How I Invest with David Weisburd - E47: Sean Warrington of Gresham Partners on Avoiding False Signals in Investing

Episode Date: March 5, 2024

Sean Warrington of Gresham Partners sits down with David Weisburd and Erik Torenberg to discuss his investment decision-making process, extreme risk factors in diligence, and his approach to investing in emerging managers. The episode also covers reference processes in fund management, the impact of social proof and momentum in investing, and best practices of cutting-edge family offices.

I said, we need to make a model that is more attractive and easier for the GPs we want to invest in. When you do these references, what are some non-obvious questions you're asking? One of the easier ways we can get to information we really need is we end up every call like, hey. A top fund investing for the first time is not necessarily a sufficient signal for you. Why is that? If it's a multi-stage that's doing many, many, many seeds per year, they might just be buying their way into the company such that they could ultimately deploy a significant amount of capital in the seed, in the A, in the B, in the C. The problem is like...

Sean, we got to know each other a couple of months ago and had a really interesting discussion. Welcome to 10X Capital Podcast. Absolutely. Thanks for having me. So let's get right into it. You work at Gresham Partners. How did you come to Gresham Partners? I began in the industry about 15 years ago at a great cause called the DuPont Trust down in Jacksonville. Think of this as the classic foundation, $8 to $10 billion portfolio. And then in 2019, I had spent a fair bit of time there, almost 10 years. It was time to do something a little different.

And I found Gresham, which is a multifamily office. We just had a number of names in common, some of them fairly unique and nuanced. And that gave me comfort that it'd be a place that I'd feel good about the investing. Give me some names. One you'll know, one's a funky buyout name, but the big one was probably Founders Fund. So you're in Founders Fund, both at the DuPont Trust as well as at Gresham.

As an LP, how do you look at their strategy of really piling into a large position and the independence-mindedness, the lack of consensus building? Uncomfortable is not the right word, but they're gonna do things you don't understand at the moment. But the good news is we're so far deep into that relationship. You know,

they've proven it works before. Like SpaceX, you know, when they were first in that in a big way, you weren't really sure it turned into a great company. Raised 1.8 billion, they said 900 million for this vintage and 900 million to the next vintage. What did you think as an LP? That was a bit of a power play. To do that, I think you have to have confidence in your own ability. They obviously saw something in the market that got them nervous. They know how to deploy money. They can write big checks. They obviously saw something around valuations or opportunities or what have you that said, this isn't the right time to deploy this quickly or certainly this much.

And they had the confidence to actually give the money back to LPs. The folks that I know in it, and I know a fair number, none of us view that anything but positively. Obviously, we like having money in founders funds. It sort of takes your allocation in our book down a little bit, but you'd rather have good money going after good. And if someone tells you we have too much to deploy, you should take their word for it. It was another feather in the cap for them, in our opinion, and the way we saw it personally. So you came from DuPont, which was a foundation. And as an LP, you essentially have a competitive advantage

as a foundation. How did you retain that competitive advantage? DuPont Trust is an amazing cause. Great team, top tier team, and it's a children's health organization. That is the easiest thing to sell around the world. If you want to get into the very best funds, at least as an LP, there is a salesmanship aspect to it. And when you have a story and a narrative such as children's healthcare, that works really well. When I came to

Gresham, look, there are lots of amazing causes at Gresham. We have 120 families. We're a multifamily office. I can get into that in a moment. they will have their charitable causes. But at the end of the day, it's not as powerful as pure play children's health. So what we said when I came and I joined with our CIO Ted, I said, we need to make a model that is more attractive and easier for the GPs we want to invest in such that we are an attractive partner for them. So we brought to bear a far more transparency. We're very quick to tell people no, if we tell them yes, we're doing work, that means we really are. We provide timelines.

We also have an easy IC. Easy, not in the sense of getting things through, but we have three people on it. It's our CIO, my counterpart on Publix, and myself. That means if the three of us want to do something, there won't be non-investment reasons something doesn't get in the book. Tell me about the friction on the IC. How do you come to the right decision? I think the IC talks are probably the most fun part of what we do. We like to have our hard conversations before the actual investment decision. And that would mean I can come at the end of the day with answers to the big questions. But where we really

push, we believe uncertainty is part of this business. As an LP, if you try to solve everything, you really can't do anything or you're kidding yourself. At the end of the day, we want to make sure we understand the key things we can understand. And on the things we can't, we want to price that risk into our decision-making. Nothing in this business is black and white, but we try to answer as much as we can with our team.

