Invest Like the Best with Patrick O'Shaughnessy - Erik Serrano - Investing in Investment Firms - [Invest Like the Best, EP.358]

Episode Date: January 2, 2024

My guest today is Erik Serrano. Erik is the CEO of Stable Asset Management, which he started 14 years ago in his early 20s and has scaled to over $3 billion in AUM. Unusually, Stable’s strategy focuses on other investing firms. They look to back the Blackstone's of tomorrow and provide those founders with capital and support so their time is spent doing what they do best, which is typically investing. We discuss the commonalities among promising founders in this sector, how Stable serves as a full resource to their companies, and some harsh truths learned from building an investing business. Please enjoy my conversation with Erik Serrano. Listen to Founders Podcast For the full show notes, transcript, and links to mentioned content, check out the episode page here. ----- This episode is brought to you by Tegus. Tegus is the modern research platform for leading investors, and provider of Canalyst. Tired of calculating fully diluted shares outstanding? Access every publicly-reported data point and industry-specific KPI through their database of over 4,000 drivable global models hand-built by a team of sector-focused analysts, 35+ industry comp sheets, and Excel add-ins that let you use their industry-leading data in your own spreadsheets. Tegus’ models automatically update each quarter, including hard-to-calculate KPIs like stock-based compensation and organic growth rates, empowering investors to bypass the friction of sourcing, building, and updating models. Make efficiency your competitive advantage and take back your time today. As a listener, you can trial Canalyst by Tegus for free by visiting tegus.co/patrick. ----- Invest Like the Best is a property of Colossus, LLC. For more episodes of Invest Like the Best, visit joincolossus.com/episodes.  Past guests include Tobi Lutke, Kevin Systrom, Mike Krieger, John Collison, Kat Cole, Marc Andreessen, Matthew Ball, Bill Gurley, Anu Hariharan, Ben Thompson, and many more. Stay up to date on all our podcasts by signing up to Colossus Weekly, our quick dive every Sunday highlighting the top business and investing concepts from our podcasts and the best of what we read that week. Sign up here. Follow us on Twitter: @patrick_oshag | @JoinColossus Show Notes (00:03:33) - (First question) Exploring the allure of investing in investment firms (00:08:20) - Discussing the scarcity of investors in investment firms (00:18:20) - Strategies for generating returns for investors (00:22:50) - Analyzing risk/return dynamics in portfolios (00:26:26) - Unveiling surprising insights from Project Legends (00:29:56) - Characterizing the ideal General Partner (GP) (00:37:23) - Identifying red flags in GPs' practices (00:44:10) - Viewing investment strategies as marketable products (00:52:52) - Delving into the emotional aspects of investing (01:01:57) - Tracing the lifecycle of an investment firm (01:13:04) - Offering guidance to aspiring young investors (01:18:24) - Reflecting on the notion that ‘nice people finish last’ (01:23:52) - The kindest thing anyone has ever done for him

Hello and welcome, everyone. I'm Patrick O'Shaughnessy, and this is Invest Like the Best. This show is an open-ended exploration of markets, ideas, stories, and strategies that will help you better invest both your time and your money. Invest Like the Best is part of the Colossus family of podcasts, and you can access all our podcasts, including edited transcripts, show notes, and other resources to keep learning at join colossus.com. Patrick O'Shaughnessy is the CEO of Positive Sum. All opinions expressed by Patrick and podcast guests are solely their own opinions and do not reflect the opinion of positive sum. This podcast is for informational purposes only and should not be relied upon as a basis for

investment decisions. Clients of positive sum may maintain positions in the securities discussed in this podcast. To learn more, visit psum.vc. My guest today is Eric Serrano. Eric is the CEO of stable asset management, which he started 14 years ago in his early 20s and has scaled to over $3 billion of assets under management. Stable strategy focuses on other investing firms. They look to back the blackstones of tomorrow and provide those founders with capital and

support so their time is spent doing what they do best, which is typically investing. We discuss the commonalities among promising founders in this sector, how Stable serves as a full resource to their companies, and some harsh truths learned from building and investing business. Please enjoy my conversation with Eric Serrano. So, Eric, what a fun opportunity this is to talk to someone that probably has looked at investing firms as a class of founders, just like I would look at startups as a class of founders, more than anybody else. You even use that word founder. What got you so interested in investing in investing firms in the same way that I would think about investing in a technology business with lots of the same process?

Like, what was it about this that originally got your interest back when you were, I think, 23 when you were. started doing this. I'm still amazed at how in the business of investing, most of the focus is on the investment strategy, how you make returns, but people don't think about what is the machine or the platform or the process that enables you to generate those returns. There's a Spanish saying, which is the cobbler's son has no shoes. And I think it's a really neat concept that the people that are dedicated to their craft often overlook that same craft when applied to themselves. And you find this in a lot of investment or professional services that you meet. Investors who spend their time maximizing their craft of returns, but when you ask them about

what they do with their own money or do they give advice to their friends, they just don't apply it to themselves. And so, yeah, when I was that young, I was working at Bain and I really wanted to set up my own private equity firm. But for me, it was I wanted to be a student of what's the best firm that I can set up. And because I wanted to start my own private equity firm, I went around asking people kind of how they got started. And that got me thinking about seeding, acceleration, and investigating the history of how do people start investment firms. And that's what got me thinking, okay, what are the frameworks that I can use to build an awesome investment firm? Why aren't there more younger people that start investment firms? Because you mentioned tech, right?

So if you want to start a tech firm, a healthcare company, there's all these VCs. but if you want to start an investment firm, there's no firms that start investment firms. And that's super weird, right? And so I was thinking, okay, why? And it's probably this youthful arrogance of daring to ask questions. And I was thinking, hey, I think I'm quite smart. I'm quite a good communicator. Let me try and start a private equity firm. And I start talking to people in my network typically that have a lot of money because you're thinking, okay, capital first. And they all kind of laugh me out of the room. They're like, you're 23 years old. You just started this job. You have no idea what you're doing. And there are actually good reasons for why you don't start an investment firm young.

And now looking back, one of those is that when you're investing, your product in a way is your performance. But to generate performance, you need time to elapse and to discern luck from skill, time has to elapse. And unless you have a time machine, it's going to be difficult for you to prove like, no, this is going to be great. Like, we're going to look back in 10 years and I've going to be made lots of money. So there is a reason why there is that market failure. behind trying to start a firm young. And so I went into doing a bit of research on that. And at the firm, we do this thing called Project Legends.

And Project Legends is figuring out, okay, who are the best investors in public markets and private markets? And it's sort of defined as lifetime P&L. Because when I think of people, it's often the case that they make a lot of money on small amounts. And then as they scale, they lose a ton. So there's ways to triangulate this. And it's hard to get that both data series.

people tend to talk about returns, but not about AUM. But if you get both and multiply them together, you can get to this lifetime piano. And on the public side, the average age of launch is 33. On the private side, it's about 37, 38. Although on the private side, and we can talk about this, it's often a duo. It's like the younger and older person, which is interesting in itself. But 33 is still quite old, right? And I'm like 10 years away from this at the time.

Not that I had the data points. but I was thinking, okay, how can I convince people to trust me? And then it became more about the mouse trap, so the shape of the firm or what I was trying to do. Because if you can say, hey, here's the framework of how I'm going to invest. People can underwrite that as opposed to saying, oh, I have this strategy that extracts alpha in this way or this arbitrage. Like, it's more about this is how I'm going to set up the mouse trap. And that's what started getting me interested in. can I actually back founders of investment firms in a way that I'm also a partner with them in their firm?

