Afford Anything - The Hidden Math Behind Every Venture Capital Fund, with former Wharton Prof. David Bell

Episode Date: July 17, 2026

#733: Venture fund managers can collect years of fees before a single dollar comes back to investors — and the bar to hand over your money is lower than you'd think. David Bell spent 20 years as a chaired professor at Wharton before co-founding the venture firm Idea Farm Ventures, where he's backed early-stage brands like Bonobos, Warby Parker, and Jet.com. In this episode, we discuss: How venture funds actually make money, and why nearly every one runs on the same fee formula Why fund managers get paid before they've invested anything Why the bar to invest in risky private deals is lower than you'd think What to ask before trusting any fund manager with your money The one red flag that should make you think twice about an eager fund manager How some investors make an all-or-nothing bet on a single breakout company Why taking outside money can quietly change what a founder is optimizing for Whether you're weighing becoming a fund investor yourself or you're a founder deciding whether outside money is worth what it costs, this episode gives you a clearer read on how the venture world actually works. ⏱️ TIMESTAMPS Note: Timestamps may vary slightly depending on dynamic ad placements. (03:41) How venture capital actually works, in three tiers (06:09) The fee formula nearly every venture fund runs on (10:30) Why fund managers get paid before they invest anything (14:19) The surprisingly low bar to invest in risky deals (26:52) What to ask before trusting any fund manager (29:27) How investors make an all-or-nothing bet on one company (34:33) The red flag hiding in an eager fund manager (42:16) What separates a great fund manager from a mediocre one (48:10) How outside money quietly changes what a founder optimizes for (55:47) Why kids today may never remember life before AI 🔗 RESOURCES MENTIONED 👉 The free FiiRE Playbook breaks down all seven entrepreneur types — from bootstrapper to funder — so you can see which game you're actually playing: https://affordanything.com/fiire 👉 David Bell's website: https://www.davidbell.co 👉 Lost and Founder by Rand Fishkin: https://www.penguinrandomhouse.com/books/547217/lost-and-founder-by-rand-fishkin 👉 Burn Rate by Andy Dunn: https://www.penguinrandomhouse.com/books/653309/burn-rate-by-andy-dunn Learn more about your ad choices. Visit podcastchoices.com/adchoices

Today's guest owns a copy of the original Uber pitch deck. He wasn't an investor in it. Someone gave it to him a few years ago. But in that deck, the founders sketched out several scenarios for what might happen to the company. At the time, Uber was largely just an idea. And in their worst case scenario, they said, we might just become another cab company in San Francisco. Nobody at the time imagined a $100 billion company. And given that the only consistent lesson that we can take from history is that the future always ends up being surprising,

how do we evaluate opportunities in your career, in your investments? How do you evaluate opportunities, given that you don't know what you don't know? That's what we're discussing today with former Wharton Professor and Venture Capitalist, David Bell. Welcome to the Afford Anything podcast, the show that knows you can afford anything, not everything. This show covers five pillars, financial psychology, increasing your income, investing, real estate, and entrepreneurship, acronym Double I Fire. I'm your host, Paula Pant. I trained in economic reporting at Columbia. And today we welcome David Bell back to the show.

He was our guest on the previous episode, Episode 732. So if you haven't caught that one yet, go check it out. But that episode really focused on that letter E entrepreneurship. Today we're switching letters and we're focusing on the letter I, investing. Specifically, we're diving into a corner of the investing world that to most of us is a black box, and that is the world, the opaque world of venture capital. We know from audience surveys that a significant portion of this audience has a net worth that's north of a million, even outside of your homes, and that means that many of you qualify as accredited investors.

And that means, per the SEC's criteria, you can jump into one of the riskiest asset classes out there without actually knowing what you're doing. And the dangers of that are probably self-evident. Here's the part that's less obvious. Venture capital is a world in which if someone's managing $100 million, they're collecting $2 million a year in fees, mostly regardless of performance, which means the incentive structure is a little bit bananas. And that makes this the ultimate case study in fees and incentives. I asked David to explain one of the most opaque corners of investing. Now, in case you didn't catch last episode, David has a PhD from Stanford. He's a former Wharton Professor. He co-founded and runs a VC firm called Idea Farm Ventures,

and he has seen this world, both from the classroom, as well as inside the machine. He also speaks in a manner that's practical, grounded, no fluff, high signal to noise ratio. His density of ideas per minute is quite high. So in this episode, you're going to learn how a venture fund actually works. You're going to learn where the money comes from, how the people running it get paid. You'll learn how to evaluate a fund manager, and you'll learn why a founder and a funder can sit on the same side of the table but have totally different incentives. Bottom line is this. Your future ideas are downstream of the conversations that you're exposed to, and to that end, David is a voice worth having in your ear. So please welcome David Bell back to the

show. You've made the transition from academia to being a VC. And, the world of academia, most of us have a good sense of what that is. Most of us have no direct experience with the VC world. Right. And that world seems a little opaque. So first, for the average person who's listening, how does one go about becoming a VC? I'll leave it. Great question. Okay. So I'll sort of answer it in three tiers that might be helpful to the audience. So I agree it's pretty opaque. I mean, some of these things now are going into sort of the pop culture. So, for example, I had the good fortune about a month ago to go to a free event at NYU. And it was Malcolm Gladwell, who's just an amazing author. Oh, with Bill Gurley. With Bill Gurley. Oh, were you there? No, I interviewed Bill

Gurley two days prior to that. Okay. So what I was going to suggest to the audience is the sort of movies and things like that about Uber. And it gives you a little bit of a sense. The venture a capitalist is the person often who's giving the entrepreneur money and there's different points at which money can be taken. So the sort of seed stage or early stage investment is when the idea itself is like very nascent, very fragile, it could be huge, it could be nothing to that point about Bill Gurley. I actually have the original Uber pitch deck. I was not an investor by any stretch.

