SPEAKER_03: this is a very long game and if you get your first funds right, you get to be in venture for a really long time. If you don't, you won't be able to keep raising capital.
All the pressure is on in those first few funds. The fund size is typically smaller, the investments, the sourcing, the picking, the winning, the adding value is typically done by the core people who thought they were uniquely positioned to start this venture from. Over time, teams grow, fund sizes grow, strategies may evolve, and some of those can be positive, but often those are not possible.
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SPEAKER_01: Hey everybody, welcome back to This Week in Startups. I'm Jason Kalakanis. I run a venture firm in Silicon Valley called Launch. And we have a couple of programs like Founder University and we do this podcast, This Week in Startups. You may have heard the other podcast that's gotten a bit popular all in. And what I do for a living is I record a podcast every day and I invest in 100 companies a year. So right now I'm doing a series here on This Week in Startups called Angel. In this series, we're having LPs, limited partners. Who are limited partners? Limited partners are the investors who put money into venture capital firms. Those limited partners can include family offices. You may have heard that term, a fund of funds where they invest in many venture capital firms in one vehicle. It could be a retirement fund. You may have heard of CalPERS or firefighters, et cetera, having their retirement funds have exposure to venture capital. These LPs could also be endowments, Harvard's endowment, Yale's endowment. So it'd also be sovereign wealth funds. You may have heard of folks from the Gulf or from Japan or China, Singapore, wanting to put money into venture capital. They're all limited partners. What limited partners do is they back venture capitalists who are also known as GPs. So LPs and GPs are the terms of art. LPs, they manage pools of money. They want to get exposure to equities like public companies, real estate, private equity. And most of them now are enamored or very interested in, somewhere between those two, venture capital. Venture capital in a lot of these portfolios are five to upwards of 25% of their diversification. So we thought we'd do a series to try to get inside the mind of LPs. Why is this important? Well, many of you are looking to become LPs in venture funds. So it's great to hear what professionals who do it for a living think about it. And then some of you who listen to this pod are of course, GPs running your own venture firms or thinking about starting your own venture firm. Obviously LPs are going to be your partners in doing so. And then finally startups, you're going to really care about what LPs have to say, because you'll understand how the entire ecosystem works. And if you understand how LPs manage their GPs, these venture capitalists, you'll understand how you and me to manage your relationship with venture capitalists, because it's all part of this wonderful ecosystem
in the United States, primarily, that drives massive innovation. And it's one of the reasons why if you look at the 25 publicly traded companies, the largest ones in the world,
it might be 19 or 20 of them are from the United States, we have really perfected this ecosystem. Today, we've got Alex Edelson, he runs a fund of funds called Slipstream Investors, and he is going to give us a deep dive into why he chose to be a fund to fund managers and what he looks for in venture capitalists to back. Alex, welcome to the program.
Thanks, Jason. Thanks for having me on. So let's talk about it. What is a fund of funds? And why have you chosen this as your profession?
SPEAKER_03: Yeah, so a fund of funds is essentially a portfolio. Ours is a portfolio of early stage venture funds. We invest in pre seed and seed funds, most are 100 million and smaller. We're relatively concentrated. So most of the capital goes into nine to 12 core funds. RLP's then get diversified exposure to early stage venture funds. So it's diversified over time, geography, sectors, companies, and the ceiling is a little lower than investing directly into a venture fund in terms of the ceiling for potential returns. And the floor for potential returns is a little higher than the floor for investing directly into a venture fund. And so, yeah, I got into this because I was at QED and sort of looking around, I started as the chief of staff for Nigel Morris there and I became the COO
and general counsel. And I was looking around and thinking like,
man, there are some great investors here
and they are very compelling founders, can add value in a lot of ways.
I'm not sure why a founder would pick me over anyone on the investment team here. But what I was learning was how to run a venture firm and what a good early stage venture firm looks like. And we spent a lot of time internally talking about that and just being exposed to it, just sort of living it over a period of years was really helpful.
SPEAKER_03: And then we got a lot of founder feedback. So we'd get founder feedback every few years. We had a lot of founders when I was there and hearing from them, what's a great early stage venture firm? How can we be better? It was pretty rich feedback we were getting. So I was getting this unique view into like, what's a great early stage venture firm? And then what I was seeing when I was there was like,
we're working with these emerging managers in a variety of ways. We're sourcing deals from them, we're bringing them into deals, we're partnering with them on events
and just all these other ways. Well, what happens?
I'm seeing great funds, we all agreed, like very high quality funds. And our beliefs about their quality did not necessarily correspond to their ability to fundraise. So we may think they're great, that doesn't mean they're great at fundraising. And so there was just like a ton of opportunity to invest in these funds and to co-invest in their breakout companies because they're small funds, they're not going to continue investing forever.
And as I built relationships with them,
what became interesting to me was like, they viewed me as helpful. They viewed me as someone who was helping build and run QED and maybe could help them build and run their venture firms and to help professionalize their firms.
SPEAKER_01: Why do LPs then use a fund to funds? Because they pay for this privilege, they pay I think one in 10%, so they pay a 1% management fee, which means if you had $100 million fund, you'd have a million dollars in advance against the returns on you get 10% carry. So if the 100 million turns into 400 million, the team would get 10% of the $300 million gain, $30 million over 10 years. Pretty good living if you can get to it, could result in if there were a couple of partners making a million dollars a year each.
And so why do they choose to pay those fees
as opposed to just picking funds directly? I mean, I know the answer, but I'm asking you to give me your perspective and what you hear from those LPs that then give you money to put into venture firms.
SPEAKER_03: Yeah, it's a great question. So there are different types of folks looking to get exposure to venture. I think the answer is different for all of them. So like a big part of our LP base
is folks who don't have any exposure to venture. They're not gonna spend the time trying to get it. Like they may have another career like that they're focused on, like they're a doctor or a lawyer or in real estate or something else. And they would love exposure to venture, but they don't know how to find or evaluate venture funds. And they may have heard of top tier brands, but those are hard to get into. And the minimum check sizes are very large. And so for them, a fund of funds makes a lot of sense.
Now there are others who know, I'll speak to Slipstream in particular.
There are others who know that the small emerging managers are a big part of the best performing funds in any given vintage.
SPEAKER_01: Why? Why are those early stage funds over perform? I mean, the statistics show this, the seed, pre-seed funds tend to do better on a multiple of cash, but they're smaller. So what do you think is the reason for that?
SPEAKER_03: Yeah, it's a great question. And let's be clear.
These are some of the best funds and they're also some of the worst funds. So I don't want to oversell this. It's hard to do well in venture by picking the right venture funds, especially by picking the right emerging managers. But if you pick the right ones, they are usually in the best, in the highest, they're among the best performing funds in the asset class. Why do I think that is? I think there are a few reasons. Some of them are like qualitative, subjective. Some of them are based on portfolio construction and fund size. So let's start with the latter first. Like high ownership relative to small fund size. I mean, ownership relative to funds as a general matter, I think is a great predictor of the return potential of a fund. So if you're getting high ownership relative to your fund size.
SPEAKER_01: And high ownership, you would say is what in a startup? You get to 10% ownership, 8% ownership, 15% ownership. What would be high?
SPEAKER_03: Yeah, so it's relative in my view. So like if you're a $10 million fund getting 3% ownership, that's incredible. That's like a $100 million fund getting 30% ownership, which you typically don't see in the US unless there's like serious risk of adverse selection. I think about in terms of fund size. So if you're a $50 million fund getting like 7% to 10% ownership, I think that's great.
If you're a $30 million fund getting, you know, 5% to 7%, I think that's great. If you're a $5 million fund getting 1% or 2% of ownership, I think that's great. And even lower is totally fine and can generate excellent returns. A $10 million fund getting 1% can do really well.
SPEAKER_01: Don't I know?
SPEAKER_03: Yeah, so the math answer, the portfolio construction answer is that if you get a winner, when you have high ownership relative to your fund size, the returns can be unbelievable,
SPEAKER_03: like well into the double digits, right? And we all know some anecdotes there and we've all seen some and maybe even fortunate to be able to use them or worked at funds like that.
SPEAKER_03: But there's also a qualitative factor to this.