So the returns isn't going to only be, I give them $100 million, they generate some returns. I'm going to give them $100 million, but I'm going to be a partner in the GP. And then to scale that GP and turn it into a great business is going to be the objective of what I'm trying to do. Do you think the reason that there isn't a VC industry for backing investors is just, if I call it to mind, I can only name like a handful of great big asset managers that I would have loved to have been a seed investor in and Blackstone and Apollo and firms like this. And that maybe there's just a limit to scale on these things. And like they aren't that great a business. They can be, of course, great businesses.

But there just aren't that many in, let's say, the public markets that are anything comparable to the million software technology businesses that I can name that achieved a similar scale. Like, is it just, is there just something structural about this? and that's the reason why there's fewer investors in investing firms? Yeah, there's a lot to unpack that. I think on the investment firm, it tends to have these oligopolistic tendencies. So scale begets more scale. And I think a lot of that is almost to do with the asset owner side of the equation. There's sort of no one got fired for investing in IBM, where at some point, the career risk of the allocator investor capital owner, asset owner is an important decision factor.

So once an investment firm has been derrised, it just tends to scale. So when you look at asset raising, it tends to be quite concentrated in the larger firms. But another thing is that bringing it back to people, you're actually really investing in people. And I think people underestimate how the lifecycle of a firm follows the life cycle of a human in investing in a way that in other industries like healthcare or tech, the product is more the code or it's the molecule recipe for the medicine. Whereas in investing, it's the intellectual capital of the humans that are part of that team. And so they just have a shorter lifespan because we live less. And so I think the building an investment firm is difficult because you're really dealing with humans. And so the focus of my work is centering on what makes this person a great investor, like what makes them tick.

There's this great saying, which is chips on the shoulders, put chips in pockets. And so I'm always trying to discern, okay, here's a founder that wants to build an investment firm, what's really driving him or her, what is their edge? And a lot of that tends to correlate with personality traits, but also your life journey. And I think that's something that most investors underappreciate or have less access to in a way. I'm really privileged because when I'm meeting a founder, I can actually get into the nitty gritty of who they are. I spend a ton of hours with them. But most limited partners, you know, most capital allocators will not have the opportunity to really get to know the person. So they

tend to focus on the investment strategy. But for me, it's really important to get to know the person because you're really underwriting this person's decision-making 10 years into the future. Like, the markets will change a lot more than the person will change. And yet we focus a lot on the market and the strategy, but less on the person. And so I have this really fun and privileged access to getting to know the person and the characteristics that show up repeatedly about what makes a good GP, what makes a good investment from founders, that they have attributes that create two things. One is resilience and one is very in perception. So if you double click into each of those in turn, resilience is never giving up. It's just getting up when you're knocked down,

when you're feeling like you don't want to get out of bed in the morning. And being an entrepreneur has that everything goes wrong all the time. And the bad news and difficulties actually flow upwards. You know, people think it's great to be the boss and to be a founder, but actually all the hard problems go up to you. So a high percentage of your day is just dealing with problems and hard things. And so that's less fun. And so resilience needs to come from a place where you love what you do so much that all this discouraging news and obstacles in the way and things going wrong and blowing up all the time are not going to discourage you from remaining focused on your investment strategy. There's many variables that bring this resilience, but there's a few fun ones maybe to talk about.

I think it's not particularly fun, but adversity at an early age. I always think that we are the product, a bit of our childhood and our parents, and a lot of how we interact with the world, our values, our chips on shoulders. I actually come from a relatively young age. So just exploring how you got here is something that I spent a lot of time on. And the data is very consistent. We always trying to start with data because you're also tempted to use heuristics of like who's successful and did they go to the right schools and are they good at explaining things. But in a broad definition of success of being an expert in your field and contribution, when you look at the data, there's huge relevance, for instance, of losing a parent young. Something crazy

two-thirds of British prime ministers until a couple decades ago, I had lost a parent before 18. It's about a third of U.S. presidents. But also when you double-click into these legends of the investment world, and again, I'm really privileged because often with project legends, my day job is forecasting forward which investment firm founders are going to be great, but I'm really lucky to come across already legend investment firm founders. And if I get to get an hour with them, I run them through this questionnaire that we call past, present future, sort of an abridged version that we use with our founders and our day job,

I run the legends through it and I try to pattern recognize back. And you'd be shocked at how many of them say, you know, is that financial insecurity in my childhood or not seeing my dad succeed? And when you really get to the core of what drives them, it's this adversity that they channeled in a very positive way to become what they are today. And I think adversity of the young age is unfortunate and sad. But I think if you think about it, something that's giving you superpower. That's really cool. So those are the kind of things we look for resilience-wise.

In terms of variant perception, that's really seeing things other people don't see, believing things other people don't believe. It's essentially being contrarian. Because in investing, if you're the average, you're beta in your market and you need to have a different view. And to be contrarian, you need a point of view that's coming from a life experience or analysis that's different from the herd. And again, that tends to come from people who in childhood, younger years,

are just looking at things a bit differently. That can correlate to the household you grew up in, what your parents did. And we find a lot of great founders just have different points of view. And I think there's a point when variant perception converts into complete stubbornness and it's negative. So there's sort of diminishing returns to variance at some point. and then maybe it becomes negative where you believe something outlandish or completely counter-consensus, and maybe you were wrong.

And in my investing, I found that it's hard to tell where that point is. Some of the investments that have gone less well have been where a founder just sticks to their guns in a way that doesn't let them live to fight another day. I've kind of corrected a bit of my strategy there of like, I used to look for extreme variant perception, but at some point is actually negative. to be too stubborn. I think just correcting your thoughts with new data is important. And that's one of the, so not so secret secrets of the industry that I think managing evolution

as an investment firm founder is difficult because the audience interprets that as, oh, you're extending your mandate or this or that. Whereas in tech or the other industries we're comparing to, that's a plus. Like, pivot is like a good thing. Yeah. And pivot is a euphemism for, we got it wrong, we're trying a new thing. Yeah, not acceptable at investing. Correct. And so I think the best founders find a way to do that within their strategy where

they're testing and changing without it being wholesale change of the strategy. And then they're good at evolving that and more than anything, communicating that. And communication is something that is really underrated in investing. I think most GPs just want to focus on investing. and they see their LPs as this necessary evil. And I tell my founders, you've got to change the paradigm. Your capital owners are allowing you to do what you love. Not only is it your passion and it makes you happy every day.

It happens also to generate huge amounts of wealth. You should be grateful to these people. And if they have questions or things are not going so well, be proactively communicative. And if you do that well, I think that builds that trust for you. to also evolve your strategy. Because if someone has money for you for long periods of time, like the world changes, you can't stick to doing exactly what you do. So my advice for founders would be,

be really good at one thing, do that, but also know that to keep your edge, you'll have to evolve over time, but also be prudent and also be very transparent and communicative to your investors about that because you almost have to earn that license and trust to evolve. And that's actually something very interesting about how that, traditional GPLP relationship works. I love what I do because when my founders have an issue,

they come to me with the issue. So I'm like a special LP, a special investor, you know, providing capital to them. And I think it's super healthy to be on the same team where it's encouraged to speak and communicate about how you can improve things. So one of the things I love about my job is that a limited partner is limited. I don't like limitations. I want to be a full partner with you. If you think about the source of return for your style of investing, I'd love you to break it down for us because it's interesting in the sense that, yes, maybe there aren't as many blackstones that you can invest in early, but you're not just earning your return through the GP itself. You're earning as an LP2. So walk us through the like ranges, I guess. If I'm just like you and I earn a return in several different ways by partnering with these investing firms, how you make that work. Because there are not a lot of seating businesses. There used to be more. I think in general, if you ask, around and took a survey, people would say the seeding business sucks. And yours does not suck and hasn't sucked. And so I'm curious what you've worked out that maybe others haven't. Like, what is an investment? What are the sources of return in that investment? How do they range around?