Somebody gave it to me years ago. And I think if I remember, they painted different scenarios of where Uber. could go. Scenario number three, like the worst case scenario would be like it's going to be like another cab company in San Francisco. I don't think it was anybody at the time thought it would be whatever it is a multi-tens of billion dollar, hundred billion dollar company. So the venture capitalist is someone who injects capital when it's kind of risky if it's early stages, maybe even before the product's created. And then there's other kinds of venture capitalists where the business is already up and running, is maybe making a lot of money and the company's thinking about

listing the founder is thinking about trying to list the company on the stock exchange or selling it to somebody else and they just need a bit of extra money maybe to get their product wider distribution, go to an international market. By then it's less risky. So there's various levels of risk. The most risky is like the very early stage, Paul has got this idea. She seems bright. Shall I give her money or not? So that's what the venture capital list does as they inject money at different points. The way they work, like where does their money come from? Might be one question. and the audience has. So sometimes if they're very wealthy, and perhaps Bill is in this category, he could just take it out of his own bank account. But more typically, that money that the venture

capitalist is managing has come from other investors and they're called, in the typical nomenclature, they're called limited partners or LPs. So they're often people that have to be qualified because because it's so risky, the government doesn't want somebody who's working and has a family to put all of their money into a venture capital fund, that would be a very risky thing to do. So the investors are supposed to be accredited, meaning that they have a certain income level and so on and so forth. And then the people managing the fund, they're called the GP or the general partner. So let's give a real example. To be a venture capitalist, you have to believe and make other people believe that you have some kind of edge and whatever

it is. So let's imagine you and I decide to become venture capitalists. and we think we have a very unique edge in investing in certain kinds of consumer products, maybe because you started a consumer product brand in a prior life. Maybe I taught people how to do it. Somehow we think we've got an edge in finding the next touchland. We have this belief. So what we're going to do is we're going to put together a presentation that articulates our point of view of how we think we can make money for our investors.

And then we run around New York, we run around the world, or we go to people who we think might be willing to give us money, become limited partners, and we're also going to decide on how much money we're going to raise. So to make the math easy, let's imagine you and I decide we want to raise $10 million. Okay. And we think this Joe guy over here, he's done very well. He might be willing to give us half a million dollars. So we'll go in front of him, we'll pitch him and so on and so forth. So you kind of go through the process of trying to convince people to give you money. this is a nuance, but if Joe commits $500,000 out of the 10, he doesn't write us a check tomorrow, but we do something called capital calls, meaning when we decide to invest in Touchland,

we ask him to send us a check for 50K or whatever his pro rata piece of the total investment is. Now, if we've got $10 million worth of commitments, this is the math that the audience, if they burn this in, this covers 99% of cases. Most venture capital companies run by a rule that's called two and 20, two numbers, two and 20. So what does this mean? The two is a percentage, 2%. This refers to the management fee. So every year on $10 million, two percent of that I think is $200K.

So you and I would collect from our investors in totality $200,000 from which we would pay ourselves a salary, maybe pay an intern, pay our legal bills, rent a space, like that's our kind of management fee. that sort of keeps us afloat. And then the 20, that refers to the profit sharing. 20% for us, 80% for the investors. So let's say we made $10 million on an investment. We put in one, we got back 11. Of that 10 million in profit that came in, you and I, as the general partner, get to keep 20% of that, 2 million. And then the 8 million, we distribute it to our investors, Joe and the others, in a pro rata of whatever they invested in us. So that's, how every venture capital company more or less operates. There'll be a certain number that

they have a managing that's called the AUM assets under management. So imagine you're managing a billion dollars. Then every year you get 20 million. But probably by that point, you might have a huge team and offices in different places and so on. If you sort of step back and say, well, let me think about the incentives. So if you and I have 10 million dollars that we're managing and we're making $200,000 every year in fees, usually for a 10-year period. Most funds are supposed to begin and end within a 10-year period. Wouldn't it be nice if we're actually managing $100 million, then we get $2 million every year in fees? So the incentive oftentimes for the venture capitalist is after they've done the first fund, number one, and one or two things in that

fund look like they're tracking. You probably haven't got any money back within three years, but some of them might have gone up on paper, then we can prepare our PowerPoint presentation number two, and we can run around the world again, or New York or wherever we think our targets are, and we can try and raise $100 million. So now by year four, we might have two funds running in parallel, one that's going from year one to 10, another one that's going from year three to 13, and so now we're collecting even more fees. Is the capital call, is part of the capital call the fees?

How does that work in terms of? So usually there's a percentage of the capital cause the fee and a percentage of the capital call is actually going into investment. So in totality, say, for example, Joe committed $500,000 to this fund vehicle. He would know going in that roughly a fraction of that was going to be his contribution towards the fees and some other fraction of that was going to be going towards actually being invested in companies. And I don't know what, I mean, I should know this.

I will know this. We're the genesis of the two and 20. Like who cooked up that that was the number. Now, it is the case that someone who's shown that they're just an unbelievable investor, since we're in New York, this might be someone like Steve Cohen who owns the Mets. If you invest in his fund, he might charge you 3% because he's so good, and he might take 30% of the profits. But because his track record's so good, you'd say, well, okay, I'm an investor. I'm going to get less.

