How I Invest with David Weisburd - E27: Fernando Pontaza of Invariantes on Why 25% IRR is the Gold Standard in Venture

Episode Date: December 12, 2023

Fernando Pontaza, Co-Founder of Invariantes sits down with David Weisburd to discuss setting up the first Guatemalan Venture Capital Fund and why he targets a 25% IRR. We’re proudly sponsored by Bidav Insurance Group, visit lux-str.com if you’re ready to level up your insurance plans.

If we assemble a puzzle of funds that write a bunch of tickets in different geographies, different sectors, with different narratives, we are going to be able to create an index representative of early stage venture capital itself. And that's going to be that 50% of the portfolio that captures that 25% average IRR that the asset class produces. Also, since we're very active LPs, like we go to battle alongside our fund managers, helping their portfolio companies, helping them get LPs. And we also get access to their deal flow.

We share deal flow with them. We get to pick deal flow. We share deal flow with them. We get to pick their brain. So it's a much more valuable than just writing a ticket and having that index. Well, Fernando from Invariantus, it's a pleasure to meet you. We were introduced by the wonderful Jamie Rowe. Thank you, Jamie, for the introduction. So Fernando, a lot of interesting things to talk about today, but welcome to the Limited Partner Podcast. Thank you very much for having me.

It's an honor, man. I've seen the roster of people that come on your show and I hope I do your listeners justice. Well, I appreciate that and appreciate the kind words. So let's start. You started the first venture capital firm in Guatemala. How did that come about? Yeah, well, it was an ongoing effort. You know, by that time in 2015, I had worked at a multifamily office managing the proprietary

trading portfolio of that multifamily office. And with my partner, who is the owner of that multi-family office we saw that there was a need and a gap that needed to be filled if people wanted access to the asset class some success cases like uh luis bonan who saw a watermelon who then went to the us and started duolingo now public they captured the imagination of the public and people wanted access to another asset class and by the same, founders were knocking on the family office door looking for funding and we didn't have a proper platform to serve those needs. So we said, why don't we leverage on what

we've done so far and start Guatemala's first capital fund? And by that time, we had amassed a portfolio of about 170-ish alternative investments, private debt placements, private equity, venture capital, direct deals, etc. through about a decade or a little bit longer than a decade. So we said, man, we have this awesome network of people. Why don't we start a proper fund and serve the needs and the wants of investors and founders alike? You mentioned the success of Duolingo. I think it's a wonderful thing how startup ecosystems bloom from these several successes.

In Silicon Valley, you've had generational companies such as Google and then later Uber and Facebook that has really sprung these angel communities and sprung this excitement. Tell me about how that happened in Guatemala, a relatively new market to venture. The local ecosystem is quite young. I wouldn't say that it's vibrant. Even at the beginning of our conceptual phase as a fund, we said, let's invest in Guatemala. But we quickly realized that the pipeline isn't there for a fund to be dedicated exclusively for a Guatemalan investment. So we started looking elsewhere. The final spark came by way of our third partner in the fund, that first fund, who is a mentor in the Teal Fellowship. And he said, why don't you come and look at what these guys are building in the Teal

Fellowship? Maybe we can incorporate some of those best practices in our own ecosystem here. And as luck would have it, we jumped on a plane in mid 2015 and went to that Thiel summit. And it just so happened that Mike Gibson and Daniel Streichman, who ran the fellowship for his first four years, were announcing the start of their own fund called 1517 Fund to capture the ecosystem of this out fund called 1517 fund to capture the ecosystem of this out of college kids that they had invested in and we said after hanging out with them and getting to see how they interacted with founders and the sharp eye they had for picking people for the fellowship i mean out of those 80 young people because it's 28 years 36

have started companies and among those you had the likes of vitalik buterin who started ethereum or austin russell who took luminar lighter sensor company public and founder of figma as well we said man what we have to do is invest in them as lps and also do the wrecks and that's where the idea of our hybrid model was born. And it's the formula we've done almost copy-paste from our first fund to today. Half of our funds we invest in other funds, half in direct tickets. We're anchored on great funds. I think it's a really interesting case study and really brilliant way to find product market fit.