It's like you're in your first two funds, first three funds, like you're betting your career on this. Like you're all in. Often some of these folks have made it, so maybe you would argue they haven't bet their entire career maybe they're a successful operator with an exit and if this doesn't work out as a venture capitalist, like they'll be okay. But as a general matter, like this is a very long game and if you get your first funds right, you get to be in venture for a really long time. And if you don't,
SPEAKER_03: you won't be able to keep raising capital. And so all the pressure's on in those first few funds. The fund size is typically smaller, the investments, the sourcing, the picking, the winning, the adding value is typically done by the core people who thought they were uniquely positioned to start this venture from. Over time, teams grow, fund sizes grow, strategies may evolve. And some of those can be positive, but often those are not possible for fund level returns.
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On a qualitative basis, you've got people who are hungry, putting their reputations on the line, they have pride, they're proven winners. So when you pick an emerging fund manager, yeah, those exist in the world who are emerging, means they're on their first three funds or so after their fourth or fifth fund, maybe they're more established and most funds never get to their third or fourth fund.
SPEAKER_03: Yeah, that's right. And yeah, it's interesting, right? I mean, there's obviously a survivorship question there due to performance in both directions.
SPEAKER_03: So like, let's say a fund doesn't do well, it's not looking promising, harder to raise capital. Let's say a fund does really well. Those people might say, hey, I don't know that I need to keep doing this ventures hard, like we've done well for ourselves. It's too much work. I'll retire.
SPEAKER_03: Yeah. Or we see people saying like, let's just use our own money.
That happened with homebrew, right?
SPEAKER_01: Homebrew was like, we're gonna just use our own money and we'll be super selective. We've made some money. We'll just we'll take 100% carry because it's our money. And so your point here is those people are hungry as time goes on, maybe they're less hungry. So that's one of their qualitative reasons why seed might over perform. But it is a lot of work. And so that has been my experience. And so, and the anecdote you're referring to a lot of the people who are the Uber first investors, when I was a scout that fund, I put 650 to work and I think it, the DPI was 120 million or something,
depending on when you sell your Uber shares. And Chris Sacca was in that as well,
the first round of Uber and his fund was famous for being, you know, also 100x fund or something crazy like that, right? 200x fund.
So I think Ron Conway had, I think, a little tiny piece of Google in that first one of his first 10 or $20 million funds, and that one did extraordinarily well too. And I was in one of the funds that was in WhatsApp, and that was a 20x fund. So it's very rare to get 20 times your money back,
cash on cash, after 10 years.
The averages, I mean, we could explain to people what the averages are for seed funds, you know, cash on cash, versus say, the stock market or IRR or both, however you want to sort of phrase it.
SPEAKER_03: Yeah, well, one thing you said though, reminds me of a point that I should have made before, which is talking about the emphasis on small funds, and I didn't completely answer your question about why folks invest in fund to funds, so I can circle back to that too. But one thing that's really compelling about
the emerging managers in the small funds, you're naming iconic winners, companies that have reached valuations that are astounding. No one you probably assumed was possible at the time.
SPEAKER_02:
SPEAKER_03: And so, you can get low ownership in those,
relative to your fund size, and still have a great fund. I mean, those exits are so unbelievable.
SPEAKER_03: But one reason why small funds and high ownership
relative to fund size is really compelling,
is that if you get more modest outcomes, which is much more likely than getting the next Google,
you can still generate great fund level returns if you have high ownership relative to your fund size. And we can sort of go through an exercise, like, hey, you had 10% ownership, not diluted much, you're a $50 million fund, what's a fund returning outcome, right? And it's much more modest than some of the outcomes you're talking about.
SPEAKER_01: 10% of a $5 billion company, if a company became worth 5 billion, and you owned 10% of it, that'd be a $500 million return on a $50 million fund, you'd be a 10xer. And you just have to go, look, how many times does a company become worth $5 billion, and you can maintain your ownership? Or even if it was half that, like 250 million on a $50 million fund would be a 5x. So the math kind of cancels out, yeah.
SPEAKER_03:
And so what I think about when I'm investing is not like what's gonna happen to this fund if they get a $5 billion exit, because if they get a $5 billion exit, they're good. Yeah. How good? Well, sure, that's what the math is for. But like, I want much more modest outcomes to generate meaningful fund level returns. So yeah, if we're getting like 250 to $500 million outcomes, which are much more likely than a $5 billion outcome, I want that to be meaningful to the fund. That actually raises, in my view, the floor on the likely fund level performance. And so there's a lot of, it's risky in many ways to invest in small funds with limited track records. On the other hand, the math is like very much in your favor if you happen to be right.
SPEAKER_03: And circling back to the question about why folks invest in fund to funds,
the one answer is certainly true for Slipstream in particular, where it's folks who just don't have exposure to the venture asset class and they feel like this is a great way to get it. They wouldn't get it if it weren't through a vehicle like a fund to funds. But the second answer is folks who know these are the best performing funds, they may know these are also some of the worst performing funds, but there are so many,
they are very hard for some folks to evaluate.
And for some of them, it may be difficult for them to get an allocation. Like some of these are oversubscribed, some of them are oversubscribed quickly. It's a lot of work, just like it's a lot of work as a seed fund manager
SPEAKER_01: to manage 50, 100, 200, 300, I have 400 portfolio companies now. Now some of the in total over just over a decade. Now some of those are gone right now or Uber's Uber and I maintain a relationship with Dara, but I'm not involved like I was as a seed investor, obviously. But your job is very hard. You're gonna put nine to 12 fund managers into your fund to funds, I understand. Your fund to funds is 50, 100 million, 200 million ballpark.
SPEAKER_03:
Well, yeah, I'd rather not talk about my fund size on here. But okay, my current fund size is like a little under 15. So it's pretty small.
And I wanna stay very small, like my next fund is not gonna be that much bigger because for a variety of reasons.
SPEAKER_01: But you might be 10% of a fund that you're going into five or 10% of a 10 million or $20 million fund.
SPEAKER_03: Yeah, you know, it's funny, I actually don't worry about the percentage of a fund that I am. I think for funds where I'm a small percentage, I actually find that I'm as close or closer to the GPs just because I think I'm working with them in ways other LPs aren't because of my experience with QED and I think I probably behave a little more like a GP and that I'm very open and I'm constructively challenging folks and I'm responding to everything they send out. And so I end up being close, I think as close as maybe a much larger investor. And I also have, yeah, no concerns about being a very large investor. Like if there were someone who I was really high conviction, I'd be their only LP.
SPEAKER_03: I don't really worry about the percentage of a fund.
SPEAKER_01:
And by the nature of investing in a dozen venture firms, you hope to, you're going to hit some sort of an average because like a mutual fund, you want to pick the best vehicles, but you could have some underperformers, you could have some overperformers. So therefore you're giving your LPs who are in your fund to funds, a bit of an average, hopefully a higher end average. So maybe you could explain your strategy there and what their expectations are, or is there expectation, hey, if you just hit the average, average is pretty darn good for seed.
You know, I'm sure.
SPEAKER_03: Here's how I think about it. When I'm investing in a seed fund,
SPEAKER_03: I want to see a path that seems plausible to like a four to six X net of their fees.
SPEAKER_03: That is very high performance based on historical benchmarks,
SPEAKER_03: and they won't all get there. And hopefully some will outperform it. That is where I hope they get.
SPEAKER_03:
For pre-seed funds, I'm hoping that, yeah, it's more like I want to understand and believe in a plausible path to a seven to 10 X net fund. Is it a failure if it's not a four X seed fund or a seven X pre-seed fund? No, no, it is not.
Because at bottom, my thinking on, you know,
what success in ventures like, if you're over a three X net, I don't think anyone should be complaining about that. No, I mean, if you were to, I mean, they typically say it takes, you know,
SPEAKER_01:
whatever, 10 years to double your money in the public markets historically. So if you are three X in the same period of time, you beat the market with, which has liquidity, of course, by 50%. If you hit four X, you know, you're probably doubling it. And so just back of the envelope, people who are allocating capital, and I do myself, I'm in 24 venture firm, my four and 20 other ones, I look at it like,
you know, I got money in the stock market too. If this beats my stock portfolio and the money's locked up for 10 years, 12 years, I'm kind of like that as a feature. I know it sounds crazy, but it's kind of nice to put, you know, I'll typically put 25K to 250K as an LP, individual LP in these emerging fund managers. And sometimes the highest I think I've gone is 500K with more established folks. So it's probably on average, 100K in each of these. I have a couple of million in venture, just as a small, you know, investment for myself, but also it helps me build my network. And it helps me support other managers. And, you know, I'm looking for a return. But if I triple quadruple on average, great. Once in a while, you'll hit a 20 X or man that lifts everybody's average, because I'm in 20 funds. Now, every fund has become, got one more turn, right?