I'm going to get my fraction of 70%. But because this guy's so good, I'd rather have less of what he can create. But two and 20 is the norm. Yeah, it strikes me that if that 2% has to cover your salaries, your legal fees, your office, your assistant, that the fund can't be too small because then it would be so undercapitalized. The management fee would be insufficient to just cover. Yeah. So, I mean, there's a concept of a single GP fund, a single. general partner. So maybe if just you or I were just getting started, we might say, I'll just do the

whole thing myself. And 200K, that's enough money for one person to manage all of that. And I think also the fee shouldn't be so high that the manager's not motivated to go out and find investments. But yeah, that's how most of the venture capital, there are other structures as well. But if you were to say, hey, what's the average VC fund look like? Most of them will have that 2-and-20 structure. Going back to the fee being part of the capital call, does that mean that if they don't find a touch land, they don't find a company to invest in,

that no fees have been collected and therefore the management fee isn't there? Well, the management fee typically gets collected regardless because you have these ongoing things, right, to pay your team, to pay your rent. So the management fees covering effectively, not just the managing of the doing the investment in the paperwork, but the other things you need to run a team. So like it gets paid up front and then later there's a capital call for the rest of

the investment? It sort of comes in at a regular cadence. So the manager, in our case, is only two employees. So it's pretty easy. But if we had a bigger fund and we had real employees, like we'd need to have enough money called in and in the bank just so we could make payroll every week, but we're never calling more than 2% of the total amount of the capital, but on an annual basis. So again, you've got to say, well, if the fund lives for 10 years, 2% times 10 years, like 20% of all the money has gone into sort of keeping the engine running and the lights on and stuff like that.

And so as someone who might invest in a venture capital fund, you might quibble that. said, gee, that guy Joe over there on a $100 million fund, he's going to make $20 million over 10 years regardless, but it's not quite that simple because there might be various clauses of performance that he has to meet. And this is a reason why to be an investor or a limited partner in a venture capital fund, you have to sign paperwork saying that you're accredited because you have to be willing to lose everything that you're putting in. Right.

But the barrier to be an accredited investor is so low. It's not super high. I think it's a few hundred K of income. Yeah, a few hundred K of income or like a net worth of. A few million dollars. I mean, pretty much any, and this is something that's always struck me about the qualifications to become an accredited investor. Essentially, it means if you are a successful dermatologist, you might not know anything about investing. No.

But you're a great dermatologist. And so you've met the net worth requirement. Heck, it could even mean that maybe you are a middle school teacher, but you are in your 55 years old. And you have spent the last 30 years very carefully managing a portfolio of Vanguard index funds. And you've done so in such a way that you now have met the net worth requirement. Right. And so in both cases, maybe you're a professional who is highly paid, and so you've met the income requirement. Maybe you are a boglehead investor, an index fund investor.

You've met the net worth requirement. Either way, it doesn't necessarily signal that you know how to either evaluate a startup or specifically what an LP would need to do is evaluate not just the startup, but evaluate. but evaluate the chooser of that startup. Yes, the GP 100%. Exactly. I couldn't agree more. I mean, it's a very risky asset class. As you say, I'm actually thinking about people that I meet because I'm an investor in some funds myself.

And this is exactly the profile you describe. And when I go to the annual meeting, I sometimes meet people who are very successful dentist. I'm thinking of an orthodontist friend and so on. And I guess what these individuals have decided to, maybe for the same. two reasons. I'd like to be part of this sort of VC startup. And bear in mind, too, not every venture capitalists is investing necessarily in early stage startups. They might be investing larger amounts of money and things that have much less risk that are already up and running. And in that case, the calculus for the investor is, gee, if I could write a check of

$50 million and I could triple that in three years, like that would be really good, as opposed to writing a check of $2 million right on day one and hoping I can turn that into 200. Those are very different kinds of fund managers typically. But yeah, absolutely what you're doing as a potential investor. Maybe you're doing it because you want to just be part of this ecosystem. You're probably also doing it because you know something about that general partner who will have actually had to pitch you directly before you write a check. You might know some other people who are LPs.

But yeah, it's a real trust. game. You're trusting that this general partner that you're sending some of your money, and there's typically a minimum. I mean, you might not even be able to invest in a fund unless you commit at least $250,000. You're not writing that check up front, but you're committing $250,000. So it's a non-trivial amount of money, but the way the system's supposed to work is you as you as the LP, you have to be willing to say, you know what, I'm totally fine if that goes to zero, which people might be signing on to without really thinking through that, yeah, it could really go to Sierra. I mean, if you're in a good fund, probably won't.

And most funds, they'll show you what their performance has been up to date. And this is why when you're a first-time fund, you have to have sort of a chicken and egg. You have to have some secret source or track record for people to actually trust you enough in the beginning. But yeah, it is a risky asset class. And I think now you can participate probably in smaller amounts. amounts through Angel List and things like that, you may still need to be accredited. It's a risky business. Right.

Oh, but I should say it's still a very important business. And this is, if you listen to someone, you're an incredible investor like Bill Gurley or you watch some of these shows, I mean, the venture capital system is still like a really important system. And it's a really dynamic and vibrant part of the US economy. And coming from New Zealand, and same thing in Australia, like access. to venture capital there is much, much less available. And so the good and the bad is sometimes a founder

will have to be much more scrappy to build something on their own with limited resources. But the downside is often they don't have the powder that could really accelerate them because the venture capital ecosystem is not as well developed. So I think the one good thing about the US is it's a pretty fluid dynamic place, which is not to say things won't go bust all the time,

as they will. Right. Speaking of which, are there specific geographic clusters where, you know, New York, of course, obviously comes to mind. But outside of that, are there particular geographic clusters where either VC funds or startups tend to emerge? Yeah, 100%. So the classic would just be sort of Silicon Valley right. So technology-oriented investors, technology-oriented founders. And usually there's a whole ecosystem around that. So if you think about, of course, there's all the major companies there from Google. meta alphabet or whatever, but you get Stanford University, Berkeley. So there's a whole sort of brain trust, if you will, of founders. And also you'll have people who may have started companies in other parts of the world. They want to be in Silicon Valley. If you think about maybe MedTech and farmer and stuff like that, there's a whole northeast corridor around Boston and other places that sort of deal with that. There's a little bit of that in Philadelphia.