But our goal is to build something that is top tier, absolute return across our entire portfolio. Speaking of sizing positions, do you think more funds should be doing what Founders Fund did? Or what would you recommend to firms thinking about fund size? Oh, it's such a hard one. I would say we are more strict on fund size than most. No one else in our book has, frankly, decreased their fund size. We can actually

do a little bit of math and get to an answer. I think that was tough as an LP to sell people against in 2021, 22, really 21 and 22. It's now much easier to say, if I were a GP, you want to have your LPs happy. At the end of the day, like we are people, we like to build relationships. If a GP is working with us and they have a little bit of a slip up, something's not working, we are more than likely to listen to them. However, if you play hardball every step of the way, the second that situation turns, the LPs tend to run for the door. And I think fun size has become a bit of a talking point around that. And the folks who are more amenable may actually build longer

partnerships going forward, in my opinion. What is the most extreme version of when something came up in diligence and you said, well, yeah, that's a risk factor, but I'm going to move forward? The one where that comes up the most now, it's a fun topic. Solo GPs, I think, is actually a topic where that comes up regularly for us. Because at the end of. Because, you know, at the end of the day, like you singularly have the hip of the rust, like hit by the bus wrist, that is fundamentally there in every solo GP. And I think the distinction we've made in our portfolio is if it's in venture capital, and we believe, you know, there's ways that if that

person's not there in three years, we can have someone else manage the portfolio. There's ways for us to manage around the downside case. One of the things we commonly run into, we'll do ex-operators who are doing small, you know, sub $25 million funds. One of those people is going to go start a company. So we've accepted that risk. So we try to just understand

how do we solve for the worst case scenario? And if we have a solid solution, game on. Say more about what you look for, what you advise or what's important to you. Maybe just leave me a quick primer on our venture book because that'll help set the stage. Ours is fairly straightforward. We have two multi-stages. I mentioned Founders Fund. We also have Y Combinator. You put those together, you get an awesome foundational layer where you think you're getting a lot of alpha, but importantly, as an LP, you're capturing enough winners. And frankly, YC does a great

job helping us. That allows us to take more risk everywhere else. So we're building the rest of our portfolio, early stage focused. We talk a lot of times with people around the breakpoints of whatever their strategy is. If someone is writing a 500K check as a solo GP, that feels like that's a reasonable check size to get in. But in our opinion, if that person wants to scale up to 800K and I'm making numbers up, I'm not really sure there's a great cap table for that to fit in.

It's sort of in our minds, if you're 500 or below, you can be friendly, complimentary capital as one of our groups says, they're Switzerland. But if you want to write a little bit more, you're almost in co-lead lead land. And that's the way we talk to people around how they're investing, what their role is on the cap tables. And we try to help talk them into staying in their lane. But you also have to win your way onto the cap table. And if someone starts to move outside their sweet spot, that's where we get nervous. And frankly, look, we're going to have folks that graduate. And it's frankly a euphemism for saying they've probably done really well. And we part as friends. That's going to come up. What about these platform plays, these large funds that now perform everything from HR

to PR to business development? How much value add do you think those firms bring? Yeah, that's, I think, the ultimate question. You know, we've tended as LPs, you know, we know there's some value to that. We think it's more of a rifle shot. Help is where VCs can make the biggest difference. In our opinion, I think the very best entrepreneurs probably fill most of those seats, but the VCs can come in and say, Hey, have you talked to this

person? You know, help me get this person across the line. Look, if they can follow on for the next six rounds, that does give whoever's joining and understand, Oh, like this company has funding, assuming we do our jobs. But if that VC is doing every single spot, my suspicion is we don't have the best team. It's somewhere in the middle. Like there's value add to be had. But my guess is the rifle shot help when it really matters is more important than having various functions that help every step of the way. We'll continue our interview in a moment after a word from our sponsor. Most businesses use up to 16 tools to hire, manage, and pay their workforce. But there's one platform that's replaced them all. That's Deal. D-E-E-L. Deal is the all-in-one HR and

payroll platform built for global work. Smartest startups in my portfolio use Deal to integrate HR, payroll, compliance, and everything else in a single product. Focus on what you do best, scale your business, and let Deal do the rest. Deal allows you to hire, onboard, and pay talent in over 150 countries, from background checks to built-in contracts. You can manage an entire worker lifecycle from a single and easy-to-use interface. Click the link in the show notes below to book a free, no-strings-attached demo with Deal today. So let's move into emerging managers. How do you go about making a decision on whether you