One more X on top of it. So if my average was three X across nine funds and somebody hits 20, well, there you go.
Now everybody's a four X fund. So the math does pencil out for me with my access, I think, to funds.
SPEAKER_03:
Yeah, and I think that's right. And so, you know, some people would say, hey, why not invest in like 30 funds, right? Why not invest in 50 funds?
More likelihood of hitting some of the sort of generational companies of any given vintage. Why not just be lower concentration? Yeah, why not? And the answer in my view is like, it's much harder to outperform. And I don't know why I exist if I'm not aiming to outperform. And so I want each investment to be a big enough part of our portfolio so that if we're right, if we're investing in top decile funds, top quartile funds, like this should be a great performer.
SPEAKER_02: And yeah, that's how I think about concentration.
SPEAKER_03: But we will have, hopefully, fingers crossed, some that outperform my underwriting and some that underperform our underwriting. That's just likely to happen.
SPEAKER_03: So I have to be very careful with returns and with how hard it is to generate DPI, because a lot of this stuff just looks like unrealized gains for a long time. And you know, what actually comes back, if it comes back as like a DPI of like 3X plus, like I think any LP in a venture fund
should be happy with that.
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How much of your strategy is based off of watching the portfolios emerge? So let's say you're in 10 funds and they have 30 names in each on average. You got 300 names. There might be some duplication there. So let's cut it back another 20%. So call it 250 names maybe. Is that what you expect to see across those 10 funds or so? 200 names, 250 names?
SPEAKER_03: I actually expect to be a little higher than that because there are a handful of funds that are lower concentration. And I also...
SPEAKER_03: So maybe 400 names, 500 names?
SPEAKER_03: Yeah, I think it's more like 400 to 600 funds. And I think we're tracking towards that in the current fund.
SPEAKER_01: So let's say 500 is the number. You're able to determine what the winners are and you're able to determine five of those. How do you do that? How do you mechanically do that?
SPEAKER_03:
Well, I would turn the tables on you. You mean which winners there are of the 500 companies? Which would be the average? Yeah, I mean, you can turn them.
SPEAKER_01: Feel free. I know you had some questions for me. No, I mean, it's a great question.
SPEAKER_03: And I think part of it is a definition question. So how do you define a winner?
SPEAKER_03: When you're getting really high ownership relative to your fund size, a $500 million outcome could be a winner even though in many funds that's not a big enough outcome because they don't have enough ownership or because they don't have enough, they need a bigger wins relative because of their ownership relative to the funds. Let's just say winners in general,
SPEAKER_01:
these are companies that are gonna break, are breaking out. I'll just use the term breaking out. They're starting to break out
SPEAKER_01: because you wanna co-invest in some of these companies. So you're reserving some amount of the fund for co-investments and then you pop up SPV, special purpose vehicle. So if I was one of your 10 funds and I hit an Uber, but I'm not doing the series B at three or $400 million valuation, you might wanna go to your 10 family offices or 20 LPs, whatever number of LPs you have in your fund to funds and say, hey, we can get an allocation in this taxi company or this stock trading app Robinhood, or we should try to get an allocation in this because we see we have inside information it's breaking out. How much do you expect of your returns to come from co-investments based upon those?
SPEAKER_03: Well, yeah, I mean, your original question, which was the right question, which was a really interesting question. I love having this conversation. I wanted to ask you, I wanted to know on you,
SPEAKER_03: how long does it take you to know whether you have a winner?
And I think I have a decent sense
from talking to a lot of fund managers and sort of living through this at QED
SPEAKER_03: for how long it takes many people
SPEAKER_03: to realize they have a real company,
but a company that generates DPI.
I mean, that it could be a long time, you may never know until you get it, but what's your experience?
SPEAKER_01:
Yeah, four to seven years, they emerge in that number of time, you knew Uber was a winner in year two or three,
just based on I knew it based on the addiction level that I saw amongst users, and the rapid interest from top tier firms in getting intros to that founder to get an allocation.
SPEAKER_01: So we saw two things there. One was user adoption, and just how maniacal users were about the product. You know, when it came to LA, you know, people were like, I'll never work in LA. And then, you know, you talk to 10 executives who use it, they're like, there's a game changer. So, you know, and the press never understood the company. So you just ignore the press and embrace the users. And then when I've got people emailing me saying, hey, can you interest me to Vlad from Robin Hood?
Or hey, my wife, my daughter, my cousin, my son is using calm, and they love it. Can you introduce me to Alex and Michael from calm? You know, like, you start getting those kind of inbounds from really top tier investors, or they want to talk to you about it. I just want to talk to you about it. So I know why you want to talk to me about it. You want to place a bet. So, you know, those usually happen
in the first couple years, year 345. And then, you know, the revenue ramp
and the quality of the revenue, I think are the things that determine a DPI
and the real breakout. So there have been major questions about the quality of the revenue at Uber, quality of the revenue at Robin Hood. And so we had to really look at that and say,
this is actually a high margin business or not. And then I just did a back of the envelope at some point, where I was like, well, they did 100 million rides, and they're losing a dollar a ride. So, you know, whatever, they were losing 50 cents a ride, losing $50 million this month. Whoa, it's crazy. But then I was like, wait a second, the average ride is, you know, whatever $19. Would anybody not take an Uber if it was 21?
And I was like, no, maybe you lose the bottom 5%.
If you lost the bottom 5%, you're making a dollar ride. Now this thing's throwing off 500 million a year.
That's easy to do. So I mean, in the press, of course, was going crazy. This can never be profitable. They're burning money. It's like, you could just flip the switch, though.
It's kind of like Amazon story, right? I think that's where I come to is you have the user love. You have, you know, inbound interest from other investors or acquirers, you know, at one point, I had a very high profile, you know, one of the top three technology companies in the world reached out to me to talk about one of the portfolio companies.
And they were like, hey, can I talk to you confidentially about this company? And I was like, sure. I talked to them and said, oh, they want to buy this company.
They want to know, you know, what the founders like, they, you know, oh, okay, I get it. You know, this is like a Google Amazon level company
having interest in one of your profiles. That's another signal that this could work out. So I have now come to, I've been working on this a lot because we have a doubling down strategy. And I guess this speaks to concentration of portfolios. And we can talk about that in a second. But what do you think are the early signs of when you know you have a winner? And how did mine match up to yours?
SPEAKER_03:
No, I mean, I think like I listened to yours. My job is to sort of listen to the GPs and listen to their experience. So I want to hear from like thousands of venture investors about, you know.
What have you heard from other GPs? Yeah, I mean, well, in terms of time, it's funny. I almost never hear experienced investors say that they know in less than two years.
They almost never hear it. But I often hear emerging managers say, oh, I'm just going to follow on into my best few companies. We're going to get an enormous percentage of the fund into those best few.
And my question is like, well, how early are you going to get those dollars in?
Because often companies are raising their next round. Certainly the market is slower right now in terms of price day round after a price seed round. But that's taking longer now than it has in recent.
But it used to be like a year later,
SPEAKER_01: six months later, they're raising the next round. Right, so it's like in a year.
SPEAKER_01:
Yeah, not much.
SPEAKER_03: Well, like maybe you have seen growth. Maybe you have seen a lot of things and you are very high conviction on this company. But you might not have even made all of the initial investments that you're going to make out of that fund. So it gets hard to know at that point, like at the time a company's raising its next round, which are the best few in your fund. So I certainly see funds where like they got the follow-ons all right. And it's amazing. And like major kudos to those investors. And some people have done it over many years or many vintages and like they actually do seem to know earlier than most folks. But most folks, it seems like it's at least two years. And so, yeah, like I'm thinking about that and I'm looking for signal from the GPs that we've invested with. I'm looking for signal from other investors coming into those companies. Like I'm typically not in the next round after the initial investment from a fund that we've made,
SPEAKER_03: we've invested in. Maybe it would be like the B round and we have exposure to the pre-seed or seed round. And now we've seen them raise an A round from a great investor at the A round. And then we've seen maybe someone come in to lead a B and we're all pretty high conviction at this point.
SPEAKER_01: Yeah. And what percentage of your reserves do you think will be for co-invest like that? Or are they all just SPVs and you'll just put them as icing on the cake? Yeah.