You realize that Guatemala did not have enough deal flow to satisfy an entire venture strategy, but you didn't stop there and you focus on finding product market fit for the market. Tell me about the ultra high net worth and the family office community in Guatemala. What are they currently investing in? You'd be surprised, but you'd be pressed to find people that do something other than buy an apartment or part their money in a one-year deposit and get that fixed income. And that is about it. So it was an uphill battle trying to convince them to participate in an asset class such as VC that has its own risks. It's a liquidity profile.

And we almost banged our head against the door on those first pitches. But again, this is where the 50% that we invest in other funds came into play because it was a way, if you will, to hedge the performance of our own fund by investing in other funds. And then with a high degree of certainty certainty we're pretty sure that we're going to return that 50 of the portfolio with gains and then the other half we can deploy into the rex to our best judgment you call investing with the funds that we are lpc or sourcing deals on our own but it was a strong selling piece like like telling what a guatemalan very conservative investor you know look this is how we're going about it. You're going to have a very distributed investment in multiple funds, each fund with 30 to 40 companies. We're not

going to be overexposed to a sector, a geography, a company, and with a high degree of certainty, we're going to get at least that 50% of the money back in your hands. I know you subscribe to the Jamie Rhoie road philosophy she's one of the great philosophers in the limited partner universe tell me about your philosophy and tell me how you marry that philosophy with your customers which is essentially the ultra high net worth in the family offices in guatemala and abroad we subscribe to to jamie and and steve's a power law distribution strategy. And much like them, I mean, they were even part inspiration. We met them about three years into our first fund, but they validated what we had done,

like through different mental frameworks, we came to the same conclusion. So then when we met, you know, it was quite a fun talk and it just so happens that they were also lps in 1517 and we we haven't met until three years after we committed to that one so so we said oh these these people are like-minded we believe much like them that if we assemble a puzzle of funds that write a bunch of tickets in different geographies, different sectors, with different narratives, we are going to be able to create an index representative of early-stage venture capital itself,

and that's going to be that 50% of the portfolio that captures that 25% average IRR that the asset class produces. And also, since we're very active LPs, 5% average IRR that the asset class produces. And also, since we're very active LPs, we go to battle alongside our fund managers, helping their portfolio companies, helping them get LPs. And we also get access to their deal flow. We share deal flow with them.

We get to pick their brains. So it's a much more value add than just writing a ticket and having that index. We also get that value add on the direct side of things. Today's episode is sponsored by Badaw Insurance Group. Badaw Insurance Group is run by my close friend, Amit Badaw, who insures me both personally and at the corporate level. Most people are not aware of the inherent conflicts in insurance, where insurance agents are incentivized to send their clients to the most expensive option. Amit has always been an incredible partner to me and 10X Capital, driving down our fees considerably while providing a premium solution.

I am proud to personally endorse Amit and I ask that you consider using Badaw Insurance Group for your next insurance need, whether it be DNO, cyber, or even personal car and home insurance. You could email Ahmet at ahmet at luxstr.com. That's A-H-M-E-T at L-U-X hyphen S-T-R dot com. Thank you. The co-invest is both a way for you guys to juice your returns, but also be a value-added partner to your GPs. But let me push back a little bit. You mentioned 25% IRR. I've looked at Jamie's numbers and the index approach, and those are the numbers. But is your essential trade-off, are you giving up some of the upside? Are you ever going to have a 10x fund by doing the strategy and is that the inherent trade-off in your strategy good question and it is a trade-off yeah i don't think we're ever going to have a 10x maybe i mean if we take a look at our first fund and our biggest position

was the commitment into 1517 fund and that fund itself is talking about a 7x TVPI-ish and already distributed about 3x. With that and a couple of directs, we could be a 10x fund. But what we are striving to do is not be the 10x fund, but be a consistent vintage after vintage fund that gives investors that are already shaky with the asset class and good experience with the asset class so that they continue to add it as part of the portfolio. And that's our way of evangelizing our own investors in the region and people in general in the region about the asset class. So it is a trade-off, but it's one we're willing to take in exchange for smoother results. I think that's a trade-off that is wise. In terms of, you're in some of my favorite emerging managers.