New York, I guess, there's been a lot of great consumer companies have come out in New York. If you go north and you go into Toronto around the Waterloo area and the university there, that's where there was Blackberry. So once sort of things get rolling in a certain location, that tends to often be an attraction of similar types to that. So for sure, there are real geographies of both types of companies and types of investors. To what extent do you see Texas and Florida playing a role? Oh, man. So Austin's certainly become a place where a lot of prominent venture capitalists have moved. I mean, I know everyone's now talking about taxes and stuff like that.

I think, yeah, certainly some funds down there in consumer and tech space are in Austin. Florida, I think, is the same kind of calculus, both people who could be very wealthy personal investors, like moving there for a variety of reasons, plus an ecosystem kind of bubbling up. And sometimes it's even the civic infrastructure is trying to lean in. So from what I understand, Miami, for example, really was doing a big push into kind of fintech, crypto, like we're the place for sort of innovation and financial products. So I remember I went down there to some crypto conference, something I don't know too much about with a friend years ago.

So you also sometimes get civic leaders wanting to promote their community around a particular kind of venture ecosystem. If a person listening to this is assuming they have sufficient assets, right, assuming they want to diversify out of more than just passively held index funds, there are a few options available. You mentioned Angel List. There's some of the more creative methods of investing. You mentioned Angel List 10 years ago. Not real estate syndications, but the thing that became super popular about 10 years ago where you could online, you could all pile into like a shopping center in Des Moines. That thing. Real estate crowdfunding.

Yeah. Real estate crowdfunding. That really became trendy about 10 years ago. Right. You could buy shares of private companies on a secondary market. Absolutely. Absolutely, yeah. And then, of course, there's the possibility if you have sufficient assets of becoming an LP,

like how would a person who's interested in some type of investing sort through and compare risk profile pros, cons? I mean, how would you even begin to frame that? There's pretty decent public information out there about the industry, and then there's things that you can dig into for particular funds to ask about performance and so on. And certainly before you ever wrote a check or made any commitment, like you would want to have an in-person or a face-to-face discussion with the general partner. You'd want to see the track record, not just the things ideally that they'd invested in that had sort of gone really well, but also the bets that they'd made that had gone bust and what their kind of rationale was. So it needs to be, we talked about marketing. In marketing speak, right, this is a very high involvement decision. I mean, it's maybe not quite as high as buying a house or something like that, but it's a very important decision.

So I think also to the extent that you know somebody who's already an LP, that can potentially be helpful as well. But you're looking for signals that this GP is really going to manage the money efficiently. You might also be looking for exposure to certain kinds of companies. So there's a fund that I'm an LP, have been in all of their funds that I think is just exceptionally well managed. and it's nothing to do with what we do at Idea Farm. It's mainly software and service businesses and things like that. And I just know the team works unbelievably hard. They're incredibly high quality.

They get into really good deals that other people don't get in. They've got a bit of magic that's allowed them to be very successful and to perform it probably the top 5% or even more. So it's something that you really need to diligence before you go in. I wouldn't just, I wouldn't be charmed. by a GP. And it's, again, it's like the old, I mean, I'm not that old. I didn't ever saw this, but it's the Groucho Marx thing, right?

You don't want to be part of a club that will let you into us, you know what I mean? So, like, if the GP will accept your money off the bat, like that's not necessarily a good sign, right? And of course, since we're here in York, I mean, there's been unbelievable scandals around the venture industry, not that longer, right? You think about someone like Bernie Madoff, who was just the guru who, you know, doing, whatever he did, who had these incredible returns for whatever 20 years. And I don't think, remember from the documentary that the guy even made one investment. He was just printing out fake reports and sort of carrying this mystique. So yeah, you really need to dig under the hood.

Who are these people? Who are the other LPs? What have they invested in? What are the big winners that they've had? How do they source all the deals and so on? Yeah. Yes, I guess it's not a flyaway decision. Unless you literally say, gee, I'd like to be part of this and I can lose that $250K, it doesn't matter. Well, then it's a different consideration. Right. Yeah, but I can imagine if somebody's listening to this, they have a net worth of, let's

say, $5,000, $250,000, that's 5%. Yeah. And sometimes you want to take 5% of your total portfolio and invest it a little bit more aggressively or alternatively. So here's one thing that you can do. Here's another bit of jargon. You may have got into it with Bill, but when you're a limited partner in a fund

and you're committing to having your capital called into that fund, the $250K,000, the fund manager, she or he is investing different bets in different companies. Sometimes what will happen, if there's one company that's a real breakout company that's just absolutely flying off the charts, and the GP managers, let's say she's already put $2 million into it, that's all she could really do,

which sees the thing as just going through the roof, but because she needs to have a whole portfolio, she can't dump the whole rest of the fund into the thing that's taking off. The other piece of jargon here is there's something called an SPV, special purpose vehicle, where she might go out to all of the LPs and say, hey, this thing is going off like a rocket. I'm going to try and very quickly bring together like another five million bucks,

and I'm just going to put the five million, not into a whole bunch of bets, but it's all going to go into this one thing. when you get that kind of opportunity, that's also something that you can do. Instead of committing your 250K to the entire portfolio that's yet to be chosen, you could dip your toe in the water by putting something into an SPV, which in theory should be one of the best performing companies because the fund manager is sort of doubling down on it. Does that make sense?

Yeah, it's a concentrated bet. Yeah, so as a buddy of mine, actually, I'll give him a shout at this. He's a great guy. I'm dating myself, but what a great guy. It's a guy called Evan Lowenstein, Evan and Geron, they were twins, and they had this great song, well, others, but the hit was, I'm crazy for this girl. She rolls the window down. If you've heard it, you might recognize it's from the a aughts, whatever. And so he does many things as a musician, entrepreneur, all kinds of stuff, but he's been very successful investing in various SPVs and technology companies and so on where he's just gone into the SPV.