SPEAKER_03:
Yeah, yeah. So I can, in the current vehicle, we can use up to 20% of the capital of the funds co-invest. Perfect. That seems smart. And we'll be recycling and over-committing. And so we have room for that
SPEAKER_03:
even after we're sort of fully allocated is the plan.
SPEAKER_01: Yeah. It's so interesting we're having this conversation right now because I have a large team because we have massive amounts of inbound.
So our deal flow because of the two podcasts,
I mean, my deal flow was absurd before All In and then it went absurd again. So it's like absurd on top of absurd. Now we have 20,000 people applying for funding. If you're one of those founders, you can just go to launch.co.apply, launch.co.apply. You can just fill out that form and meet with our team as long as it's like an actual adventure style business, not like a pizzeria or a movie or a CD you're doing your next album. We don't invest in those kinds of things.
But we, in training folks, I literally have to,
I forced myself to write these things down. And I've written down now two instances because in our current fund structure,
half the fund is going into the primary investments, the first bet through our programs, et cetera, if I'm a university, et cetera. The second half of the fund is going on to follow on. I'm pursuing like a Brian Singerman, who I had on the podcast recently, hey, we're gonna put the half the fund into the top five names, let's say 10 names, 15 names. We'll see what the market tells us, right? If we hit a unicorn every 25 and we have 200 names in this fund, well, we've got to divide that second half of the fund by eight. If we have three unicorns, we're gonna divide it by three, but we also have to be able to pick them, right? And that's a good point to your point. And so we've come up with likely winners,
definitive winners. And so I now have a criteria of what's a likely winner
and have a criteria of a definitive winner. Now that doesn't mean it's definitively DPI.
It doesn't mean that the money has come in and it's gone public. It just means at that early stage, we can then say, okay, it's a likely winner. We should put an X amount. We should put another 100K and we should get another one, 2% ownership. This is a definitive winner. Okay, we want to get more like three to 5% of additional ownership and get us past the 10% hurdle of ownership. So yeah, I've really thought about that.
SPEAKER_03:
Yeah, I love it. And one thing I think about is the information that folks should track over time that might be actionable down the road. And so like one thing I encourage people to do who are investing is, hey, like track your level of conviction. Could this be a fund returner? Not likely to be a fund returner. Like, no, this is a zero. Track that on a quarterly or every six month basis or more often if you'd like. And track like how these companies are trending. Like, are they trending positively? Are they trending neutrally? Are they trending negatively? Like if you have time and interest, like maybe force rank these. And then like we can talk in two or three years and we can say like, hey, how likely is it? Or maybe further down the road.
Does it ever happen that you get to a point where a company is trending negative and it ends up being a fund returner? Or how often is it the case that like-
SPEAKER_01: Very rare, yeah. Well, yeah. It does happen.
SPEAKER_01: Like a save, you're talking about like a crazy save.
SPEAKER_03:
Right, or like how long did a company go without in your mind having the potential to be a fund returner? And then it actually could still become a fund returner. Like use that information. So now it's like, you have this information. You can look back historically and see like, well, historically nothing has ever emerged from a likely 0X or likely three to 6X return to being a fund return. It's never happened in our history. It's happened three times out of 100. It's very unlikely. If only I had that from 10 years ago
SPEAKER_01:
when I was doing this all in my mind. This is why I'm writing deal memos. And so what I do is I capture all of this now. We have two investment team meetings a week. I now record them. So I had to tell the team like, hey, never talk,
SPEAKER_01: you know, in a spicy way on the investment team call, but we're recording every call, we're transcribing it, we have it, and then we can go search it.
So, you know, in three years, we can go back to the original decision for making the investment in Uber, calm, grin,
you know, Robin Hood or whatever. And we could actually look at that. And then we can look at, oh, we had an opportunity to buy more shares in the company. Oh, we didn't have them as a likely winner.
We didn't have them as a definitive winner. And that's where like, forcing your team to define things, you know, in a very specific way is super powerful. So I can say to the team when they're having this discussion is 14 people on a phone call.
Okay, is it a likely winner or definitive winner?
And then make your case, you want to put more money into this? Is it a likely winner? Here's the criteria for a likely winner? Or is it a definitive winner? Here's the criteria for that make your best case and write it down.
And that's why I try to like, we do what's called
SPEAKER_01: the mini deal memo. So if people want to fight for an investment, I should put a mini deal memo in slack,
and give us the criteria of why we shouldn't invest why we shouldn't invest. And then I asked other people who maybe have domain expertise
who I think value the opinion, okay, do you agree or not?
What would you do?
Some people might say Stan Pat. Stan Pat is one of our internal terms. Like we're not going to add to our position. It's a poker term means like check basically Stan Pat. Stan Pat, we're not adding to our position, but we're not selling our position.
SPEAKER_01: And let's have a thoughtful discussion about that. And man, has that changed everything in our firm over the last couple of years that people are using a framework for debate?
SPEAKER_03: Yeah, I mean, I think it's really thoughtful. And it also like dovetails with another thing
that's on my mind when I'm thinking about managers, like are you thinking about every round that a company raises as like a buy or sell opportunity?
And if it's a sell, like what are you doing about it? Doesn't mean you need to sell. It's not always possible. And if it's buy, it doesn't mean you're in a position to buy.
SPEAKER_03: But I think it's helpful to think about it. It sounds like, you know, your analysis is similar to that.
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The sell side is super important. Do you talk to fund managers about when, about their strategy for clearing positions
and returning capital to LPs? Do you do that when you're selecting them? And then what would you like to hear?
SPEAKER_03:
Yeah, I mean, it's really important to me. So like, I think about,
and we can talk about sort of what I look for when I invest, but at a high level, I think about like venture, like, you know, there's like a five tool baseball player, I was like a six tool venture capitalist. And in my view, like everyone talks about like sourcing,
SPEAKER_03: picking, winning, some people talk about adding value. I would add two more to that that are really important when like we're making an investment in a substream. And that is like getting your portfolio construction right
and getting liquidity from these investments.
And yeah, what I want to hear from folks is that they are thinking about it. They are thinking about it every time a company raises capital about whether they're buyers or sellers, they are not necessarily acting on it.
I want to get a sense for whether they're sort of in the ride or die camp, like no, we'll never sell early. We're just right until the end, which I think can be great, but has some drawbacks. There's risks associated with that. And I'd say like, if there's one regret when it comes to getting liquidity that I hear the most and that
I've seen the most frequently. Yeah, it's well, yeah, it's I waited too long. Like I regret taking the, oh, it was a unicorn. I could have sold a little into that round. I didn't now the company didn't work out or it went public, but it was locked up. And after the lockup by the time, you know, the lockup ended, I wasn't comfortable selling. It's very different for seed stage investors
SPEAKER_01: versus series A and series B investors when you sell.
Because if you're a series B investor, you're almost always overpaying. And if you're investing 25 million for 5% at 500 million,
okay, like you're not gonna sell that position at a billion or 2 billion.
And very few companies get to a billion or 2 billion. So you have to wait till it hits five 10 X, right? If you've got some basic portfolio construction.
If you're invested in 5 million, we invested at Comm as an example of 5 million.
We had the opportunity to sell 10% of our position at 250.
It was like a 40 some odd X, you know, 50 X. I took that opportunity to sell 10% of our position.
SPEAKER_01: We had an opportunity to sell another 10% of our position, I think we sold $11 million of our position, $12 million in our position when it hit a billion change. And I took that opportunity. So we sold 24% of our position going up that had nothing to do with our belief in the business or the founders.
It just had to do with the fact that, well, 50 X,
how often do you get a 50 X and you have the ability to sell some of it and lock in a 50 X, and then do it again at, you know,
man, 200 X.
The great irony of that is it was that we had some money in SPV when we told the LPs that we had sold,
person was like, oh my God, you got me a 50 X. It's never happened to me in an SPV. And I was like, yeah, we still have 90% of our position. They were like, you have 90%?
I don't know what you mean.
I'm like, we only sold 10% of our position. They're like, okay, so we sold our position, we own 10%.
And so we got a 50 X. I was like, no, we owned 6% of the company.
We now own 5.2% of the company. We sold about 10% of our position. We were diluted.
You still have 90%. The person could not understand that we had not sold our entire position. Oh my God, J. Cal, I love you.
But wait, there's more money? We still have 90% of our shares? Yes, we still have 80% of our shares. Now we've been diluted a little bit, but that's par for the course. And you know, I did the same with Uber, you know, and I haven't talked too much publicly about it, but I was able to sell some back to the company, you know, in like 30 some odd dollars a share years before it went public.