Tell me about how you go about choosing an emerging manager. One part of the framework is that they fit within that puzzle of funds. Like 1517, they invest in sector agnostic funds, but they invest in people outside of the college system. That's one way to go about it. But then we also invest in uncorrelated fund, Salil Deshpande's infrastructure software fund. He has a completely different way to go about it. And you're going to see very little overlap within the two. Add another piece to the puzzle, a hustle fund. They invest in execution speed and write a bunch of tickets,

maybe over 125, 150 tickets, and then graduate them if they execute accordingly to a hedge position and ultimately to a core position. Completely way to go about it. And then we also have investments in Latin America, like 500 startups Latin American fund, and they invest in the companies that go through their program, well, there's a different geography right there. I wouldn't have two funds

that do the same thing in a sector or a geography or a narrative. So that's one piece of it. Another one, of course, is fund size. We prefer emerging managers managers funds that are usually under 150 million in assets you know i was i was looking at our average fund size of funds that we've invested in and it comes to about 121 million is the average fund size of the funds that we collaborate with another one is that we get a direct access to the gps i, these are relationships that almost go beyond just a transactional relationship. It brings me to, are you familiar with the Dunbar number? Have you heard about that? Yeah. The amount of people you can manage. Yeah. It's about 150 stable relationships, like correlating the size of a primate brain to humans but then the same

number also says that you have a five a core people that you have a relationship and about 10 to 12 more than that are the ones that you can fully trust those 12 apostles if you will then every time we invest we have to know that there's a potential that this manager will be one of those 12 apostles like mike and danielle from 1517 we talk on a daily basis we joke we i had a shoulder procedure and had to take doing in the us and i recovered it at mike's house uncorrelated with salil we just met went to the Bay Area, we meet for wines and philosophize. We have to have that direct access to the GPs to collaborate professionally, but also to develop a closer relationship. Also, co-investments are important to us because we do

value that co-investment. It's hard enough to generate deal flow being here in Guatemala and so so that co-investment piece is a definite value add and something that we look for and finally I mean it's just maybe it's a cliche but much like investing in direct tickets and founders you invest in in funds in the GP and you somewhat develop a pattern recognition, if you will. And I think this was developed throughout the 10 to 12 years that we managed that multi-asset class portfolio, ended up investing in 174 different vehicles. So we screened an order of magnitude above that and you start seeing, oh man, I invested in this GP for this reason, and it

proved itself in results, a mix out of all those criteria. And that's about how we go about picking the funds. Let's double click on that, because there's a lot of people, a lot of brilliant people such as yourself that maybe five, 10 years back, they're starting to invest in venture. What is it that smart people get wrong about investing in emerging managers? One mistake we made in the investment on one fund, it was that they had a letter of intent for a big LP, and they were anchoring their whole brochure on that letter of intent. That was a commitment going to be made into their fund by a very well-renowned bc fund and they raised some commitments with anchoring their pitch on on that their strategy was sound they were good managers but at the end of the day this particular lp ended up yanking that commitment out of the

table and we ended up being almost a majority owner of a very small fund that without the scale that they were they set out to raise now they can execute their strategy so I guess one thing we do when it's a the first time we invest in an emerging manager is we wait at least after the first or second close so that we know that there's enough volume for them to operate now this is not the case with our Legacy positions like they take for example 1517 or 500 startups if I were to look into my cover there's a t-shirt that 500 Latin America it did for us that it's we were first money in their current vintage we we know how they work and in that case since it's a legacy position we do go in as first money into these funds it's another

type of thing that we would do to add value to our fund managers but that would be a piece that i would like to share like wait until the first or second close to just to know that they are indeed going to get the mass on the volume to operate and execute the strategy as they planned i think that's important to have a minimum viable fund size meaning that you have enough of dry powder in order to have execute on your strategy whether that be certain level of diversification certain round sizes certain check sizes i think that's critical What other benefits do anchor investors, anchor LPs have for non-anchor LPs? We get to share deal flow. We get to pick brains off on sector-specific managers on deals that maybe we don't have the precise

technological knowledge on how to evaluate a biotech investment. For example, we're not biochemists, but we know we can turn to one of our funds and they do have a specialist and we can validate a cross-reference deal within our own pipeline with them. Maybe we introduce that deal to them and we end up co-investing in that deal. A recent deal that we invested in, it was because this company was raising a Series B and the Series B investor that was leading the round stuck their elbows out and brought out egregious pay-to-play provisions.