Obviously, it's more risky. It's only one company, but the fact that an SPV is even being raised to begin with tells you that the GP has very strong conviction. So, again, for the audience, I made a huge mistake with a fund that I was fantastic GPs. They were doing an SPV in Alibaba, and I was like too stupid to throw all of my retirement money into that SPV, which if I had done, would have been a huge return. I already had some exposure because I was part of the fund and the fund had put money into Alibaba, but had I thrown a huge chunk of money at the SPV, that would have been a huge return. Right. Yeah, you always remember the opportunities that you met.

There does come a bit of loss aversion where it's like, oh man, I remember passing on an opportunity. And that's part of the game as an investor for sure. And you might see this. Some people even have it on their websites, but they'll be the so-called the antiport. So you might go to the website of a fund that their anti-portfolio that they miss is, oh my God, we knew Jeff Bezos, but we didn't invest in Amazon kind of story. Right, right. Here are the things we missed. Here are the things we passed on. Yeah, exactly. As a small business owner, one of the hardest things, one of the hardest skillsets that I still have not fully learned is hiring. Hiring is probably one of the most difficult things to do.

And as we talk about VC funds, it strikes me that in a way, if somebody is an LP or an aspiring LP, or they're considering becoming an LP, they are in a sense making a quote-unquote hiring decision about that GP, that fund manager. How does a person, if you think of it in terms of the quote-unquote hiring skill set, how does it? how does a person evaluate a good one from a bad one? Oh, man. So there's all the surface things like the credential. Oh, gosh, this woman went to MIT. That's very fancy. So there's the credential and the label.

But I think if you could accomplish this, maybe it's not easy to figure it out. But if you were able to have a conversation with a company that that GP had invested in and you could learn a bit about whether they were helpful or not, like that would be a very, very good signal. So you look at the portfolio that the GPs had and they had a huge win by investing in company X. If you were able to somehow get access to the founder of company X

and say, hey, did this person really help? Were they a good investor? Did they add value? Did they bring another capital? Did they help us hire? That, I think, is a very, very good signal. If you could ask the recipient of the GP's money, whether the GP was actually good or not,

I think in these kind of things, right, you're always trying to look for signals. And I'm sort of thinking, allow what would those signals be? That would certainly be one, if you could get access to it. And not to be too esoteric, but there's a guy who got the Nobel Prize

for the economic theory of signaling. Michael Spancy became a dean of Stanford Business School. And he wrote this sort of, it was actually quite humorous in a white paper back in the 70s when he said, Paul is trying to hire someone. She's got two people where the resumes are equally good.

reference letters are always good as well, right? You never give an employee a reference to this. I'm a total idiot. So the problem you have is you have asymmetric information, meaning that you don't know whether this potential employee is good or not. They know, right? You're trying to choose between hiring between me and Joe. We both look amazing on paper.

So the theory of the signaling says, is there a candidate who does something that's so painful that a lazy person wouldn't do it? and that's what separates them from the pack. In technical term, it's called a separating equilibrium. And sort of the joke here is like, if Joe was a guy and he went and he burned a whole bunch of money, getting a fancy education and working his self to death and graduated top of his class, like that's a credible signal that he's good because that cost him a lot of time and effort to accomplish it.

It's like the reverse problem where Hyundai offers you a 10-year warranty on their car, they're not going to be able to do that if their car's a piece of crap. The whole thing's going to unwind. So you're trying to find something that only someone who's truly like the good person could actually deliver against. You know what I mean? I know it's a little bit esoteria, but this guy, he got the Nobel Prize for basically saying, and here's the cynical part of it, is like if you went to a fancy place

and worked like a dog, even if you learned nothing, you know, the signal's still valuable because he had to put in so much effort. to actually accomplish it. Does that make sense? Yeah, yeah, yeah. That absolutely makes sense. Yeah. I kind of wish I'd come up with an idea. It's like a Nobel Prize winning idea, but it's quite deep in a way, right? I think you're looking for these signals all the time and companies are sending your signals all the time, right? I have no idea what's going on on the inside of my Mac, but I trust that little Apple logo and that's a signal to me that's a good product.

Right. Let's take the example of someone who went to a fancy place and worked like a dog. There are going to be certain areas in which they have tremendous talent. They're very good at X and Y. But there are also going to be specific areas, as is true with all people, where they fall short. Some people are great visionaries, but they're poor on operations. Some people are great at operations, but they, overcomplicate things and overdesigned for edge cases. So you have, I guess, with any person

and with any basket of skills or talents, there's a variety of both pros and cons. And that's just inherently true of all humans. And a good team is comprised to people who counterbalance each other's strengths and weaknesses. From the outside, how do you evaluate that team cohesion? That's a tough one. And again, I certainly don't want to. I mean, in the context of just explaining the theory of signaling, the credentialing could be important because it represents something else. But certainly by no means, does university credentialing doesn't really mean, I think, very much at all.

Right. Maybe it's like 2% of the variance. And this would be a fun one for your listeners because I'm sure many of the products they might have actually used. So I'll give a shout out to like the most successful entrepreneur from New Zealand as a guy called Nick Mowbray, who, with his siblings, started a company called Zuru that makes all kinds of toys for kids. And now he's a consumer company called Zuru Edge that in the last six or seven years

has built 27 consumer brands like Milliman Diapers, Rascal and Friends, Monday Hair Care, by far the most successful consumer builder in the CPG space, probably in the entire world. I think Nick, when he was 18, was probably building a toy company not going to. to MIT. So yeah, there's many things. So to wind it back, I think somebody who other people look up to or want to work hard for or aspire to be part of that team, if you get a signal of that as part of their personality can be important. And again, I think what you said is like having the mix. And one thing I enjoy about my partnership with Jam at the fun is like he and I are quite different in a lot of ways. Like we have similar thoughts about things, but I'm probably like overly