Now, that seems like a stupid trade when the stock's at 70 now, but you got to remember that was eight years ago.
I put that money to work. That money has done more than Uber has in that time.
So, you know, there's two sides to this coin.
SPEAKER_01: I think Peter Thiel was, you know, very famous saying that he missed the best investment of his life, which was the round I think Jerry Milner did the year before Facebook went public because in nine months people doubled their money. So like 100% IRR on an IRR basis, that was extraordinary. But in terms of like other opportunities, Peter Thiel has to put money to work or founders fund does, maybe selling and not having that opportunity, but putting that money into their next fund would have been a better return, right?
SPEAKER_03: Yeah, I mean, look, I think it sounds like you've done a really thoughtful job getting liquidity and there are no rules. Like my conclusion about getting liquidity is like there are no rules. The rules are if you ask me, if there are rules, they are as follows. Think about every round as a buyer's office. Like hopefully you have enough information to make an informed decision, track your decision even if you don't take any action in buying or selling,
because it will be interesting to see and we might have learnings from that.
And if you have an opportunity to like return your fund or better by taking off 20 or 30% at most,
I would hope folks are like seriously thinking about doing that, but it's case by case. And the last thing is I hope people are just being reasonable about what a company could be worth
SPEAKER_03: at a later exit if they're not gonna take it now. Like I've heard people say, oh, no, no, no,
like this $2 billion company is growing so fast. This could be a $100 billion company. And I wanna say like so few companies are $100 billion. Like $2 billion is an objectively successful outcome
SPEAKER_03: for you. If you're just like doing the whole thing right now, your fund gets multiples. Is it top decile performer?
SPEAKER_03: Let's be careful about like talking about $100 billion exits here. I'm not saying this won't happen, but let's be careful.
SPEAKER_01: When you bring up the Uber example, there was a famous accelerator. Uber didn't go to an accelerator, but they had invested a little bit. And I think they sold their entire position at 4 billion,
which returned to multiple of their fund, like you're saying. And I think Travis had told them, don't sell, don't sell, don't sell. And the secret was the angel investors, the people in the four and a half million dollar round for Uber, myself, Sock, a couple of other people first round, they didn't have the restrictions on selling their shares. The series A people and further had restrictions. They couldn't sell. And you had to jump through a bunch of hoops. The company had the ability to buy the shares back, all that kind of stuff.
And then the 9 billion, I think eight or $9 billion round was announced within months of that person clearing their entire $4 billion position. So LPs were like, what? You didn't know? And then Travis told you not to sell and then we would have gotten two X and whatever number of months. So I've come to the conclusion that pairing 10%,
two or three times for seed funds is the right strategy on the way up. Because if you were an LP,
Alex and I said to you, listen, I know we were in Facebook. I sold 10% at 5 billion. I sold 10% at 10 billion. Yeah, I know the company's worth 50 billion in IPO.
But we locked those in and hopefully you appreciate us locking in those returns and hitting, returning the fund with that first 10%, making it a three X fund with the second or two X fund with the second 10% and hey, we still have 80%.
Would you be mad at that? Would you be furious? Or would you think thoughtful person?
SPEAKER_03: No, I would think thoughtful person. And I think liquidity, I think DPI is really hard to get in venture. Yes. And getting meaningful DPI, getting multiples of your fund means so much to your LP base. It means so much for your ability to raise future funds, both from them and from others who are looking, especially these days for fund managers who know how to generate liquidity.
SPEAKER_01: So tell me a little bit about how you pick managers. We've talked before,
if you're going into this emerging sector, these are typically unique individuals in the world
who want to start their own fund as opposed to go work at one or start companies, be an associate somewhere, be a partner somewhere and kind of go up through the ranks.
So how do you pick emerging fund managers? So they tend to be iconoclastic, yeah?
SPEAKER_03: Yeah, so it's a great question. I kind of have a handful of threshold issues, but then there's a bunch more. So I guess we'll see how deep we're gonna go here.
SPEAKER_03: But yeah, my threshold issues are portfolio construction
that can generate fund level returns.
So high enough ownership relative to fund size so that if we get even modest winners, that's a good fund.
And if we get some of the big winners that we've sort of talked about throughout this conversation, that's an amazing fund.
SPEAKER_01: So fund construction,
SPEAKER_01: so high ownership relative to fund size.
SPEAKER_01: Yeah, so high ownership relative to fund size. I have a $10 million first fund.
SPEAKER_01: I'm getting 1% ownership. I'm putting 100K checks 100 times into 100 names on average. I get 1% ownership that gets me down to 50 bps after dilution at the exit, 50 bps.
In a 1% of a $10 billion company is 100 million, half a percentage point is 50 million. My 10X fund with a $10 million becomes a 5X fund.
Congratulations.
SPEAKER_03: I even think about a little higher ownership, but when the fund is that small, even a little change in ownership actually makes a big difference. So if you're a $10 million fund getting 2% ownership, that's amazing. That's equivalent to a $100 million fund getting 20% ownership, but you have a much broader opportunity set
because if you wanna try to get 15 to 20% ownership, those are very competitive. You risk adverse selection. There are only so many opportunities, but if you're writing small checks trying to get 2% of a company, there are a lot more rounds that you'll be able to invest in.
SPEAKER_03: And so, yeah, if you're getting like 2 to 3% ownership on a $10 million fund, I think that's excellent. If you're getting 1% ownership on a $10 million fund, I think that's solid. I wouldn't be looking for much less than that on a $10 million fund, but it starts feeling a little ridiculous because, oh, what if they get 0.75% of the next great company? Are you gonna wish they hadn't done that? Like, no, you're gonna wish they did that. And so- Of course, yeah. So you kinda just, you have to have sort of a sense for- This is where accelerators come in.
SPEAKER_01:
It's one of the reasons I was attracted to putting in so much work to our accelerator and pre-accelerator.
We can do 100 or 200 names at 125K for 7%. You get water down to 3.5%, but to run an accelerator is the hardest work I've ever done.
I think we do 14 weeks with the companies, and man, they squeeze every ounce of value out of our team, as they should.
Every introduction, every lunch, every phone call, every strategy session. There's two reasons why more people don't do accelerators. One is the amount of work it is, and two, you need to have, if you're just doing, we do seven people per cohort,
you need to have 700 people apply. You can't run an accelerator with 100 applications and accept 7% and expect a good outcome. You gotta be accepting 1%, which I think, yeah.
Very tense that they accept one and a half now or something. We accept like 0.5 to one and a half, depending on the class, yeah. Is it historically?
SPEAKER_03:
Yeah, you have to get in very low, you're getting in very low entry valuations. So you get great ownership with small checks, and that's great. The second thing I'm looking for is some competitive advantage unique to the team that is sustainable. So it's something,
it's some reason you think they will win across multiple funds, it's typically not gonna change. Like in QED. Give us an example.
SPEAKER_01: Yeah, like QED,
SPEAKER_03: and it usually relates to sourcing, picking, winning. QED is what you're talking about,
SPEAKER_01: the fintech venture firm. Yes, that's where I worked prior to starting Slipstream.
SPEAKER_03: And I think about, I mean, I'll put this in context of QED, but I'll start by giving a little more context. So usually this would relate to sourcing, picking, winning, adding value, ideally all of those things. It could be some domain expertise, like deep domain expertise. It could be operating experience at a successful venture backed company.
It could be some track record of working with founders and showing that you can win competitive rounds with certain types of founders because of certain reasons that they're picking you. And so, or something unique about your picking
and your sourcing. Well, like QED is an example, because QED was founded in 2008. In 2008, I mean, fintech wasn't really, it wasn't a word, it wasn't a category. People thought the category is not, like financial services is not big enough to support a sector focused fund.
And so there were no fintech investors. There are many today. So just being in fintech is not a sustainable competitive advantage, but no one else had started a company like Capital One. And that was really relevant to fintech founders who were at the time like founders starting companies in financial services. And if you were one of those founders, how could you not want to talk to the folks who founded Capital One? They're one of one. They're so invaluable. And it impacts their ability to source. Of course, all these founders want to meet them. It impacts their ability to pick. They have very unique perspective. They know all the industry players. They know what it takes to build these companies. They know what it sells to, what it takes to sell to customers in financial services. They know operationally what it takes to build a high growth company to go through an IPO. They're very unique.