So what we ended up doing to protect the position of the fund that we're all piecing is writing up a direct ticket from our fund and also raising an SPV into that company so that the affiliated amount protected our funds pro rata and reduced that potential dilution with the pay to pay provision. So what they got out of that is they kept their undiluted position. We got access to a very great deal. The founder was happy because he kept his early investors happy and undiluted. And it's a win win win, like a virtuous cycle. I think that should be in the dictionary under LP value add, do a direct and syndicated

investment in order to protect your funds position. That's something that's something new. I've never heard that. That's amazing. But you did mention biotech fund and being able to diligence non-technology opportunities. So if the biotech fund was to go in reverse and to bring you a co-invest, how do you go about diligencing something like that? And are you even able to make investments beyond the core competencies of the three partners? We do on a regular basis. I mean, most of our investments tend to be a B2B SaaS company, something that we can

understand and digest much easier, but it has been the case that the investments that are tracking better have been hard science companies. Case in point, Luminar, which is a LiDAR sensor that went public. Luminar, which is a lighter sensor that went public, Lambda Labs, which is an infrastructure processing company that tends to the processing needs for AI and deep learning. They give their services to hyperscalers on the cloud like Amazon, Google, etc. That's something that perhaps we wouldn't have had the core competencies to do a proper

due diligence, but that's where this vetted network of trust comes in. Not only could I get introduced to that deal by one of our fund managers, but I can pick another manager's brain or two and come to a more well-informed conclusion with three different sets of eyes looking at this, plus our own judgment. Yeah, so let's double click on that and have some generalized learnings. I think a lot of GPs send co-invest and it kind of goes into a black box and then the LP comes back and says yes or no. So let's uncover that. So I send you a co-invest. What is this process for evaluating that co-invest?

What is the timeline and anything else you could expand? As the typical fund manager will tell you, we look at things like market size. It has to be a massive market. The team, they have to have the technical capacity to execute. The product has to be in order of magnitude better than anything that's out there. Good understanding of the unit economics and if the valuation makes sense. But then we tend to add little nuances there. Like for example, is it a differentiated technology where there's an urgent need or forcing function? And then there's

something non-obvious about it. Like why isn't everybody doing this? And this particular set of opportunities gives the founder a sort of breathing room to build out a monopoly franchise. And it's not necessarily a technical note, but that type of thing that's contrarian about it. We've been impregnated with the funds that we invest in. Each of them has their own particular styles and we lend from them and mix them into our own. Another thing we look for, thinking about 1517,

they like hyperfluency in a founder. The founder is able to dumb down a complex theme and explain it as if you were talking to a five-year-old or that the founder has a self-sustaining motivation because it's money that he's after. I mean, this is going to come five, six, seven years into the future. You got to have some other driver there. And then we mix all this criterias

and decide if we're going to write a ticket or not. That's how we go about it. We talked offline. You're incredibly direct and transparent. So I'm going to ask you a very direct and transparent question. What percentage of the decision is made on a new lead coming in for the first time? You know, let's say you have Andresa and you have Sequoia,

you have pick your top DeSalle fund. How much of a signal is that? And how much of your decision making is based on the lead alone? Trying not to get influenced by the fact that a brand name, the flagship fund is in the deal or not. It's nice, but I mean, in the real world, it's not a guarantee that that company is going to be better or worse. What is nice is that you have a fund in there that could help you lead the subsequent round.

That's something that's powerful and useful for that company. And we value it that mind frame more than the fact that it's like a brand name fund in the cap table. Nice to have, but not something that is a must for us. Most of the deals we do are done within the universe of this emerging manager community.

And I value more if one of the funds that we're piecing is participating in the deal than if a flagship branding fund is participating because I know how these managers think work and their track record and how they go about business. I think it's one of the most under leveraged part of the ecosystem. You mentioned talking to 1517 on a daily basis and staying with them when you were rehabilitating. That's also a new use case. But what is the best practices? How should GPs interact with LPs? And how should LPs interact with GPs? What's a good way to build a relationship between the two parties?