should invest in emerging managers? This is the most fun part of our job, probably the hardest part of our job. Like it's back to the word shades of gray, but you will never have certainty around these types of folks. And the reasoning for that is you don't really have a track record typically that you can actually transfer to what they're doing today. They probably did some angel investing, but the check sizes were small. There's lots of things that may feel different in this new version. So we're honest with ourselves and we give them credit for seeing the ball right, making some good decisions, but we're also not going to tell ourselves that they can just replicate what they were doing. The way we think of the world is very

simple. And other people said this, I think directly to you, but do they see great deals? Can they pick great deals? And then can they win great deals? Those are the three criteria we think the most about. Now we differ in what we think we can evaluate. In our opinion, we should be able to figure out, are those people seeing great deals? Because to us, that's somewhat straightforward. We can reference that. But frankly, if they're in the right circles, if they worked at the right company, if they had the right wool, that would probably tell us that they are seeing the right deals. Now, go all the other end. We're looking for someone that can also win their way into the company, win their way

into the cap table. That is something value-add to the founder, something unique about their personality. We like people that are quirky, that feel a little bit different, because we think that can actually separate that person and sort of win their ability to get on the cap table. The hardest one for us is can they pick? We probably don't have a fulsome track record to evaluate. There's some uncertainty there and some uncomfort. But I think if we pick well on the ones we can control for, we can generally get to better than not type decisions on those folks. You've been doing this for 14 years. What are some of the mistakes that you've made?

The biggest one I've made, I mean, it's back to something we talked about earlier. Eric was pushing me on, but fund size. I think that's where we've made some of the biggest mistakes. When someone starts with the wrong amount of capital, it really just pushes them to do things that's uncomfortable and outside their sweet spot. You mentioned you don't go above 200, but there's a lot of these funds, 300, 500, 700 that are doing seed, they're doing some Series A. Are they kind of in no man's land in your view? Or is this just a kind of short term thing? It's not really going to last? What are your thoughts? It's an interesting question. We're in some funds that have done

that. So I don't want to like, we're not, well, we're religious on fund size. We also are not infallible. I think the way we like to think about it today is if you're going to be a seed fund you're probably 200 below um we spend a lot of time on that follow-on strategy i think that's where you're going eric but we want to spend a lot of time on what is an a round deal you'll go into what is the b round one you follow into the one we hate is when people tout their essentially their, their follow-on rate, like 60% of our deals became A or B rounds and we're in all of those. That to us is not, that doesn't make us feel good. We'd rather someone say, hey, you know, we're going to follow on with our 10%, you know,

15% of our best deals and really size in. What I'll tell you is, you know, we've been told that many times and it's few and far between. We've actually seen people get the bulk of that following capital into the right deals. It ends up what inevitably they end up doing. If they tell us 10, they'll do 20. And then it ends up being, in our opinion, probably a lower returning portfolio than we would have hoped for.

I hope that's changing, though. We're in the next vintage of that. And maybe people learn the lesson. On references, I'm curious when you do these references, what are some non-obvious questions you're asking to try to help you identify, hey, is this a manager we want to be in business with? You really have to get off list, but let's just go to people that are on list. I think one of the things, like one of the easier ways we can get to information we really need is we end up every call like, hey, is there anyone

else in your network that would help us out here? Because that might be an easy way for that person. If they have something they're not comfortable sharing because they're friends with the person, what have you, we've seen that before where, well, they will connect you to someone who might say something a little bit more pointed. But honestly, I think some of the wording that people use, I mean, one of the tricks for in Silicon Valley does not work outside of SF all that much.

But the superlatives, when someone's not using the superlatives, you know, look, I recognize different people personality wise may not, but you can sort of pick up on that through the conversation. And if you have someone who does speak in superlatives and then describing when you get to the person and attributes, they take it down a whole few notches. That gets us nervous. If someone ends with, you know, oh, but they'll make you money. That's a phrase that at least for us is like, we better double click that many, many times. And what are some non-obvious, if you were hiring somebody, it might be a negative quality, but for a fund manager, it would be a positive quality. The LP breed, most of us are pretty like, you know, we're clean cut. You know, we're pretty straight laced.

So I think if you actually look at the LP community and then at least in our sense, and then the people we partner with, I think the quirkiness factor of our portfolio goes through the roof. The crazy question, though, is like, we love investing in quirky people. Would I hire someone that's, you know, like, definitionally quirky? I never even thought about that. But actually, I almost question, like, maybe that would lead us into different trains, like a completely different portfolio structure that might ultimately win the day.