SPEAKER_03: So it's some amount of pedigree expertise
SPEAKER_01: and a sustainable one is critical. Yeah, it impacts their winning.
SPEAKER_03: It impacts their ability to add value. And the advantage that QED hadn't fund one is still true today in fund eight. There is still no one doing fintech, early stage fintech investing who started something like Capital One. Now there have been sort of digital entrants and other folks, but QED is really uniquely positioned and they will always be, I think.
SPEAKER_01: Fantastic. Okay.
SPEAKER_03: So we got portfolio, construction,
SPEAKER_03: sustainable brand advantage of some type.
SPEAKER_01: Sustainable competitive advantage unique to the team.
SPEAKER_03: It typically is the reason why they can build a flywheel
SPEAKER_03: in a founder community, because founders love them. They all want to work with this venture fund.
SPEAKER_03: And I hope- Which speaks to deal flow, right?
SPEAKER_01: That speaks to proprietary deal flow is another way. I think that's what you mean by flywheel. Hey, they have that definitive, sustainable advantage. Founders recognize it. And that drives the flywheel, the flywheel being more founders apply for funding.
SPEAKER_03:
Correct. If QED is great to fintech founders, then the next generation of fintech founders will hear from that. The folks who have worked with QED, hey, QED is amazing. You really should talk to QED. They're the best in fintech. And then QED has this flywheel of making great founders love QED, helping great founders, getting great exits. And then the next crop of fintech founders want to meet QED. And then they keep seeing great deal flow, investing in great deals, generating great returns. And so the last part of that point though, the competitive advantage that's unique to the team and sustainable is that you want the strategy built around that,
that whatever thing makes them so special. It's gotta be tailored to them.
SPEAKER_02: And so like QED shouldn't go and do deep tech investing.
SPEAKER_03:
That doesn't make any sense. And like QED should be relatively comfortable. They should be able to work with founders closely. They shouldn't be so low concentration that they don't have time to work with their founders because their founders really value their involvement after investment. That's a big part of what makes QED special. So they have to have a portfolio construction that allows them to do that.
SPEAKER_03: Okay, so that's the second thing. The third thing would be like founders love these folks. I think it is common to say and believe that venture capitalists don't add much value. And I think that's probably true in many cases, but I think the best funds, they often do add value and at least their founders love working with them and send their best founder friends their way. And that's a really important part of what I'm looking for. The next thing would be like the best investors at the next stage from this venture fund, trust this VC, track their deals and invest in them. It was like nothing feels better to me as an LP than seeing that like the companies that we have exposure to are now being marked up by the best investors at the next stage. And then the last thing would be just like scrappy, entrepreneurial driven, hungry folks. I think that is often more likely associated with folks on their first few funds, but it's not always. And some folks who have, they don't,
SPEAKER_03: more money would not impact their life and they are as hungry as anyone who's just getting started. And so, but that's an important part
SPEAKER_03: of what I'm looking for. And yeah, we can go deeper into any of these things, but like at a high level, those are my five filters.
SPEAKER_01: Yeah, there's the ability to compete for deals
that I hear come up a lot. The thing that I don't understand at the seed stage and why people are obsessed with this is when I look at a cap table of a seed stage company, most often there's between 20 and 30 names on it.
And so I look at that seed stage funds and I'm like, if you can't be one of the 20 names on the cap table before series A or 30, what's going on here?
Like they must hate you.
Like they're passing the hat. And I literally think it's 98 out of 100 startups
pre series A when they do around is passing the hat, especially in today's market. Like you're not fighting for an allocation. Now you might want a larger allocation in a great company.
You want to put in 250 and they're saying you can put in 150, 150K or something, but yeah, generally speaking. So do you think about fighting for an allocation at seed stage or do you think it's irrelevant?
Yeah, I mean, let's,
SPEAKER_03: I guess are we distinguishing pre seed from seed here?
Why not? Why don't we do that?
SPEAKER_01: Why don't we do pre seed versus seed? What do you think the difference is between those two? How do you do it? Some people would say pre product launch, post product launch
and people might do valuation. How do you define pre seed versus seed in 2024?
SPEAKER_03: Yeah, I mean, the way I think about it is in terms of entry valuation, but, and-
Okay, you know the entry valuation for pre seed and seed.
SPEAKER_03: Yeah, what's that? I have two numbers in mind.
SPEAKER_03: I'm thinking of like pre seed entry valuations as like sub 10 or $12 million post. And then I'm thinking of like seed stage venture or seed stage entry valuations as more like,
you know, 15 to 30 post.
I had six and 12. These are changing as the market evolves. What's that?
SPEAKER_01:
Yeah, I had six and 12.
Oh yeah.
SPEAKER_01: And the reason I was saying six and 12 is because I'm including accelerators in there. So accelerators getting at a 1.7 to $2.5 million valuation. And then there could be, you know, six to $10 million valuations at pre seed and seed. Yeah, you know, could be eight to 15. Yeah.
SPEAKER_01: Yeah.
SPEAKER_01: And then series A obviously is 30. Yeah.
SPEAKER_03:
Yeah, and so what's interesting is like, I think there's a lot of activity at seed. There are a lot of funds playing at seed.
SPEAKER_03: There are a lot of tier ones who are later stage investors primarily. And I know there's just like multi stage investors who are playing at the seed. Now those companies might be inception stage.
They might have revenue and be a little more further in their evolution.
SPEAKER_03: Pre seed is typically pretty early in their evolution. And the entry valuation, yeah, is very low.
And I think there's less competition there, but the same company might be getting offers from a pre seed fund and, you know, or like pre seed valuation offers. And they might also be getting offers at what we have here today defined as seed valuations, right? Like Sequoia might come in and say, hey, we want to value this at 30 post. And someone else may say like, hey, we want to value this at eight post, right? So like in that sense, these categories, it's hard to distinguish them. But I do think there is a lot of opportunity at pre seed. I don't think there are that many folks in relative terms investing at the earliest stage, like company inception or before the company's created. We're just bouncing ideas around. Oh, you decided to start that company. I'm gonna invest right now. We're sub 10 million dollar entry valuation. That to me is very compelling. That is where I am more focused there than seed. Although I'm doing reinvest in both types of funds. And yeah, I think winning is important in every stage, but I think at seed, it's really important to be able to compete at seed because there are so many players playing at seed. There's so many venture funds playing at seed. And so what I think about is like, what is the reason, like, do I have a reason to believe, or is there some good reason to believe that this investor or this team
will find these companies early, great founders early, and that great founders will pick them.
And you have to win unless you're the only investor
at the table. And that is so rare. And even if you are the only investor at the table, you still need to win. Like you still need to convince this founder that they should want to work with you. And so it's really important to any investment that we make is understanding like sourcing, picking, winning.
SPEAKER_01:
Yeah.
I, now my criteria is doubling down.
How do you decide on what to double down on? That to me is my obsession right now at the moment,
because I have deal flow, right, like a deal flow,
too much deal flow, decision making, I figured that out.
Got a really good system for that. We know what to look for in that early stage, multiple co founders, builder co founders, product velocity, consumer love, you know, early adopters really loving the product, two to three x growth, right?
We've got a whole criteria there. But really doubling down is the hardest decision I think people have to make. You just told me you have questions for me.
Now, I wanted to turn the tables on me here.
SPEAKER_01: Now, usually I don't allow this kind of Michigan. But I'm going to allow it for a couple of questions here. Go ahead. You want to hit me hard with some hard hitting questions. I'm good. I don't know what questions you want to ask. I know they put them in the notes. I told them don't show them to me. I want to give my lightning round here in the last 10 minutes. One thing I just before we get to the questions you have for me, optimal fund size.
SPEAKER_00:
SPEAKER_01: Why is this important? You know, most people in seed, I think they say maybe 50 million or less is the right size 25 million 75 million. What's a what's a number if you had to pick the optimal size or the range? And then why is this important?
SPEAKER_03: Yeah, those are such great questions. And so I'll talk about it first in terms of like the factors that I think about. And then I'll sort of like give rough answers. They're like more direct.
The the factors that I think about are like, in the first
question, someone has a venture fund because there's something very unique about them and typically relates to sourcing, picking, winning, adding value. They should be building this around them.
And so that's the first question.
There's no one answer like every pre-seed fund should be 64 million dollars and every seed fund should be like under 108 million. Like I don't have that answer and I don't think that answer exists because this is such a personal industry and it and the success of a venture fund has to do with the people who are sourcing, picking, winning the founders they are working with the sectors they're in. Like it's so specific to every person on a venture team and
every venture fund and every venture. So I don't have one inch. But it sounds like 25 to 100 million seems like or 25 to 75
SPEAKER_01: might be typical.