Like, you're kind of a unique beast. So just describe how you earn your returns for your investors. Yeah, thank you. We're all unique snowflakes. No, I think to look at the history of seeding or how investment firms came to be is quite illustrative. And this is something I did early on, setting up stable, I tried to find as many people as I could who had been involved in that day one, that first, because someone gave Steve Schwartzman his first dollar and someone gave Bonderman and culture the first dollar. Someone gave Ray Dalio their first dollar. The history is that it was typically very wealthy individuals, families, who knew an investor somewhere, maybe was even an operator on the private side. And they were impressed by their capital allocation, essentially.

And this founder said, oh, you know, well, why don't I make it into an asset management firm? Why don't I launch a private equity fund or a hedge fund? And so really, the history of seating comes from these high trust relationships where a pool of capital knew the person. And I think the key aspect of that relationship is that there was less principal agent problem. So the principal agent problem in investing to me is that a lot of the decision makers who write a check to an investment firm aren't the principal or the agent. And a lot of firms actually do a good job at aligning incentives and I think it's moving in the right direction. But generally speaking, probabilistically you can assert that in terms of LP types, it's typical that an individual or a family, the principle is making the investment decision. And so historically, they would be able to take that career risk, because in a sense, it's their own career, so they're taking their own career risk on a new founder of an investment firm.

And some of them worked well and some of them didn't. But generally speaking, there wasn't a professionalized way to get help with setting up your business. And then when I looked at the case studies, there were some firms that were starting to think about this in a more systematic way. but often the people that were seating tended to come from more of an allocator or a fund-to-fund seat where, again, they were very focused on the strategy, a bit less on the person. And critically, I think, were not focused on the business side. So I was lucky to spend a bit of time with Gil Caffray, who worked with Julian Robertson at Tiger. Julian became very famous for seating on the public side.

and there I learned that distinction between the portfolio and the business. So investing is actually two very different things. But everyone's just looking at the portfolio and they're not looking at the business, which comes back to my surprise that there just aren't many people who are studying what makes a great investment firm in terms of how their structure, their decision-making, their process. And I think my realization that potentially drove a bit better outcomes was that we need to focus on the person as well as their strategy.

and we need to provide help. I focused a lot on helping founders initially think about on the business side, what things can we do to set it up for success so that your investment strategy maximizes its returns. And a lot of it is minimizing distraction. Because what's interesting in backing investment firms and backing emerging talent is that when you're in a bigger firm, a lot of the things are done for you.

So you may be spending 90% of your time investing. But then you're becoming an entrepreneur, you become a founder, and you might be down to 40% investing, and then 30% operations and 30% asset raising. It's not that the founder has forgotten how they're investing, is that they're spending a lot less time on it. So that means that all the distractions are creating that poor performance. So if you can be a true partner helping them with run the business, I think that's one of the more powerful roles you can play to maximize those returns.

So walk me through, like, if I had to build an attribution model that was customized for the style of investment that you're making, there's a bunch of different kinds of cash flow associated with this. So there's the literal returns you earn as the LP dollars go into the company. They invest it for you and you earn your return. That's one. There's the excess fee income, the net income from fees that you own as part of the GP. And then in many cases, there's carry.

So you've got like all these different ways that you make money in your, what do you call a full partner, not limited partner. And if I looked at your whole portfolio across your whole history, what percent would be at each of those buckets? Yeah, great question. It depends a lot on the strategy in terms of what is the risk return profile. So we invest across asset classes. We started on the public side and then now we invest across private markets as well. To recap your framework on income, absolutely, there's return on the capital you're investing. then there is excess management fees as well as carry.

And then there's monetizing the enterprise value of those GPs, which is something that 15, 20 years ago when I started, people weren't even thinking about. And then these amazing founders and business builders have taken their firms public. Now when you look at these integrated alts managers like a Blackstone or an Apollo or KKR, the amount of wealth created in monetizing the EV is amazing. You know, we do some like calculations, but when you look at the wealth of these founders,

we would argue the majority of their wealth, which actually created monetizing the EV. And a big chunk was created with the excess management fees and not that much from Carrie. And I think that misalignment is something that we love correcting because when asset managers were small, that 2 and 20 model made sense. But the management fee was always meant to just cover costs.

You weren't meant to be getting rich on managing. You were meant to get rich on performing. And so that hasn't adjusted, surprisingly as much as the industry has grown. Like 15 years ago, the private markets industry was one trillion. Now it's 12. That's wild. And yet there hasn't been this evolution and alignment improvement to correct for that growth. And so, yeah, if I look back, when you're looking at on the public side, it depends for how long you keep your money in the fund. But for us, our model is we give founders a three-year runway. So you have three years, you can hire people,

we're locked up, and that's a huge value of partnership with us, is you can actually plan for the future, you can attract talent, you can get that lease on the office for a few years. And just assuming that at the end of the three years, you're not invested, just to create an example to answer your question, it's about a third, a third, a third, a third came from that performance. A third would come from the excess management fee and carry over the lifetime. And then on the back end monetizing that stake, typically back to the founder. So we think it's important to have an aligned structure with the founder as well as with the asset owner.

And for the founder, I think it's an important attribute that from the beginning, we say, as you succeed and we get rewarded for all the hard work and trust and risk we took, you can buy back our minority stake in your business. And then in private markets it's a bit different because there obviously your capital is locked up for the whole first fund and they take longer to grow because enterprise value is step function as opposed to open ended. So the maths is a bit different. There's probably a bit more waiting to the LP side also because the multiples are probably higher. So you have to normalize for return. Private markets you're expecting to have somewhat of a premium on the return for the liquidity and value add and whatever you're scribing that alpha from.

But yeah, I think a significant amount of return you can expect in an investment firm is the returns from building a fantastically run business, not just from investing it. And I think when you look at the examples of these legends, you'll probably see quite quickly that they became very successful, at least financially, not necessarily from being the best investors, but being the best business builders. What was the most surprising findings from project legends? So some of them are common sensical and again, heuristically. The younger age on publics made sense, but if you sort of double-click a bit, in public markets,

when you invest, you don't necessarily need to know the other side of the transaction. You know, you can sit in front of your screens and with your Bloomberg and just transact. In private markets, the other side of the transaction needs to want to transact with you. And so I think there there's more returns to experience, network. and to some extent, likeability as well, which is something that would be interesting to talk about. So from Project Legends, in public, it's a bit younger, but it also tends to be that on the public side, founders can get away with being less likable and less able to build relationships and potentially lower EQ, lower empathy.

In private markets, the age is a bit higher because, again, you need network and you need to find the investment opportunities, you need to source the deal. return on age is higher. And what's interesting in privates, actually, that we discovered is that there tends to be this dual act. So if you look at some of the legends here, with Blackstone, you have Shortsman and Peterson. At TBG, you have Bonderman and Coulter. And the pattern is repeated with Rubenstein and all the bigger private equity firms where I think you have one person who is slightly older. They have the network. They're the door opener. They have a bit of great hair. They're making sure that the management team or a founder of the portfolio company

you're buying feel safe. And then there's the younger hustler, hard worker, see around corners person. And this is something actually that I learned from Shortsman. His insight into that was actually quite revealing was people don't give money to the people they think are going to be the absolute best returners. They give money to people they like. And I thought that was super interesting because in our industry, everyone tends to focus on dollars and percentage returns. And again, we're not looking at the person. We're looking at the numbers. And it's all about money and it's quite transactional. But actually, when you look at the returns to likability are quite high, and I don't mean likeability and you're super charming and you tell jokes and you're funny. I think

likeability is a proxy for something very monetizable in investing, which is that you're reliable. You will probably act in a way that's not going to be offensive. you're going to behave in five and 10 years in the same way you do today. Because disagreeable people are less predictable. They act in ways that might be contrary to a common goal. They tend to be people who at the negotiating table, they just want to negotiate every single last dollar. Where people who are more likable, it's like, let's think bigger pie

and split that as opposed to more zero sum. They're kind of more positive some people. And I think that in private markets, It's if you combine this likeability network that seems to be a recipe for success when we look at all project legends. If you think about what I'll describe as the perfect GP, so somewhere out there, there is a business that if you were to back it now would be your career definer, right? Like the thing that is just perfect in all the ways that you've conceptualized it.