optimistic, a bit too laissez-faire, like he's a guy that just really gets stuff done. He's always more pessimistic, which is good, because especially as a GP, you don't want to be writing checks to just everybody who comes through the door. So when you get into the team situation, you are looking for these, I think, complementary skills, but there has to be some underlying core of similarity and agreement. I think that's absolutely critical. So whatever that underlying core is, like that has to be solid because if you have deep philosophical differences about what the heck you're doing and why, that's probably unresolvable. But if you have different viewpoints that's coming together is a really good collective whole, that's very positive. Right. If a person is thinking about

potentially becoming an LP, but they're weighing that against buying shares of a private company on the secondary market, where there you've got something that's a bit more established. Right. So you're weighing it against that option. You're weighing it against some crowdfunding options. You're weighing it against investing in syndications. Other than risk profile of later stage, a little bit safer, early stage, a little bit riskier. What are some other ways to understand the risk profile differentiations?

It's such a good one. Boy, I wish I had some bit of divining rod into it because, yeah, I think the first thing is certainly stage, like somebody who's got to, further along probably is more likely to get to the end but that also has to be tempered by like a really important question which is at the end of the day like who the heck is going to buy this thing and for what price i'll give you a really interesting example so i was at a consumer conference maybe a year or so ago and there was one founder and she was talking about a beauty brand that she had built and she said once i had a hundred million dollars in revenue i had like a dozen people knocking on my door, maybe from L'Oreal to Church and Dwight to whomever. And there was another guy on the other

side of the room and he said, I was building sort of a mattress type company with a tech angle to it. And I literally had one person that I could sell to. And we had one go around that fell through. And luckily two or three years later it came back and it got done. So I think with all of these things, right, like money on paper is just that until it's money in the bank. It's been in the news a lot lately, right? It's a bit of an unfortunate story about all birds, how it was $1.4 billion, I think, at the peak of the IPO and then dropped to $39, 40 million. And now I think I saw it's being rethought of as an AI company or something, right? So you might have said on the secondary market back in whatever, 2018, like to buy that could be a good thing because it was really

taking off. But if you'd bought that and held it too long, you'd really be in deep trouble. So why are the investors? the founder like putting those shares up. Maybe if it's a founder, you might say, well, she just got married, having a family, needs to buy a home, that makes total sense. So it kind of depends on the motivation for why those things ended up there. Maybe it's an investor with a different risk profile, wanted to unload a few. But I guess just being in this venture world for so long, as optimistic as I am,

I always see these things as really, really risky. And I think if it is an SPV and something that's taking off, that's probably less risky because that GP's probably had a lot of experience. Maybe it's not even their first fund, so they're really backing this thing for whatever reason. So that can be a little bit de-risk. If it's a secondary where the founder, you know, she's just wanting to, and I can't really say it, but one that I'm thinking of, boy, some people came into a secondary transaction with large checks and like triple-d their money in 18 months. Like, that definitely happens too because in this case, a founder was just wanting to give some money back to the parents.

And so if the reason for liquidity is more of a personal reason and you can kind of see that the end point is only three or so years away, then that can be a really, really good thing. And this is typically, though, more for more institutional type investors, you know. So even as a small person, if you come in and you put in 250, okay, well, 7,000. 50's not bad two years out. But number one, you may not have access to that opportunity because the person who's doing the secondary might just want to deal with two or three investors.

But yeah, so there are signals. So we're talking about signals. So a founder who's doing really, really well, who has a personal motivation to offload a little bit of equity, that could be a real opportunity. What do you make of the idea that the founder or entrepreneur, that their incentives, The incentives get changed the moment that they begin to take in outside funding because, let me just cue this up a little bit. I'm a small business owner that has up until now chosen to be completely bootstrapped. Great.

And the reason for that is largely because I want total autonomy over all of my decision making. And I do not, A, I just don't have any desire to have an exit. Right. I'd like to be doing this until I'm 100. Right. But B, I certainly don't. If I can last beyond 100, we can come back. I might have to be quite a bit beyond 100 to make it when you're 100.

It's fine. But then B is I don't want to have financial ties with partners who would be pushing for growth that is maybe a little too big for our britches, growth that might be unwise because it wouldn't be paced out in a way in which we could do it well. Nor would I want to have financial ties with funders who are just pushing for an exit. Right. Even in cases in which an exit might not be the right thing to do. Man, this is all the right stuff.

Yeah, 100%. I always say to people sometimes, and you're obviously very judicious about this, but with many founders, they think the first problem they have is money. I need to go out and raise money. That's actually the last thing. Like the proper order I always counsel people is, so what is the strategy and what are you trying to get done? Then who do you need beyond yourself to help you do that? And having figured out those two things first, like what amount of, what's the minimal amount of capital that you need to achieve the first two things?

But oftentimes you'll see if I need to raise $5 million to, yeah, okay, but why five and not four? So you're thinking, this is the right thinking, is it's like, what's the strategy, what am I trying to do? who do I need to do, and then do I need money at all? So that's the first piece. The second piece, you're absolutely right. When you're bringing in capital, you're bringing in someone else into your ecosystem who may have a totally different objective function to you. And going back to our early conversation about funds, if I'm a typical fund person,

by giving you money, I want you to be marking up that valuation as quickly as possible. So I can now put you in my presentation to my LPs to show how good I am or to put you into a presentation to raise even more money for a future fund. So my motivation is for you to on paper and in actuality give me returns there as high as possible as quickly as possible. And that might actually be to the detriment of your business. So again, without naming names, you could probably think of particularly consumer businesses that probably never should have been aspiring to be bigger than about a billion. Like that's kind of the cap, right? Like you're not going to have a direct-to-consumer sock business that's going to be worth $50 billion. Right. You might have a

have a platform business like Uber that might be worth north of a hundred. Like that makes sense. So first of all, consumer businesses should never raise too much money because there's a hard cap on how big that they can get. But if you were to take money with someone who had those two motivations, like grow as quickly as possible, give me a markup as quickly as possible, and maybe money back, you might start making decisions that don't make any sense, like burning through a whole bunch of money or meta, for example, hiring people that you don't really need to hire, making products that are outside of your core product. Like you think, oh, maybe I should start making a movie now.