SPEAKER_03: Yeah, we're not saying you have to pick a number but it's typical.
SPEAKER_03: Yeah, what gets me most excited from a fund math perspective is pre-seed funds are 50 million and smaller.
SPEAKER_02: So like if you're a 50 million dollar fund getting seven to
SPEAKER_03:
10% ownership, sub 10 to 12 million dollar entry valuations, like that's great fun math.
SPEAKER_02:
You can generate great returns without needing enormous
SPEAKER_03: winners and if you get enormous winners then you have an amazing fund. You need only hit a 500 million dollar outcome to a billion
SPEAKER_01: dollar outcome to return the fund with one investment.
SPEAKER_03: Yeah, I mean it's all relative to dilution and all those things but yeah, like rough math. And so I'm looking for yeah, like high enough ownership relative to the fund size on a pre-seed fund 50 million dollars getting that level of ownership often gets you like 20, 25 companies at least could get you a little more depending on how you deal with reserves and how early you're getting into these companies.
SPEAKER_03: And I think that's a good number for folks to have. I think I see funds that are more concentrated does make me a little nervous.
SPEAKER_03: But if they people have a history of investing and you can get comfortable with that level of concentrate like I can get comfortable with that level of country. You got a minimum number minimum number to hit the power law.
SPEAKER_01:
You think of companies you know it's so interesting like or as
SPEAKER_03: we say less logos in the logos.
SPEAKER_01:
Yeah, less than 20 logos makes me uncomfortable but more is
SPEAKER_03: more comfortable as long as I believe the team has the capacity to source pick and win and work with those companies
SPEAKER_03: post-investment. I'm typically drawn to funds that are working pretty closely with the companies and so there's a limit on how many companies they can invest in. But then you see any given fund and you're like wow look at that that's a 20x fund. And you're like how did that happen? OK. It was actually one big winner and like a couple other solid
SPEAKER_03: fund returners and that's like that got us to 20x. And you're like man if they just did 32 instead of 33 investments would they have missed the big you never know. It's like this game of just a small number of winners making all the difference. And so I don't think there's a magic number here. But yeah like less than 20 I'm uncomfortable. More than 40 I'm typically not doing because it's hard to work closely with those companies although it is possible. And I'm typically drawn to folks who are working closely with companies. So I'd say it's somewhere in the 20 to 40 for me it's usually more like 20 to 30 companies on a pre-seed fund. And yeah like ideally around 50 million or smaller getting yes having a 10% ownership on a seed fund. Yeah like I'm comfortable with funds that are getting up to like 100 million dollars at the time investing the seeds. If they're investing in bigger rounds hopefully the company
SPEAKER_03: is a little further along and maybe a little less de-risked
a little de-risked. Although I think the data would not necessarily support that. I think it's a great risk reward and pre-seed like you don't see a lot of death from like a high mortality rate between like pre-seed and seed. And so that is a part of the reason why I am focusing increasingly on pre-seed funds because of that mortality rate and because like smaller fund size higher ownership relative to fund size like there are a lot of and there are fewer funds playing at that. So there are a lot of seed funds there are a lot fewer folks investing at what I'm thinking of as like pre-seed. Seed funds are generally trying to buy you know 10% of the
SPEAKER_02:
SPEAKER_01: company for two or three million bucks yeah. Something in that range. Seed funds leading rounds.
SPEAKER_01: Yeah seed funds leading rounds or co-leading yeah.
SPEAKER_03:
Yeah like there are folks who say hey we're going to be a 30 million dollar fund we're going to get 4% ownership in seed rounds you know we're going to be investing in 15 to 30 million post or whatever we're calling a seed round.
SPEAKER_03: And that strategy can work too. Totally. Yeah.
But like if you were to say hey Alex are you interested in a 30 million dollar seed fund targeting 4% ownership or a 50 million dollar pre-seed fund targeting 10% ownership. I would be drawn just from a fund math perspective to the 50 million dollar pre-seed fund.
SPEAKER_01: Yeah and I think your point is really well taken. The difference between a pre-seed and a seed stage company is typically like very little and sometimes it's like the charisma of the founder able to raise a bigger fund going bolder. Some you know founders are like you know I'm heads down I only want to raise 250k right now. I don't want to raise two or three million. I got two developer co-founders. I'm a UX designer. We don't need that much money. We don't want to take the dilution. And so that's the that's one of the trends I think is under reported right now is founders being very judicious in how much dilution they allow in their companies. I think this could be one of the big trends of the cycle is founders like not wanting to liquidate you know or dilute 30 or 40% in you know, you know at their by their series a and they own 50% of the company and seed investors pre-seed investors in the series a on 50% you're seeing less and less of
that people want to skip rounds. I call them.
SPEAKER_01: Yeah, I see that too.
SPEAKER_03: And I should be careful here because when we're distinguishing between pre-seed and seed like many funds are just kind of both.
Yeah. Oh, if we could invest in an $8 million post like we would it's not that we're only doing that like now if we see a great company at a $20 million post and we can get the ownership that we think we need to generate fund level returns like we're gonna take that one too. And so I don't mean to be so rigid in how I think about these funds because I think the reality on the ground is that many funds are a mix of I guess pre-seed and seed what we're calling pre-seed and seed.
SPEAKER_01: Yeah. All right. You had a couple questions for me. We got to wrap this up here, man. We went long. Yeah.
SPEAKER_03: Yeah. Great discussion. Great guest. Oh, no, it's been fun. So one few questions for you. One is like, what's the ideal LP for you? Like, how do you pick LPS to the extent that you know, you're oversubscribed, you're trying to choose or you meet people and you're like, hey, this person's not a fit or hey, that person is a fit. What are you looking for?
SPEAKER_01:
I like there seems to be two groups of people who enjoy
working with us and that we enjoy working with there are some who are set it and forget it.
Hey, we understand venture, we want to place a bet.
We know we understand, you know, you're going to have some funds, you know, fun one and two might overperform. Fund three might underperform. Fund four might be average fund five might break out, we understand the dynamics and the randomness of what you do. So we're going to be in it for the long haul. And yeah, you know, we want like this level of communication, which is typically yearly audits, you know, and then we have another group, which I really enjoy working with, which is the new retail investors who, hey, you know, I, I've made some seed investments is my first venture fund, or my second venture fund, I'm looking to, you know, put 250k to $5 million into venture funds. And, you know, I, I want to learn and yeah, I like looking at the Google Sheet that you share with your major LPS, you know, over a million dollar LPS that have all the, you know, companies in in real time. And I kind of like the rush. I like the sweat, as we would say, and gambling, of like seeing the companies you're investing in and being part of the community, right. So people who really, you know, they seem to fall into those two buckets. The ones we don't like working with, are maybe ones who are a little skittish, maybe they're, you know, overextending themselves, they don't understand the asset category. You know, I've, I've had people in our syndicate, who will get really upset at a founder failing, and they'll write like an email, I didn't get updates. And, you know, why didn't I get updates, and now you're failing,
and you work hard. And I'm like, hey, reputation wise, like, you came into this knowing that 80 90% of seed stage companies go to zero.
And, you know, you invested in five, and three or four of them went to zero.
But isn't that what's supposed to happen here? So, you know, let's be gracious and magnanimous in defeat and victory, right? You got to be humble in victory.
Hey, you know, people ask me about my investments. I'm like, yeah, you know, I got lucky a couple times. There's a lot of hard work involved. And I also, you know, some of its luck, you know, and be in the right place, the right time, sliding doors, whatever.
And, you know, the more you focus on your process, and the better you get at your craft, the more I think you quote, unquote, increase your luck.
SPEAKER_01: And so I Yeah, it's some people are skittish, you know, and I always encourage them to not go into venture, they should put their money into a mutual fund, they should put them into Vanguard funds.
SPEAKER_01: And you're not being this asset class, if you want liquidity, if you can't take losses, if you can't take, you know, founders
who are, like I said, earlier, iconic plastic, effervescent
would be like a kind way, some of them are hard to get along with, and the hard to get along with one sometimes are the ones who are the most successful.
And you should not be in this asset class. It's just going to be a two that all.
SPEAKER_03:
Yeah, yeah, that all resonates. And I'm curious, like, many GPs I talked to say that they don't
know where they stand with their LPS. They don't get much feedback from them.