Can you describe that in some detail, like almost like the, I'm sure that doesn't exist, but I never will, but in your mind, describe the. the perfect GP. Yeah, I think that's a good question to put a framework together. I will say that what I have discovered, and this is also with age, I think when you're younger, you say, like, there's the best school and there's the best place to live and there's the best that, but it's all contextual to some extent. So I think you have to match your talents and your compulsions to a design of a firm that

will make you be your best. And I just caveat that by saying, if you're thinking of building your own investment firm, I don't think there's a recipe for success, generically speaking. I think there's a recipe of success for you. And so the starting point, if I had to design the perfect GP, would be for the founder to think about themselves and think about what do I love doing, what's my superpower, and somehow design a firm and an investment strategy that leverages that talent, compulsion. When I was younger, I thought talent was really amazing and then hard work and hard

effort was like, anyone can do that. And now it's the opposite because I think talent to some extent you sort of inherit and I'm not sure you're deserving. So I actually admire people who work really hard and show up every day. So that over time has changed. But I think back to the perfect GP, I think it comes from following your own path. And following your own path means design things that make you the best. Don't necessarily get normalized by society or by what people want. on designing your firm. So if you start with that, first find a market that you think there's some inefficiency or some way that you're going to extract alpha from.

We can use public or private examples, but I think one thing that is common to the perfect GP is that they're very good at identifying what the agenda of each stakeholder in whatever their strategy might be and understanding what each party wants. And then they can design a structure to the deal, evaluation, compensation structure, something that extracts value from each stakeholder, but makes them feel like they're getting what they want. And so a lot of the great investors we find have this incredible ability to understand

what does each stakeholder in this want out of it? And how can I be the solution for that? And sometimes we talk about capital as a service. It's like, what service am I providing? What am I getting paid for? And so I think designing the ideal GP would be someone who matches their skills compulsion to the platform they're building around them. Within that designs an investment strategy that extracts that by understanding what the players at the table want, but then also make it long lasting because I think life's a bit of a repeat game. So I think people need to want to come to you for that.

And they want to need to think, oh, this is a problem that only Patrick can solve. he's the best placed or we want him involved in the cap table. And in private markets, it's easier to think about it. I think Publix has like a complexity of the speed of the game and the unknowable potentially participants in terms of scale. So it's easier to conceptualize in private markets, I think, but the same rules apply there. I think some of our better founders display in public markets, very deep domain expertise. So there's interesting studies in public markets to make that example come alive.

there's different return on specialization in different sectors. So in things that, and again, it's sort of common sense to some extent, but things that are highly complicated, highly technical, like healthcare, that has probably the highest alpha to specialization, whereas things like consumer or other energy utilities has less so. So I would also advise a founder to, again, find that narrow domain expertise, but tie that to your own talents and passions. Often great healthcare investors are doctors.

by background. We have a founder, a trained doctor and has become after that a fantastic investor. And not only that, he's still a doctor at his hospital one week and a month, just to stay in touch with his craft and see the front line. That's amazing. Even during COVID, he's running super successful investment firm and he's just a doctor helping out on the ward once a month. And that's really inspiring. And it doesn't have to be glamorous. A lot of financially successful people will go to university campus and they're like, oh, follow your passion and this and that. And then you ask him like, how did you make your money? It's like iron smelting or something like super not glamorous. But I think in investing, you need to have a passion for investing. And there's a really cool study where these

academics map what car you drive to your performance. And they do this with publicly available sources. They sort of map, okay, car ownership. And then they say, okay, cars that are flashy, they tend to be more expensive, maybe they have bigger engines. And they map that to the performance of the fund managers. There's two really interesting conclusions. One is fund managers who drive faster or flashier cars, they return a bit better, but not commiserate to the increased risk.

So on a risk-adjusted basis, they're worse investors. And that in our mind has all to do with sensation-seeking, with a psychological concept that often people are talking that you're kind of born with it. But generally speaking, higher sensation-seeking, higher-risk-seeking, and you don't get banged for your buck.

But the second order insight, which I thought was really interesting to have a way to prove it data-wise, was that fund managers who had flashier cars went in a drawdown, used to give up sooner, which basically means if you do the third derivative order, if you're in the business of investing because you love money, which is probably correlated to you buying a flashy car because it's a material objective, means that you probably love what you do less. So then when you're so far from the high watermark and the bonus is running away from you, you don't keep at it. And I thought that was so beautiful that someone had come up with a way to define a statistically significant and sort of academic study around for what is probably a relatively commonsensical heurism, which is like if you're motivated by the wrong thing, you probably won't have the resilience to stick with it when it gets really hard. And that for me is really interesting. So when I talk to founders, I'm really trying to understand, are you in this for the money or do you just love investing? And money doesn't bring happiness, but it definitely is important to make enough money that you don't worry about money. But a great answer there from a GP is that they just want freedom from thinking about money. They have a great business and they might want to deliver amazing returns, build a great business on the way, build a great culture.

those answers to me speak volumes as opposed to, hey, what's your five and 10 year plan? And if the first answer out of your mouth is, I want to be $5 or $10 billion, that just doesn't feel like the right answer. What about the other end of that spectrum, I'll call like the most dreadful GP or something? Like obviously some of the part of this answer is just the opposite of everything you just said on the perfect side. But is there anything else that you see as common like dark patterns amongst investing firms or we could call these red flags, personality traits or business traits, like things that you think are the most correlated with bad future outcomes, either at inception when you're looking at a new founder or if you were to go investigate 100 existing GPs, like the things that would stand out to you as like,

this one's probably in trouble. Yeah, when I look back at things that have gone wrong is we try to filter it out, but one bad signal is just wanting capital and not the advice and support that we hope and believe comes with it if you work with us. And it's a bit like getting married, you know, that old saying that as soon as you get married, people change. They kind of got the commitment. And we were discussing earlier, I think the commitment to marriage is decreasing. And the commitment to serving your capital is also decreasing in some way. And by that, I mean a GP that just wants to get some capital and then forget about being open to feedback or being self-aware.

That for me is consistently what has driven bad outcomes for our investing. And we try and filter that out by both asking you as the founder, but also referencing. Referencing is super important for us because there's less data for us. You've often been in a firm where you had a boss, a risk manager, a big deal team, sourcing, structuring. So it's hard sometimes to allocate response. for returns to you on a quantitative basis, but qualitatively, you can understand,

okay, who source this investment, who talked to the management team about it, et cetera. And I think the referencing is also quite powerful around, is this someone who is open to advice? Is this someone who's open to feedback? Are they self-aware? Like, we ask people, what is a piece of feedback you've got that surprised you? I think that's a really interesting question because it starts to dig into this outside perception versus self-perception. And when referencing, we're trying to determine that we're partnering with a founder who,

they might not always take your advice, but seeking advice and being aware of the things you don't know is very important. I'm always reminded, probably apocryphly attributed to Mark Twain, but it's this, it's not what you don't know that gets you in trouble, but what you think you know for sure that just ain't so. And I think one big red flag for a bad GP is one that thinks that they know everything. And particularly in that framework sort of portfolio versus business, they think that just because they're very good at managing capital, that they're also going to be good at managing a business. And that's where they fall.

