI operating groups. I didn’t pay that much attention to it until I got approached by a recruiter searching for a portfolio manager for one of the CSI operating groups. This is how I got introduced to Scotty Saklad at Jonas Software. As time passed and I learned more about the CSI operating model, I got more interested in the opportunity to work together with Scott.

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‍Gustaf: I see, and what is your view on the CEE opportunity?

Marcin: I’m focused on my first acquisition as I need to build up a platform that will allow me to extend the portfolio in the future. My goal is to build Orbit into the largest portfolio of vertical market software companies in CEE.

The thesis behind Orbit is quite simple. I identify three groups/cohorts of B2B software companies in CEE:

• ‍Started in the 90s: Legacy on-prem, often bootstrapped. Selling 3rd party software & implementation services. Some with proprietary software, especially in the ERP, Accounting, HR, Manufacturing (MES), and Logistics (WMS/TMS) segment. These are the whales, the largest companies.
• ‍The 2000s: Many still bootstrapped, some VC backed. Mostly selling their proprietary software through the cloud. There are some outlier successes, but most companies are fairly small in revenue and headcount.
• ‍The 2010s: Mostly VC backed, B2B SaaS, engineered for high growth with moderate success. This cohort is the biggest in the number of companies but also the least profitable.

Companies in the first cohort have been acquisition targets for a long time, and there is a long line of potential acquirers. Competition for these targets is high, and it is a price-driven process in most cases.

The second cohort is a mixed bag. The smaller companies in this cohort are too small for traditional PE or strategic buyers. The larger ones are still run by owners who have many years in front of them, and they are not really interested in selling those businesses.

The last cohort is the most interesting. Most of these companies are unprofitable and addicted to external capital to fund operations and growth. Churn rates are extremely high, and cap tables are turning toxic in some cases. Some of the first companies in this cohort are nearing year 10-12, and investors will soon need to liquidate their positions. Valuations at which money was invested into those companies might not support the exit valuations paid by potential acquirers. In some cases, liquidation preferences will become challenging. I anticipate that we have anywhere from 2 to 4 thousand of these companies in the region.

Each of these cohorts will present opportunities for Orbit if we wait long enough. There are some great businesses there. The overall high price expectations are challenging for now, but the tide might be changing fast. We have already seen a decline of 70%-90% in software valuations on the public markets. EV/NTM multiples have compressed to 10x for high-growth and around 4x for low-growth software companies. I expect that soon we will be in a territory where a 3x multiple on net recurring revenue will be considered a great outcome both for founders and investors.

I want Orbit to be the first choice for founders in CEE selling their software companies. I believe that by leveraging my VC experience, B2B Software focus, and CSI’s vast operational knowledge, Orbit has a unique value proposition for CEE-based founders.

I would be lying if I said I believe it will be easy, but I have proven time and again that grit and consistency is the winning formula. I plan to spend many years on this market and hopefully, with a bit of luck, realise the vision for Orbit.

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Gustaf: I look forward to following your journey. What have you found most surprising so far?

Marcin: Transitioning from VC to M&A is hard. Especially if you have been seed investing for more than a decade. The main difference is that the VC crowd is inclusive (co-investments), whereas the M&A market is exclusive - there can only be one acquirer.

I am also surprised by how few founders/owners really understand the M&A market. For many of these entrepreneurs it is a new concept. They are mainly focused on running their business and not thinking about how to sell it. That is why I believe it is a long-term play. You need to build many relationships over years even to come close to a transaction.

Another surprising data point is that most companies I come across are fairly small in revenue and headcount. It seems that software integrators are much bigger than product-first companies. For every UIPath, there are thousands of €1M-€2M VMS businesses in CEE.

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Gustaf: When we met the first time, I got the impression that some competitor acquirers, such as Visma in Poland, have lower hurdle rates than Orbit. Why do you see owner-operators being so interested in your offer?

Marcin: One of the things I learned quickly is that working within the constraints of a strict valuation model doesn’t make you a great fit for many targets. If you accept it as part of the game, you structure your approach entirely differently.

I know that I am not able to pay the highest price. If that is the only driver for the exit process, then it is clear that I am likely to lose that bid. I focus on companies and founders who see value in the overall CSI model.

A forever hold, distributed management, global support, and stability - those would be some of the attributes of my value proposition. Visma has so far acquired two companies in Poland to the best of my knowledge. In one case, I know they were more generous than CSI. This is fine. I know that Orbit will not win all the deals. I focus on the ones where I have an unfair advantage and where price is not the deciding factor.

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Gustaf: Got it, and what kinds of firms are you targeting?

Marcin: We are looking across all the major verticals like Education, Healthcare, Retail, Hospitality, Transportation, Logistics, Real Estate, etc. Our sweet spot is centred around product-based companies (or as we call them Vertical Market Software) with net recurring revenues of at least €1M, a fully functional team operating in a clearly defined niche anywhere in CEE.

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Gustaf: You recently released a presentation on CEE’s education VMS landscape. And soon, you will release one covering healthcare. What are your thoughts on these markets for the coming years?

Marcin: My main high-level view is that these markets will continue to digitise. We will see more niche VMS companies emerge. I strongly believe that the market will be much more fragmented than it is right now. I also believe that maybe we will see less VC money going into local niche B2B Software plays, and other forms of funding will emerge. Finally, I think that as VC funds across CEE reach their investment horizon, we will see many more acquisitions across the board.

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Gustaf: What is the best way for people to follow you?

Marcin: I try to be fairly concentrated in my online presence. You can easily find me on LinkedIn, which is my main online channel. Besides that, I publish a newsletter called Rounds Review where I try to cover investment rounds in CEE. When it comes to offline presence, I will be attending the PE Insights conference in Warsaw this May.