You burn a bunch of money hiring like Leonardo DiCaprio or something. You know what I mean? So that is the thing. So again, it's like I was having a conversation with a friend who was in town from New Zealand. And he's building what I think is an unbelievable business in the pet food business. And his consideration is I build it all myself with my own money because he already had a big exit previously and his partners. and his only reason to take money from an investor would be, will that money and the expertise of the investor help me to grow more quickly

than I would otherwise grow by just continuing to fund it myself? And that's really the key consideration that that investor who's giving you the money, if they're wanting you to grow in your valuation to be juiced, well, they should have some clear path that they should be pitching to you of exactly how that's going to be accomplished, as opposed to giving you the check and hoping that you figure it out. Right. In that case, would that relationship naturally have to end in an exit? I think, yeah, good question, Paula. I think honestly most investors at some point need an exit

because most people that you would take capital from, if they were venture capitalists, they need to also return the capital to their LPs. And it becomes a little bit of a problem for them. If most funds have this kind of 10-year, you can extend a bit, but call 10-year the rough thing. So if I've got to year 13 and they haven't got any money back, that's creating a bit of a problem for them with their own investors. So whereas if you took money from an individual or an entity that just was playing the long game and maybe you're giving them some sort of dividend or something like that, then it's a different story. But yeah, there's a great book that a founder posted on LinkedIn. I was just talking to her the other day. and I think it's called something like founder unfriendly

like it's friendly but I forget who the author is but you'll be able to find it from AI and I've not read it but she posted it and she's a great founder so there must be something to it and I think it's getting to this root of the problem which is the investor and the entrepreneur may have different time horizons different objectives different views on

so the more alignment you can get before the money goes into your bank yeah the better for me that idea developed after I read a book book called Lost and Founder. Oh, yeah, what a great title. I haven't read it, but I was like, man, I'm working on this other book right now. I've got to come up with it.

I've got to come up with a good title. Yeah, lost and founder. Lost and founder, yeah. I would buy that book, even if I never read it, just have it on my shelf. Yeah, it's written by Rand Fishkin, who is the founder of SEO Maws, which later became Maws.com. I'll not to, well, again, coffee kicking in. Here's another great title of book I have actually read.

he wrote a book called burn rate and it's it's in the same thing right everyone knows what a burn rate is right but it was also about getting burnt out as a founder and sort of mental health issues but yeah lost and found a burn rate there's a few where the titles just right on the money right yeah but yeah in in in that book Rand Fishkin talks at length about the different incentives that a founder has versus the the founder versus the funder Yeah, yeah. And I think that's why you've talked a lot about different asset classes, right? And if you think about just buying some stock in Apple, the good thing about that is,

first you could get some advice from someone who tells you whether they're good. You could read up about whether you think Apple's on the right trajectory, but also, if you didn't like it, you can sell your shares tomorrow. Right. So liquidity becomes important too. And if you invest in a venture capital fund, depending on the manager, it might take you a little while for some of that money to be recuperated, again, depending on what their philosophy is. Right.

Are there any questions I haven't asked? Anything else that you'd like to cover? I guess we were having a chat earlier with Joe, too, just about AI and stuff like that. I don't have a strong viewpoint. On that, except to say, I think it sort of behooves everybody to try and learn a little bit about how it impacts them personally, impacts their opportunity set, and also would help if they want to be an entrepreneur or business person, how it helps in that regard. And if you go back to 20 years ago, whenever the internet was first kicking off,

I remember I was at an academic conference and I was there with a fellow who's my academic granddad. So my advisor's advisor, very nice fellow. His name is John Little. And he's a professor at MIT, actually very renowned as an institute professor. And has a law named after him, Little's Law. And I remember saying to John, we're at this conference, every frigging paper was something to do with the internet. Like this late 90s, 2000.

And I said to him, I said, John, why is every track of this conference, there's all something about the internet? So is this going to be a big deal? And he looked at me and he's like, Dave, do you think the automobile was a big deal? Just to say, yeah. And that turned out to be pretty transformative, right? But I think people are saying with AI, like the transformative index or whatever you want to call it, is going to be exponentially bigger.

I mean, that kind of remains to be seen. But I think just staying abreast of what it is, how it works, how it can help me, I think it's really, really important. Right. Well, if you think about, I mean, the internet was for millennials, the differentiation of the millennial generation is that we are the last generation that will ever remember what life was like before the internet. Right.

And that is the key defining attribute of the entire millennial generation. Right. And what they're saying is that gen alpha now, the key defining attribute is that that is the last generation that will ever remember what life was like before AI. Oh, this is, yeah, what a great observation. Yeah, 100%. It's funny, I'm sitting here as a Gen X, I think. We're like the forgotten lot. Like, you know, what do we forget me?

I remember, it's funny, I was talking to somebody yesterday. Oh, actually, it was on another pot. It was so fun. We're talking about, like, now milk vending is back, I guess, in Jersey or Philly or whatever. You can get milk delivered by the milkman. Oh. And this was a thing when I was a kid in New Zealand, my job, I had to walk to the end of the driveway, leave out the milk bottles. And you put like 10 cents in each bottle, like an honor system.

And I remember I got like in deep, deep trouble with my parents because my buddy across the road and I were like six years old. We decided to be a good idea to run around the neighborhood somehow at night. parents, we snuck out and like steal all the milk money, up and end all the bottles, and then go and buy candy the next day. So like I'm old enough to remember like milk delivery and bottles and, you know, what you said is interesting. I wonder what kind of things will come back to. So I remember roughly 2000.