So some symptoms of that when you're building your own investment firm or maybe thinking about building one, A lot of it is team cohesion, so attracting good talent and retaining it. We see that a lot. Sometimes we see quite excessive churn at the beginning of a firm. Sometimes I call it organ rejection. When you start and you firm, everyone typically takes a pay cut, right? The asset base is smaller.

My advice to some of the founders that are having organ rejection from team is you're working really, really hard. And in your prior incarnation, a lot of people were trading off that pain with money. now you have to reset this pain equation in your mind and you have to make sure that you're creating an environment where working a huge amount of hours, getting calls at 7 a.m. on a Sunday on a deal, is sort of okay, acceptable,

or at least expectation set with the people you're hiring just because they know that's what they're signing up for and they're trying to build something with you, not because you're going to pay them to take that pain. It's almost like a recruiting filter. And if you get that wrong, that's also something that goes wrong pretty quickly. And another thing is also back to this managing expectations of the capital. One thing that I see GPs doing wrong comes back to this,

wanting to do different things than what they say they would do. So I always tell my founders, losing money is inevitable. We all make mistakes. There's going to be good investments and bad investments. But you need to lose money the way you said you would lose money. lose money in new and wonderful ways because that gets penalized. Ironically, if you start doing different things and investing in a new market, a new structure, something like that, and it goes well, then unfortunately, like, most people won't penalize it because it went well. I think really good

investors are like, okay, this worked, but not for the right reasons. And I don't think this was a good idea. But structurally in the industry, there's this permission that if things are going well, you get to do it. So I always say, even if things are going well, if they're not going well for the right reasons, it's probably not a good outcome. And they tend to deviate away from what they were doing and you invested in something that had a certain mandate. And with things like crypto or something that was quite rife, people would be attracted by this blue light. I think it's ants or one of the cartoon movies that's awesome. There's like two mosquitoes, one of the mosquitoes like, no, no, whatever you do, stay away from the light. And the other mosquitoes are like,

but it's so beautiful. And it gets like electrified on the light. And I think about that a lot because there's like a lot of blue lights around. And in investing, because you also think very highly of yourself, it's a high confidence game, people assume that just because they're good at doing one thing, they're going to be great at doing another thing. And I think that portability of skill and alpha is something you have to be very careful with. So I think when we are evaluating a founder, if we get the sense that they're going to be

all over the place, that would probably be another red flag. I'd love to talk about investment strategies as products. One of the, I guess I would call it harshest truth that I learned in my investing career was that returns, everyone thinks of the investing product is a return stream, which obviously in some sense it is, or in the major sense it is. But what I learned the hard way was, at one point in my career, we had this, our flagship strategy in the quantitative business that was an unbelievably good performer. It did exactly what you would want something to do over a long period of time.

And we couldn't sell it. And the reason we couldn't sell it was that allocators felt that it was too simple. They would look at it and they'd say, surely you must be doing more than what you're telling us. And it was only what you're telling us then we're not interested, even though it's worked really well. And that was a harsh but very useful lesson to me that in the investing world, LPs are not just buying returns. And sometimes they're not buying returns at all. And they're buying something else, which leads you to believe there's some product thing going on here that a strategy. as a product is more than a series of returns. And I would love you to just like riff on that as much

as you could because I feel like this is like one of the big secrets of the world of investing and you're in the best position to talk about it. And I'd even love, you don't have to name the names, but like favorite conceptual examples of like what a great investing product is beyond just its returns. Yeah, I think you've hit on the holy grail of building investment firms and lasting strategies, which is there is a lot more to investing than just the pure return. And, And I love that example on your past business that you built successfully. I think there's almost a premium for hard work or complexity that people don't want to believe or pay for things that seem simple.

And yet that's the most powerful strategy of all. If you can come up with something that requires pretty simple inputs and edges, that's just beautiful. So yeah, I think a lot of investing might be people dressing up really simple things. And often in founders, particularly in public markets, you find this is when you really dig into a founder's edge, they're kind of a one-trick pony, but they're really scared about anyone finding out. So they often don't even tell you, which is self-defeating because then they don't have even a pony and then they don't get funded. But that's so true. And that's really amazing if you

can find that and repeatedly do it. When you look at some of the better investors, I think they just do very simple things time and time again. And maybe they're good at product design to make it seemed that it's really complicated. Product design. I think that's a really underappreciated aspect of building an investment firm, which is most founders don't think of themselves as a product. And I think that's almost an emotional thing because, again, there's some mysticism that there's these amazing stock pickers that see the future in a way that others don't.

And this mysticism is beneficial. About 10, 15 years ago, we were looking in Kwan. And it became almost a marketing moat to say how many PhDs you had on staff. This was like really important. It didn't matter if the numbers were good. It was like, well, how many PhDs do you own on staff? And how many PhDs did you have the staff? It was loads, right?

So the big firms... We probably had none. Right. Well, this is even more genius. The big quant firms, I think, just started hiring PhDs so that they're... I mean, I know this to be true as a fact. Like, I know one example where there was 100 of them, and they were just stuffed in a room. And they did nothing.

And they did not affect the strategy. It was a pure window dressing. Yeah, well, at least they were real, right? Some investment firms, they have like fake LinkedIn employees, things like that, which is... University of Phoenix. In this day and age, you need to be careful with that, D.D. But yeah, back in the days that, the Wild West, when I started the business, some of our first investments, there wasn't even like a site visit. They would just wire money into an account.

And that changed a lot post-financial crisis, post-Madoff and things like that. It's obviously an improvement. And it was sad that it was precipitated by people abusing trust and misbehaving. But I think the industry has come a long way in that regard. In terms of product design, so there's some mysticism around it. Explaining something in life almost makes it less exciting. And I feel this way. Like I love movies.

In another life, I would have loved to be a movie director. I find movie directors to be fascinating humans. And one of them told me that the one thing he hated about becoming a movie director and going to film school is that every time he now watches a movie, he just analyzes every scene and he doesn't enjoy the movie. So there's things like movies or art or certain things that I love that I try not to learn too much about because I will go from like an appreciator to an analyzer and a lot of that happiness and hedonism that I get, even like food, just like understanding how it's done.

You talk to a chef and they break down like the crunchiness, this is this. And I'm like, I don't want to know. I just want to like, please taste it. Don't ruin it for me. So there's a bit of that in product design, which I think is if you demystify something, it becomes. So let's ruin it for everybody. Let's ruin it.

I think the product design aspect has to start with, again, identifying both stakeholders. So there's you as the founder and then there's the asset owner who are essentially the buyer of this product. And first, I think you need to match this skill set, talent, contextualize that with what platform and what do you need in terms of resources, access, whatever is going to make your interest, passion, superpower, compulsion, the best expression of that. And then when you're thinking about product design, you have to think about the asset owner. And I think too many founders, again, don't try and empathize with what is the asset owner trying to get out of it. And the focus is purely on this very unidimensional return metric. But I think over the last 10 years, sophisticated large investors want to get more out of the relationship they have with the investment firms they entrust with their capital.

one very clear one that we feel passionate about is knowledge transfer. So it's about I'm not only generating returns on your capital, but I'm explaining to you how things work. I'm explaining to you how I do things. And I'm trying to make you a better investment firm picker. And so a lot of the knowledge transfer we do at stable is we share how we think about picking founders. We share what processes we use in writing our memos. we share the importance of referencing.