That's up to the GP, I think. I mean, if I look at it from the standpoint of us and our LPs, we have a lot of LPs in different sectors here in Latin America, and we try to be close to them. As you know, Latin Americans, we're in love with WhatsApp. So we are open to all our LPs for a WhatsApp message. We send quarterly reports, we do events, but we're approachable. We're open. We're an email or call or WhatsApp message away. And every time, for example, we also, we are proactively reaching out to them. Case in point, one of our portfolio companies, Job Excel, what they do is they incorporate video into hiring processes, like web-based video hiring experience. We reached out to one of our LPs because he is in the BPO sector and we ended up getting that particular company, Telos, as a client.

And it was their second paying corporate client. And then from here, Telos hired them as Telos Global, our LP that we reached out to. And he's happy because he added value to one of the portfolio companies of the fund he's an LP in. The founder is happy because he got that pending customer. So you proactively go about being open and approachable to your LPs. But I think that's the GP's job more than the LP itself. In our case, we do a hassle. Our GPs are like picking their brain. I think it's up to the GP. So that's up to the GP. So what should the role of an LPAC be? Is it analogous to a board?

What are some best practices around LPACs and what should LPACs not be doing? Yeah, LPACs are sounding board for when unusual decisions, should I do a follow-on investment on a company from the previous vintage? Is it ethical or not? But an LPAC, pretty much, I think its job should be being there for when there's this type of situation, more than getting in the way of how the GP manages its fund. That should be the LPAC's job, being a sounding board for when sticky issues arise. In terms of Latin American LPs,

how should GPs interact with Latin American LPs? What are some idiosyncrasies that one should be aware of when raising capital in the region, when building relationships in the region? Key point is that Latin American investors are very conservative. The more you can ground the concepts of VC relationships in the region? Key point is that Latin American investors are very conservative. The more you can ground the concepts of VC to the reality of a very conservative investor,

that's one thing. Frame it as if it is a portfolio construction exercise for them. Like, look, I don't know how prevalent this is when you pitch to US investors, or if this is relevant or not, if if you tell an american investor look you have this amount of assets this is your company that where you generated your wealth you have this apartment which is real estate you have this accounts maybe you have some stocks etc you have no bc exposure you should have that at least five ten percent exposure to the asset class because it performs and compounds at a higher

rate and it will be complementary and maybe not even correlated to the rest of your assets. And you can also distribute that risk geographically outside of your home country. And that's kind of how we go about it in our pitches to our lps and they receive that message well and another thing is that there's a tax advantages for example take guatemala as an example we we are a guatemalan investor our fund is domiciled in cayman islands and if we invest in the us we're non-us investors so that investment doesn't have a capital gains tax on it. And then, the Autonomous Jurisdiction doesn't pursue any gains that you generate outside of the geography. So, basically, every exit or distribution that we get is tax-free.

So, that's another important thing. Each country has its own tax considerations, but that's the case, at least for Mexico and Central America. I think taxes, however not sexy, is one of the biggest driver of returns. Of course, in the United States, we have qualified small business stock, which essentially if a company has raised less than $50 million, oftentimes the gains are tax free both on a state and a federal basis, depending on the state, but most states do comply with that federal tax code. On the other end, you have LPs,

you have a new region, Latin America, that is accessing venture more aggressively. Outside of investing into invariantists, which I think would be a great way to access the venture asset class, what other best practices do you have for Latin American LPs in order to access the top US managers? One thing to avoid is that, and this is something that I've seen recurrently, is that the way Latin America typical investor wants to access BC is they go directly into a company and maybe it's a local company. And the chances for success are small. As hard as it is for BC in general, I think within Latin America, there's even more obstacles for getting an exit. There's less liquidity, there's less large companies willing to do a merger and acquisition,

the stock market is robust. So if they do a direct deal and it goes sour, and they usually have seen that they write too large a ticket, you become completely disenchanted with the asset class. So I would definitely point people towards getting that first taste of BC through a fund. And I mean, the ecosystem isn't that big in Latin America in general. At least our focus is Central America and Mexico. That's where our network is the strongest. And if you give us a call, I could tell you what funds we participate with, what funds in Mexico you should look at. And there's about a handful of them that are good managers that have