SPEAKER_01: No, that's been hard for me. Yeah.
SPEAKER_03:
Yeah, I'm curious. Like, if you could ask your LPS questions, like, what would you ask? What do you want to know that you don't know?
SPEAKER_01: Oh, I mean, you know, one thing is like, just tell me why you're passing on the fund, in all honesty. And I think a lot of LPS are like, like VCs, we're passing on the majority of what we see in order to, you know, and, but there's no upside to being honest on why you passed.
And so, you know, if you pass because you thought, Oh, you know, your fee structure or your carry structure is, you know, I think a little too rich. I would love to hear that piece of feedback. You know, there was a fund of funds was like, I just can't, you
SPEAKER_01: know, do 25% carrier 30% hurdle because I'm charging 10%. That's 35 and 40. It's just way too much. I can't get it past me. I would love to know that. And I would love for that person to say, you know, I would put 10 million and I put 5 million in if the fee structure was this. But, you know, Jake, I like I can't do your fee structure or
whatever. Okay, fine. Let's have that discussion. You know, maybe at least like to know, right. And so there's no feedback loop. I'm trying to give people permission to tell me candidly. I don't know if they will, but.
SPEAKER_01: Yeah, it's hard to get them to. I mean, it's funny.
SPEAKER_03: It's an emphasis of mine, like to be clear. And I really do try to be real with people and tell them like,
Hey, like, here's what I love. Like, here's why I'm not going to get there. And like, if you're open to it, like this is a fund that I'd love to, like, I'd love to see the next fund. Like, I'd love to stay close. I'd love to try to help. Sometimes if I don't think a future fund would be a failure, I
don't say that. But it often does result in like staying close to folks because they feel like I was honest. I mean, I was honest. I had one. Yeah, I had one LP, because I insisted that she tell me and
SPEAKER_01: she was like, we just haven't seen somebody have 200 portfolio companies in a fund and then also be concentrated. I'm like, great. Let me explain to you how we're doing it.
I explained it all to her. She's like, great, still a no from us. But I said, I just want to make sure you're not out there. You know, when you're talking to other LPs or whatever saying, that this is a bad strategy, because I am convinced it's a great strategy. Here's why I think you're wrong. I told her why I think she was wrong. You know, you might be right with most folks, but here's why you're wrong in terms of our fund. And here's what I'll show you in the coming years. And she's like, great, if you do show us that, then we would love to be LPs. Because, you know, just because we haven't seen it before, and we have an investment committee that requires us to, you know, hit these notes doesn't mean it's not going to work. And so I just insisted on getting on the phone and just making sure, hey, if you disagree with our portfolio, and you know, listen, I have a different I have a unique idea.
SPEAKER_01: And my idea is different than what a lot of people have seen,
I believe you can put two or 300 logos into a fund, and then reserve 50% of the dollars for the top five names. And the only reason I know I can do that is because I've my
portfolio before had a you know, a first one had 109 names and in four unicorns. And then we looked at it, and I asked
myself, did I know Robin Hood calm, superhuman, and density will become unicorns. And I knew three of them definitely would have been unicorns. You know, with enough time to put the
investments in. And if we had instead of that being a five x fund, which is where it is on paper right now, it would have been a 15 or 25 x fund if we had just made those second bets. And so I'm like, you know what, that was my mistake, not making the second bet on Robin Hood, the second bet on calm density, and superhuman. And we had the opportunity to in every single case, but we didn't reserve the dry powder. And that, to this day makes me insane. Like this makes me mental to only have
five x fund, because I knew it could have been 15 would have
SPEAKER_01: been easy to put another 250 k into those four names. And if
you had put an extra 250 or 500 k into those names, boom, you
SPEAKER_01: know, legendary fund. Yeah, my last question for you is, yeah.
SPEAKER_03:
You know, VC is a really long duration asset class. And I
SPEAKER_03: think there are plausible arguments to believe that
liquidity could come sooner for vintages now, then maybe
SPEAKER_03:
vintages 10 years ago. And maybe like, it won't be such a long
wait for LPs and funds these days as it was for LPs. And
SPEAKER_03: because of the secondary market, how vibrant the companies
SPEAKER_03:
companies grow faster for cheaper, they may raise fewer rounds. Yeah. So I agree with all that. opportunities. I'm
SPEAKER_03: curious. Yeah. curious what you think? Like, do you think 10 years from now, we'll say like, actually, like, it used to be a
much longer duration asset class than it is today.
SPEAKER_01: I think, yeah, I think if the GPS choose to build a secondary
SPEAKER_01: discipline inside their organizations, you could be right. And I have decided to do that. So after we finish, we're
going to wrap up our fund May 1, has been the date. And so when we wrap up our fund, my plan has always been to when we get, you
know, whatever to a certain number of investments in fund for to start that process of building the secondary group, you know, like deputizing a person, your job is to look at all of the just talk to the secondary markets every day. And there's so many of them now. And just make friends with them get their phone numbers, and say, Hey, you know, our names,
you know, here's the price when this hits $10 a share, you know, we might be inclined to sell 100,000 shares and take a million off the table if you find somebody and they might say, Oh, can we go find somebody for you? Well, you know, the
highest you've gotten is $7 a share. So probably not. But when you consummate a $9 Yeah, that's when we would probably want to engage. So I was reactive to people selling, calling us because, you know, people would get your cap tables, these companies and start calling the seed investors, precede investors. And so now I want to think about actively doing that. Or this, this is a little controversial, you know, just
SPEAKER_01:
talking to the other funds that do the series B or C and saying, Hey, you did the series B, you know, the rounds close, we're
both on the board of this company, we're looking to pair our investment, if at any point, you know, we don't want to sell our holding, but we know we want to get our LPs liquidity, you want it to buy 20% of our position for 200, we have a million shares, you want 200,000 shares, you know, we're, we're kind of at our target now. And we wouldn't mind paring back our
ownership, and just see what they say. Now that a lot of VCs have not wanted to do that, because founders might interpret it as a vote of no confidence. But I think the
markets maturing, and there's a way to do it, you know, without
having it reflect badly on the company, like I'll talk about
secondary sales now, you know, way in the rearview mirror, but
I wouldn't talk about them in real time. Right?
SPEAKER_03: Yeah, I mean, two, two things that come to mind there. One is, you know, I think, increasingly, like coming out of what happened
in 2020 2021, in partially 2022, like, I think that pressures on for I think people feel pressure to get liquidity. But I also wonder, like, whether we're overstating the potential relationship issues with founders when we talk about
preceded seed stage investors selling it's like selling secondaries and growth stage companies. I actually think
SPEAKER_03: those issues can be managed. And if the investors are close to the founders,
SPEAKER_03: it's a process. I mean, founders explicitly tell me like, we want
SPEAKER_01: you to waive your party pursue, like, we want you to not sell in secondary. So we as founders can sell more. Now, that's when you've got a real situation where I got to say to founders, you know, I understand, I understand and appreciate that you're asking. I want you to understand and appreciate that
SPEAKER_01: we've told our LPS that we would pair 20% of our position. And in a case where I had to do that, actually, I had to do that in one case, they're like, totally understand.
Yeah, I also hear of stories. Oh, good.
SPEAKER_01: No, and I said, Well, okay, how did that go with the other investors? Oh, four out of five other investors said they would waive and they wouldn't sell. You're the only one who's selling. And I'm like,
Yeah, it's interesting. And I've heard others. I've heard of
SPEAKER_03: founders who say, who try to block their in their early investors from selling on the secondary market because they just think their company's worth more than that investor has
SPEAKER_03: agreed to sell for. I'm hearing that coming out of the last few years of very high valuations. And that is, I'm wonderful see more of that in the mean, if you were an investor in figma, and
SPEAKER_01:
you could have gotten out at 10 or 15 billion, and they had that sell for 20 billion, if you had sold a 15 on the way up, you
know, in the Adobe figma deal, then a 20 billion cracks, and now who knows when you're going to get liquidity at 10 or half that amount? Yeah, you probably would have felt great about
selling at 16 or 14 or 15 some percentage of your ownership, right? So I mean, yeah, the hope is that founders let investors
SPEAKER_03: do this, but we'll see. All right, guys. All right, Alex.
SPEAKER_01:
Well, since you're interviewing me, you get to sign off. All
SPEAKER_03: right. Thanks to everyone for tuning in to this week in startups. We'll see you next time.