And LinkedIn, by the way, has been this amazing revolution in referencing. My thesis is that the younger you can go in the referencing, the more true assessment of a person's personality and motivations are. Because I think when you're younger, you don't think about repackaging yourself for the world. And one of the founders, he literally had blown up his dorm room with like an improvised bomb. I'm like, well, there's an omen, if I ever heard one, of blowing up your track record or capital. But I think coming back to the product design, I think, you need to think about how am I adding value with knowledge transfer? One example is, for instance,

macro insights. Good investment firms are really good at sharing that. There are some firms that, I think, add more value through their newsletter or their conference than they do through their performance. But asset owners find that really helpful. And when I talk to CEOs of big asset owners that were lucky to work with. I think they find it quite insightful, kind of on the coal face developments that we're seeing, because they can apply it elsewhere in their portfolios. And if we also share, we backed over 30 companies now, these are best practices that we see in terms of data collection, organizing the memo, these types of basic things. Like, no one teaches you how to invest. It's back to this theme that everyone focus on the output, but what are the inputs? Another one is

optionality. And sort of this is like a relationship optionality. So over. the last 10, 15 years, there's been an explosion in co-investing, for example. And co-investing has some really interesting attributes. I think asset owners think about it as a tool to actually achieve quite a few things. One thing, it definitely achieves knowledge transfer, because in co-investments, typically the GP is sharing more information about the deal. That's great for the asset owner because their team is learning a lot. Maybe over time, I have this thesis and in 20, 30 years, there's going to be this harmonization, this sort of meshing together of capital owners and capital managers. And it's happening because a lot of the very large

pools of capital now have direct teams as well. That was spearheaded. The Canadians did a great job of that. The Norwegian model of in-housing a lot of their investing. Did Harvard do this originally, like a long time ago? Yeah, Harvard's gone through cycles. There's like pros and cons to this model. I feel like Harvard internalizes a lot, and then something's don't work and they externalize and it kind of goes in cycles. But collaborating with your investors in that regard, I think it's an important part of the equation. So there's these layers.

There's knowledge transfer. There's liquidity management. Then obviously there's fee management. Co-investments tend to be lower fee than commingled fund commitments. And so often an asset owner will be in the commingled fund at a higher fee, but then the co-investments are lower. So they're trying to average down their fee load. So things in product design that allows for the relationship optionality between the asset owner and the founder and the investment firm to be tailored, I think is really important.

And part of that is not only on a deal basis, but if you take a step back, think about the relationship over time. So an asset owner's dream to a certain extent is that they're investing so much money, but also time and effort in getting to know you. And they're entrusting you with their capital, right? like this is the biggest vote of confidence they can give you. And it's their job. And a lot of people at asset owners, again, they're taking career risk by backing someone, particularly if they're emerging because it's easier if you give money to a big brand and it goes wrong. It's like, oh, but it was brand X.

Like, how could I, the old IBM thing. Again, the ability for you to have a relationship where they trust you with your money is amazing. What about the emotional side? Like, these are very rational sounding. Knowledge transfer is great. I'm a huge believer in this, obviously. Optionality is great. It's like good for everybody.

What about the softer, more emotional side, like how you make somebody feel as part of the product design? Yeah, great question. Again, I think in finance, we underestimate that because it seems fluffier or softer. But actually, I found that the best investors can build an emotional connection with their LPs in a way that's really around trust and reliability. So we spoke a bit earlier about likability. I think that creating a sense of security for the capital provider that you're going to be reliable, trustworthy, and that you're going to put their interests ahead of yours and act as a true fiduciary is absolutely key.

That might sound a bit emotional and fluffy, but I actually think that it's not something that people talk about explicitly. And I'm not sure in investment memos, we actually have in our investment memo. those things like trustworthiness and expectation of being a good partner. I remember when at Bain when we were recruiting, there was this question, which was like, how excited are you about having this person on your team? And when I was younger, like, what does that matter? How smart are they? Where did they go to school? Did they ace their interview? But actually, this level of excitement of who you want to spend your time with is really important. So underrated. So underrated. And actually, I think the best

asset owners do think about this a fair bit. And although it's not explicit in our industry, I think the way you're perceived on that emotional plane and more human plane is really interesting. And I think we've seen that in the industry, right? Things are changing. I think maybe there was this allowance in the industry that even if you were maybe not a great human being, but you were a great deliverer of returns that was more okay in the past. And I think it's a really good development that we are also holding people accountable about

how they treat their people and kind of what they stand for in a way. But there will always be that conflict or trade-off between, okay, this is a person that maybe emotionally or values-wise doesn't necessarily align with me on a cultural or, yeah, values basis or emotional, as you say. But actually, they're really, really good at making money. And I think that's a really difficult decision. Personally, at least for us, I always say to the team, I'd rather we back an 8-9 investor who's a good person who we can see ourselves being partnered for a really long time. Because for us, this is more like a marriage.

Not only do we lock up our capital, but we're trying to build a business and building a business takes longer than an investment to play out. It's just a longer commitment. And so for us, we'd much rather have an 8-9 investment. who's a good partner, than a number 10 investor who's actually just not that pleasant as a human, who's like a bit unpredictable, who maybe has values not aligned with us, who's going to create a culture that we don't think is a good environment for their team. Could you describe how you think investment firm GPs, the enterprise value prices? Like at what multiples, what are the components of the multiple?

You mentioned earlier that this is like an underrated part of the return that you earn, that you can generate starting one of these things. And that's one of the special insights. How do these things price? Like, what do they price on? Are they some of the parts? Are they, like you said, there's feed, there's carry. There's some are private with long lockups.

Some are shorter with hedge funds with no lot, quarterly lockups or something. So how do these things price? Give us a little education lesson there. Yeah, so that's changed a lot. I think when we started the business, there was not this appreciation that GPs were also businesses. And so there was very little institutionalization around. what these businesses are worth. And there's a few firms over the last 15, 20 years have done an

amazing job at almost developing this industry. So there's a few sort of 80 pound guerrillas. The biggest one is Dial, now Blue Owl, was a new Burger Berman firm. And both Blackstone and Goldman have teams that do this. And they're 80% of the market or something in terms of capital raised to buy stakes in asset managers. So for us, we're builders. Think of, What we do is stable as building asset managers. They're a VC for investors, basically. Yeah, to some extent. The VC nomenclature is a bit scary in the sense that people might think like eight things

out of 10 go wrong. When things go wrong for us, we don't lose a ton of money. You have sort of ways to, in public, we'll have risk parameters with maximum drawdowns. On the private side, we have ways in the LPAC to ensure that we're not going to blow things up. So it's VC like in the sense that the stage. Yeah, it's early. But also our day job is very much around helping with product design, talent acquisition. The role that a VC partner would play for a tech firm is kind of very similar. And also shoulder to cry on cheerleader. So much of this is just helping the person because

it's really tough. But anyway, other than the VC downside is not the same. The upside is quite concentrated. There is a lot of power law outcomes. So there are some similarities. But back to your question was on how they're valued. Yeah. So these firms, have educated the market that, look, there is a huge amount of value as well in these businesses. And so we think that for alignment, it's fair for asset owners to participate in that. Because as firm grows, like one of the misalignments is when you're smaller, management fees aren't a source of profit. And as you grow, there's a misalignment where the GP wants to scale a UM, maybe keep volatility low and sort of, you know, in public markets, you can do that in some

ways in private markets, there's like volatility dampening on how books are marked and things like that, which gives private GPs more stability. And there's great literature on whether investors actually want that volatility dampening. There's this whole philosophical debate and a few great academics that are shining a light on that. But that discussion aside, I think this misalignment between LP and GP grows with scale. And a beautiful way of mitigating that misalignment is for the LP to participate in that upside, as you mentioned. And so enterprise value is really a function of what are the revenues of the GP. And the parlance in the industry is FRI and PRE.