The truth is, though, I think that would be a hard person for us to hire because they don't look like the 99 other percent of people that are LPs. To be a great LP, you have to, you know, look, you have to be analytical. I think you have to have processes, but know when to break. By popular demand, the 10X Capital Podcast has officially launched our newsletter, powered by Carrier Labs, a full-service content marketing firm that's partnering with us on the newsletter. In our weekly newsletter, we will keep you updated on all things emerging managers and limited partners, including industry trends that are critical to know as an LP, VC, or founder. To subscribe to our totally free newsletter, please visit 10xcapitalpodcast.com.

Again, that's 10xcapitalpodcast.com. We thank you for your support. What are some of the biggest mistakes that you've made that you wish you knew about when you were starting out as an LP? One of the things that took me a lot, I think it takes everyone a long time to get comfortable with. But when you come into the industry, your goal is it's uncomfortable asking questions. You want to feel smart. You're a lot of times again, you're talking to people who clearly know a lot more about the space. There's a lack of comfort. And that forces you to think really

deeply about the questions you ask and ignore the easy and dumb ones. And I think one of the key lessons I've learned in my career is the simpler the question tends to lead to the better answer. The ironic thing is that tends to show some humility. It tends to open the other person up and it tends to lead the conversation so many different ways. What other mistakes have you made? Biggest mistakes I've probably made is getting caught up in, and this is one everyone makes, the cycles. We didn't do this in the most recent, but like, oh, we have to have an AI fund,

or we got to pile into crypto because all my friends are doing it. As LPs, there's always groupthink, right? Groupthink can work in multiple ways. If a certain group of LPs moves into the same fund, then it feels like it's a race to get in. One person's in, a few to get in. One person's in, a few others are in. You're almost silly if you're not in. I think that happens in hype cycles as well. And look, I've chased a few managers to where I hear a couple of groups fall in,

and then I cut my process short because I'm like, oh gosh, I got to get in here. I'm going to look silly if I'm not. And those have been some of the worst decisions I made. Just to play devil's advocate, have there been companies or funds that you've gone in from social proof, essentially momentum that have worked out really well for you? That's an interesting way to put it. We've definitely had a few of them work again, like, look, the first person might have made a really good decision. I think in our world, you want to do good work and have good decisions. If I can do good work every time, I think I'll have a long career, a long successful career.

You mentioned last time they were talking that a top fund investing for the first time is not necessarily a sufficient signal for you. Why is that? It's not that we don't respect a top fund's decision-making. It's just the question, what is that company at that moment

playing for that firm? And what I'm getting to is if it's a multi-stage that's doing hundreds of seeds or many, many, many seeds per year, they might just be buying their way into the company such that they could ultimately deploy a significant amount of capital in the seed, in the A, in the B, in the C, et cetera. And that is a very smart decision, right? That is they're taking optionality and playing it into their own model. That makes a lot of sense for them. The problem is, I'm not sure how a VC in our portfolio can think of that as signal.

It's different, not in benchmark, but I like their model. If you're doing one and a half deals a year as a GP, my suspicion is you can trust when they make a decision that that is some good signal potentially. So you have 120 families. You've seen some of the most elite families and what they do with their money, but what is the best practice of in the cutting edge family offices that you work with?

Private equity, alternatives, whatever you wanna call it, have become soup du jour for the wealthy class. The nuance is I don't think many of them outside of the single family offices we could all name get into the most sophisticated stuff. So that's what we're trying to do for our families is we want to make sure they're getting when you want this once in a portfolio, it's not just getting 20% private equity or 25. It's getting like top tier, certainly above median.

So I think the important thing for us and our families is let's get into the highest quality groups that we can. Let's be thoughtful about how we build a portfolio. It's not just access. It's how you put it all together. The question for us is co-investing. So you want to get to an interesting question. Like co-investing is something that I think most groups want. Family offices love it. Well, Sean, this has been really enjoyable. I appreciate you taking the time to chat. What would you like the audience to know about yourself and about

Gresham Partners? The two things that matter about yourself and about Gresham Partners? The two things that matter, you know, Gresham Partners is great at helping families. So if someone is needing some help on that side, like reach out, I think we build great portfolios. On the investing front, like, look, we're friendly users. It's on my LinkedIn, we're user friendly GPs. If someone is looking to deploy capital, we always read emails, we always respond, it may not be what people want to hear, but we give quick no's though and we make it efficient. Great. Thank you. Thank you, Sean.

Look forward to all meeting soon in New York or elsewhere and grabbing a drink. Thanks, Sean. That's good.