I was in San Francisco and he's out of Buddy's house. We wanted to watch a movie and have a couple of beers. It was a Sunday night. And there was a company called Cosmo back in the day, which, you. You could go online and some dude on a bike would show up with his, whatever, Titanic and a six-pack of beer. And then I forget how you returned the DVD. But anyway, you could, and the thing went bust, it was overcapitalized by VCs. But you think about, well, yeah, now there's DoorDash and all these other companies that are worth multiple billion dollars.

And so sometimes I'd try and think about what was kind of before it's time. So we talked about pop-up pantry, shipping these pre-cooked meals. I mean, I think if I might be pronounced, Tavola or whatever it is, like, they've kind of done that several years later and they're killing it. Like, they're doing several hundred million dollars a year in revenue. So sometimes you're just a little bit too soon. Yeah, too early. Too early. And then the idea kind of comes back.

But yeah, that's interesting. They will be the last generation not to know what it's like to grow up with AI. Wow. Yeah. Yeah. Well, thank you again for spending this time with us. Thank you, Paula. Where can people find you if they'd like to learn more?

Oh, sure. They can just find me on LinkedIn, probably the easiest place, David Bell, B-E-L. I have a personal website as David Bell.co. Those are probably the best two places, yeah. Excellent. Awesome. Well, thank you. My pleasure.

Thanks, Paula. Thank you, David. What are three key takeaways that we got from this conversation? Key takeaway number one. When you invest in a fund, you're not betting on the startup. You're betting on the person picking the startups. Almost anyone with a solid income or a solid net worth can become an accredited investor. You are qualified to write a check.

But that says nothing about whether you can tell a great fund manager from a con artist. David's whole message here is to slow down, dig under the hood, and get suspicious when someone makes it a little too easy to hand over your money. I wouldn't be charmed by a GP. It's the Groucho Marx thing, right? You don't want to be part of a club that will let you into us, you know what I mean? So, like, if the GP will accept your money off the bat, like, that's not necessarily a good sign, right? And of course, since we're here in York, I mean, there's been unbelievable scandals around the venture industry not that long. I think about someone like Bernie Madoff, who was just the guru who, you know, doing whatever he did, who had these incredible returns for whatever 20 years. And I don't think, remember from the documentary that the guy even made one investment,

he was just printing out fake reports and sort of carrying this mystique. That is key takeaway number one. Key takeaway number two. Money on paper isn't the same thing as money in the bank. What matters is who actually buys the thing and for how much, because a valuation can look incredible right up until the moment that you try to sell. And that's when reality sometimes punches you in the face. David describes two founders in the same room,

and they had the exact same pay. paper success, but completely opposite outcomes. One built a company that a dozen buyers wanted, and the other built a company that had a single possible buyer, and that person nearly lost the whole deal when it almost fell apart. So, before you chase a hot private deal, ask who's waiting on the other side when it's time to sell? I was at a consumer conference maybe a year or so ago, and there was one founder, and she was talking about a beauty brand that she had built, and she said, once I had $100 million in revenue, I had like a dozen people knocking on my door, maybe from L'Oreal to Church and Dwight to whomever. And there was another guy

on the other side of the room, and he said, I was building sort of a mattress type company with a tech angle to it, and I literally had one person that I could sell to, and we had one go-around that fell through, and luckily two or three years later it came back and it got done. By the way, this concept about money on paper, I talk about this frequently in the context of real estate as well, because people get really caught up in their home value. And the reality is your home value only matters at three points, when you buy, when you sell, when you refinance. Those are the only times, the only three distinct point in time times when the valuation actually matters. Other than that, it's purely theoretical. So we can take that lesson from residential real estate

and apply it to the very opaque world of venture capital. It's the same concept. Don't get too caught up by what's on paper because until it becomes reality, it's all just fancy imagination. That is the second key takeaway. Finally, key takeaway number three, money is the last problem to solve.

Not the first. So most founders think that step one is raising money. David flips this order completely. Step one is figure out the strategy, figure out who you need beside you, figure out what you're doing, and then ask whether or not you need outside money at all. Hopefully, ideally, you don't. But this is a sharp check for anyone who's tempted to throw cash at a problem before they on the actual thinking. With many founders, they think the first problem they have is money. I need to go out and raise money. That's actually the last thing.

Like the proper order I always counsel people is, so what is the strategy and what are you trying to get done? Then who do you need beyond yourself to help you do that? And having figured out those two things first, like what amount of, what's the minimal amount of capital that you need to achieve the first two things? Those are three key takeaways from this conversation with former Wharton Professor. and co-founder of Idea Farm Ventures, David Bell. Thank you so much for being part of this community.

If you enjoyed today's episode, there's one thing, one and only one thing, that I really want you to do. To the milkman, assuming milk delivery has come back to your neighborhood, send it to the guy on the bike who's delivering a DVD of Titanic and a six-pack of beer, send it to Steve Cohen if you happen to run into him at a Mets game, send it to that successful dermatologist

who's never evaluated a startup. Send it to your orthodontist, especially if he's an LP. Send it to the intern who's getting paid out of the 2% management fee. Send it to the founder who raised $5 million even though they only needed four. Send it to the bogal heads you know. Send it to that 55-year-old middle school teacher with a Vanguard Index Fund portfolio. Send it to anyone charging $2.20. Send it to the founder of a DTC sock business.

Send it to everyone who passed on the Alibaba SPV and still think. about it. Send it to the Gen Xers who feel forgotten and then send it to the Last Gen Alpha Kid who will remember life before AI. Send it to all of those people and more because that is the single most important way that you spread the message that you can afford anything but not everything. Thank you in advance for sharing this episode far and wide and far. Thank you for being an afforder. This is the Afford Anything podcast. My name is Paula Pantt and I'll meet you in the next episode.