So FRI is fee-related earnings, PREs performance-related earnings, which on the hedge fund side, it's performance, on the private equity side tends to be called carry. And those are valued on a multiple with a discounted cash flow like any other business. And actually asset managers, investment firms are just amazing businesses because they're capital light, they have huge margins. If you look at even publicly listed investment firms, they tend to have 50% margins. And I think private investment firms are even higher. So just as a business, they tend to be beautiful businesses. And some famous investors have used things like insurance companies and float to really maximize their returns, obviously like the Buffetts and mongers

of the world. I think the understanding of the power of that capital light, scalable, model. Investment firms are almost like software, like the incremental cost as you scale. It's a bit heavy on the private side, but on the public side less than. So FRI and PRE get multiples and the longer lockup capital gets higher FRI multiples because obviously you're just discounting management fees over longer periods of time. And then on the carry side, again, on the public side, it's typically lower multiples on the private side, but you're valuing it from a DCF like a cash flow business. And then I think in investment firms, there's also huge value to brand and goodwill and trust because, again, managing people's money is a real trust-based exercise.

And coming back to your question on the role of emotion or the role of likability, I think if you're someone giving your money or the money of the people you represent, like pension funds, their members, it's a real responsibility, right? If you manage a huge pension fund, the retirement future well-being of thousands and thousands of people depends on what you do with their money. So in my experience, the CIA of public plans in the U.S. are incredibly thoughtful. They're incredibly mission-driven by serving those members. And so for me, it's very important that the founder understands that better. If you think about the life cycle you mentioned earlier, we haven't actually talked that

much about your product, like literally what you do. We sort of assumed it in our conversation, but I'd love you to delineate it because I think a key insight you have is that you need to match your capital product, capital as a service, as you called it, to the circumstance of the customer. And you've alluded to this life cycle that like all investment firms go through. Can you delineate what the stages are of that canonical lifecycle cycle and how your product, your capital product, matches on to that concept? Yeah. So I think that let's separate the two stakeholders again, founders on one side and asset owners on the other. And let's maybe start with founders in terms of the audience.

So the way we think about supporting founders is we have this founder cap stack, which is a concept that we came up with to distinguish it from a cap stack of a company instead of equity and debt and growth and IPO. Think about the life cycle of a founder. And so anyone who's listening who wants to start their own GP or is in the early stages of their GP, what they will be thinking about. and here's the what is the stable product to the founder. One is capital and one is support.

So on the capital side, when you're starting your own investment firm, probably what you want first is working capital. So we need to find a way to provide working capital to you. That might be a working capital line or it might be we're going to give you an LP check. So we're going to invest in the fund. And just to make the numbers easy, maybe if we're giving you $100 million and we're paying 2%. Again, 2% is a high number and probably not what people are.

are getting paid, but we tend to pay at the beginning high fees because we want to make sure you have enough capital to cover your costs. And that's, again, one of these misalignments of the LPGP relationship. It tends to be quite adversarial in the sense that the founder says, oh, I want high fees. And the capital says, oh, I want low fees. But actually, that's sort of shooting yourself in the foot as an asset owner because you do want your founder to have enough money to attract good talent and pay for the right service providers and pay for deal fees and technology and whatever they need. So I try and turn it on its head and I say, actually, we're collaborating with you. We're happy to pay high fees at the beginning. But as our relationship grows, those fees are going to

come down and down and down, maybe as a function of us receiving part of the revenue from incremental management fees and enterprise value and all of that, but maybe also having capacity at discounted fees go forward or having co-investment capacity that's much less. There's all these ways to reduce fee load to be appropriately and justifiably rewarded for initially being very thoughtful about, no, I'm coming to the table to tell the founder, I'm happy to pay high fees. Like, that's an eye-opening discussion. When I'm talking to founders, they're like, oh, I'm definitely going to need high fees. And I say, yeah, absolutely. And they're like, flabbergasted this stuff. Like, what? I don't have to argue with you about this. I'm like, no, that's the whole point of a partnership.

I'm not paying you excess management fees to go and buy planes and boats. You're going to be spending it on your business, which is what management fees should be for in the first place. So it's a much shorter discussion with them, and I think it's a good first meeting. In terms of back to the product design or the proposition design that we bring to founders, after working capital, then you need investment capital. So that's the LP check. And in public markets, again, you can kind of scale that in. You can start at a lower base or lower size.

But in private markets, the minimum efficient scale of LP capital is typically higher. And when we think about the sizing of the LP check, again, it's a bit of an art, not a science, but it's multivariate. And it sort of falls into three categories that you need to consider. In our due diligence and proposition design, we think of investment issues, operational issues, and commercial issues. So if I talk about each of those in turn, the most important one is investing. So you think, okay, I'm going to build a portfolio, a portfolio of investments, either on the public side or the private side. Each of those investments will have a minimum size, and I need to have a portfolio construction framework where I'm diversifying risk. So to make the things easy,

I'm going to invest in 10 things, they're going to be 10 million each. And I'm super streamlining this. I'm sure a lot of people are going to be like, life is messy and this is nonsensical. But just from first principles, yeah, bear with me. You'll have a sense for what is the minimum size you need from an investment point of view. And also to be part of the conversation, what deal sizes are you doing? In certain credit strategies, you need to be a certain size to be on the creditor committee. And maybe you're going to be activist or whatever it might be. So there's a lot of nuanced drivers of what size you need to be from an investment point of view. The second one, One is more operational.

So this is back to what is it going to cost to run the business? What are the management fees? Are they coming up front uncommitted? Are you going to have to wait on invested? And then on the commercial side, that's more around what is the perceived minimum efficient scale from the market? Or are there concentration limits? And this, again, is empathized with the asset owner.

Are there concentration limits in the asset owner's mind that they don't want to be more the next percent of the fund or something like that. And you need to get that right in terms of having a size that will actually allow you to raise assets from the LP base that you're targeting. And it also, to some extent, is also there's some levels, us humans we like round numbers and we like these watershed type of pivot points. Like, is it 50 million? Is it 100?

You know, everyone's always raising a round number. We joke at the office that whoever comes and says, I'm raising 327 million will definitely fund that founder. But jokes aside, that's the way to think about a bit of that ticket size from an LP check. And then on your founder journey, the way I think about it, X-axis is time. and Y axis is cap stack. As time progresses, you go on this curve as the firm progresses, and it's like first it's working capital,

then it's LP check, then it's co-investment capital, then it's growth capital, and all the needs that you need to satisfy from a funding perspective to build an exceptional firm. And that's all to do really to people, process, all the kind of firm building frameworks. And that's something that founders don't think about enough, asset owners don't think about enough.

It's not a linear sort of fee this. It's like where the fees going, what are they paying for? Are they making you a better investor? Are they being spent? Because it's not only caplication on the portfolio, it's capitalization on the business. So for instance, if you see a founder spending tons of money on fancy offices, we always say red flag is like the water feature. When the water feature shows up at these firms, it's like sell, sell, sell. Because then there's too much excess management fee. But where that capital is being invested in the cap stack varies lifecycle-wise overtime as the product. And then we've talked about capital,

but what is the proposition on the support side? And this again goes back to VC-like role, which is, I think one of the differentiators of our approach has been, we think founders need help more than they need money. Money is almost like table stakes. And it's a bit meta because in investing money is your product. The fact is you're going to need more things. So those things are HR, its operations, its distribution.