track record. So it isn't that hard to narrow it down to good investors that have track record. Now in the US, it's more complex. It's harder, I think. That's our job. That's what we bring to the table that we've screened and created these relationships through a decade of being in the game. And we have selected and have our way of finding these emerging managers in the US. But within Latin America, I think it's pretty clear. It's not that hard. You have 500 startups again, you got NASCA, you got the Wall of NXT Ventures in Argentina and other players. But just with those that I named, you have top people in the game. I want to highlight something that you said, which is a very common mistake that individuals that come into venture capital make, which is

concentrate their investment to a few companies. The reason LPs have that intuition is because it tends to work in other industries such as buyout, such as credit, but with the loss ratio being what it is in venture capital, in many ways, venture capital is both the greatest and the worst performing asset class in the world. Jamie Rode summed it up in episode 13 really nicely,

where the median return in venture is 10%, which you might say 10%, not terrible, but it's actually a pretty terrible return when you think about the illiquidity of the asset class. But the mean return is 50%, 5-0. And what differentiates the median from the mean? And there's only one thing that you could really control, and that is the diversification of your portfolio. So if you have a portfolio of 5 of 10, you're almost guaranteed to get the median. If you have a portfolio of 200, you're almost guaranteed to get the mean or close to the mean. So it's very important to look at your portfolio, whether it's via funds that access many different asset classes, or whether you individually build an asset portfolio of 200 direct investments, I do not recommend that direct investments

is a very sophisticated skill set, just to give you a sense. Many institutions take five years before starting their direct investment program. And these are the top endowments, top institutions in the world. But I would very much caution people from making one or two investments. It's better to start with a fund and start to learn and build up your book from there. And after several years, start to build up

your direct investing platform. Completely agree. I subscribe to what you just said and to Jamie's Church of Diversification as well. And it's something that's worked well. Like, for example, some of our LPs, after we've given them a good taste with our first fund that now it's

fully returned about 1.44 times with four exits they got that first success case in BC then participated in the second fund and then they come at us and approaches us and ask us questions and they pay close attention to our reports and about maybe five or six of them are already angel investors themselves now eight years after writing their first check into our first fund. And I guess that's something that makes us proud. It's part of what we set out to do, which is help out the local ecosystem. As this is the way we're going to go about it, then this is going to be how we're going to help instead of investing directly in local founders, which we do by the way, but it's

a small sample of our direct. In many ways, venture capital is like any product and you want to deliver a magical experience to the customer as quickly as possible. You want to close that loop. Uber famously, or maybe infamously, when they were starting out and a customer would take their first ride, this is something I know from direct feedback

from people at Uber, they would cancel everybody else's Ubers and drive the best car to that first customer because they wanted to make sure that the first experience that that customer had was magical. make sure that the first experience that that customer had was magical. I think it's brilliant. It's somewhat controversial, but I think you want the same thing in venture capital.

And the problem is that the first experience could often take eight, 10 years. So you want to be very thoughtful about how you invest in the venture capital ecosystem, that you're diversified and that you make sure that you account for things like liquidity, risk, and diversification. I think you've done an amazing service for Guatemala and for Latin America, and not only helping them access this asset class, but helping them access the asset class in a predictable and smoothed out manner. So I want to thank you for jumping on the podcast. And, you know, the floor is yours. What would you like our listeners to know about you, Fernando, about Invariantes, about Latin America, anything you'd like to evangelize? Well, thank you. Thank you for having me. Again,

it was a pleasure being here. Thank you for the opportunity. And just know that our doors are open here. I mean, we're very friendly. If there's a company we can help out, if there's a U.S. company turning their gaze down to Latin America and they need a friendly door to knock on, please, by all means, you can just write me an email, send me a message in WhatsApp in a very Latin American fashion. We're here for the long run. And I hope when we raise our forward advantage, we keep doing this good work. and platforms like yours that allow more people to know about what we're doing are priceless to us. Thank you, Fernando. And I look forward to meeting in New York City and Guatemala. Maybe we meet halfway in Miami. But I look forward to this.

It's a new relationship. And I look forward to the friendship and thank you for jumping on the podcast. Thank you for listening to this week's episode. In order to make sure you do not miss out on next week's episode, please make sure to subscribe below. We thank you for your support.