We think about it in two big. functions operations and distribution and we try and support you on each one so there's a framework around pre-launch or pre-investment you know often we're seeding something from scratch or we're coming into a firm that's been around for a year or two it's still small and that's more of an acceleration investment but we want to be sure that we're supporting you and building your operations to top-class standard so this is hiring the right people making sure the service providers are right but it's also nuanced things like what

your valuation policy? Have you thought about the asset liability matching of your strategy in terms of redemptions and subscriptions? I can't tell you how many firms, and not even emerging firms, but come across more mature firms where it's clear to us that the subscription and redemption or structure of the vehicles is just not aligned with the investment strategy. That creates these huge risks that you're more liquid, people want their money back. There's tons of blowups that have nothing to do with performance. It has to do with a sort of emergency forcing decision that has to do with the duration of the capital. And often that's a real issue. LPs do and need to be very careful about assessing what is the patience, downside appetite, particularly in open-ended or sort of public

markets investment firms. What are the tolerances there of other investors? Because other investors will, it's not only the investment strategy risk, but other investors. It's not only the investment strategy risk, but other investors' behavior will become a risk for you as an investor. So those are the things that we're helping on pre-investment and post-investment. It's more about being a support function for how do we do this new thing. We've built a lot of business business right now. So we understand on the life cycle what is happening four, five, six years down the line. We call it future-proofing because you don't know what the demands are going to be in the future.

So you structure in a way that you future-proof it so that you know that your product is life cycle insulated from the demands future on. But that's not like smart or common sense, no matter of what amazing investor. Yeah, that's just like you've been there. It's like we've watched the whole box said. I know what happens in episode eight. Yeah.

Let's like be careful. If what happens in episode eight is bad, let's not go into that room, you know. So that's a sort of more ongoing forward-looking help. A lot of it is future-proofing and a lot of it is firefighting. Because again, going back to the travails of an entrepreneur, I think people forget that founders of investment firms, are also entrepreneurs and entrepreneurs,

there's just stuff blowing up all the time. And don't get me wrong, every year, something that hasn't blown up, blows up in new and wonderful ways, and then we learn. But you have this institutional legacy knowledge about what problems arise,

how they go wrong, what are the best ways to fix it. And so that's the proposition product, as you mentioned, on the founder side. It's the capital and it's the support. And then maybe moving over to the other side of the equation, on the asset owner side, I think that goes back to a bit of what are you actually providing your asset owner with.

First and foremost, returns, risk-adjusted returns, what do you need to hit? What tolerance do they have for losses? There's not only this basic, oh, I'm making this amount of return, IRA or Moic or annualized or whatever your strategy is measured in, and this amount of risk, however that's measured. And that's sort of a big philosophical question. Is volatility really risk? In privates, you get rid of that.

but are you taking more, it's often hard in our view to measure how much risk you actually took for the return. It's really hard to do. In addition to that, then it's also, are you providing knowledge transfer? Are you providing for a way for them to allocate more capital as you grow? Because it's such a big investment to get to know a founder that I think most asset owners would like those relationships to be pretty long term. And that essentially means, are you providing capacity, discounted fees, access, all of these things other than performance are really important to asset owners to get more value out of the relationship. I think the less collaborative the relationship is, the less the asset owner gets out of it. If all you get is a sort of administrator's statement

once a year and maybe there's an annual meeting for a few hours with a nice lunch, that to me feels leaving huge amounts of value on the table because that founder you've entrusted with your capital can get you ideas, insights, access, all sorts of other layers of value. Do you find it underrated for investment firms, especially started by young people like you did, to bootstrap through deal-by-deal experience early on? I've noticed this with you and several others that you didn't just raise a fund to start. You actually went deal-by-deal.

Talk about that experience and whether or not you recommend it for more would-be young, especially young investors out there. Yeah, absolutely. So I think the deal-by-deal in the public markets is start with a very small amount of capital. and sort of try and scale that. It's a bit difficult there because one problem is that investors would often not give credit for your performance on return if it's a really small amount. And sometimes it's fair and sometimes it's unfair.

So what I would tell GP would be founders on the public side is make sure it's externally validated. You have a law firm or an administrator or someone who's validating that you weren't changing with benefit of hindsight, but also make analysis of things like liquidity or pricing to say, I could have put, you know, I only had $100K or a million dollars of whatever you're able to scrape from your friends and family. But actually here's all the data that shows I could be at a much larger size. And these are the externally auditable emails where I said or interactive brokers or something like that. On the private side, absolutely. When I started, I didn't even know the name for it, but often they're called fundless sponsors now. And I think necessity is the mother of invention. And when I was starting, I didn't have a track record. of doing this. Again, most people laughed me out of the room. I managed to find an asset owner who believed in the mouse trap. And when I was putting together, the first investment firm that I helped launch, it was really difficult because you're trying to build the plane at the same time as you're

flying it. And you're actually, you need to be really on top of both sides of the equation. You need to be on top of the investment. So putting the team together, the founder, the talent, the business building there. And at the same time, you have to make sure the capital is there. But there's nothing really to do diligence yet and hasn't built yet. So you need to keep the capital aware. And I think there it's all about candid communication to both sides. I think there's a potential risk that I see sometimes assessing fundless sponsors where there's a fine line between keeping the confidence in it coming together and then overpromising or being disingenuous about is the capital really there? Is the team really going. I think honesty and reputation is something that you'll take a while to build

and you'll lose really quickly. It's doing it one at a time. It's a lot of sweat equity. I was the de facto sort of team member at a lot of these firms because we didn't have resources to build it. So each firm, I was playing a role. And for me, the hardest part was the distribution side because I was coming an analyst at Bain. I felt like I had a good grasp of the investing side and also the operational side, but the distribution side is very complicated. And raising money, no one tells you how to do it. And I have huge respect for salespeople because it's a really tough job. It's super hard on the ego. You get so many nos. You often don't know why people say no. But that was the last piece for me that the insight there again is a bit what we've been talking about, which is I was focused all the time

on the firm, the business, the founding team that I was putting together. And I failed to really focus on the asset owner's side of the equation about who am I serving? What does the capital want? What are the risks they're facing and backing me? I mean, it seems like most insightful things, they seem very insightful in hindsight, or once you're explaining that, seem quite obvious. But I didn't, I wasn't quick enough or smart enough to figure this out. On the asset owner's side, you need to make sure they can build a portfolio because all of these things won't succeed. And so I think of one advice for the fundless sponsor phase for me is make sure you're taking bets. that if they don't go well, you still have time to go back to the table.

So it's almost just live to fight another day. Because if you get lucky and your outcomes are good to the upside, then it might have seemed like the right answer. But what I see fundless sponsors getting wrong often is that they might take excessive risk because they want to get there faster. But if you're just patient and more long term and you are in investments that even if they start going wrong, there's ways to correct them so that the outcome doesn't end up being bad.

And that might be cutting your losses or, pivoting or exiting that investment and trying a new one. But just make sure there's this like operations concept that I liked where it's like a quadratic equation of inventory of when you need to have more inventory. And I think of life a bit like that. You need to stay at this level where it goes down, down, but you can't go over this alert level because you're not going to come back from that. The beauty after the fundless sponsor bootstrapping phase is that then you can take more risk. You don't have to rely on luck and path dependency to get there. Taking risk is a huge privilege, which again is something I tell my founders, people who have very little, they can't afford to lose it.

So being able to put chips on the table means you have enough chips to lose them because we're not always going to get things right. And so actually one thing that's quite encouraging for that funless sponsor GP listening is that it actually just gets easier in a way because you can afford to trip. Whereas early on, those first eight, nine years of the business for me were incredibly stressful because I knew that I didn't really have that much margin of safety. there wasn't that much buffer. And when things started going wrong, things just got incredibly close to that line on the inventory where we weren't coming back. Any closing secrets, patterns, things that you've noticed about what makes this world go, what makes people successful or fail that we haven't talked about yet?

I know we've covered a lot of ground, but any closing esoterica for us? I like to think, and I'm a bit of an optimist, delusional optimist somehow. We do these things called Seeds of Wisdom at the firm, and we wrote a piece around do nice people finish last. And I think about that a lot because I think particularly in investing, there seems to be some return to disagreeableness. When you look at the people that succeed in our industry, and again, I'm giving success a pretty narrow definition of financial earn high returns. Earn high returns and wealth and financial success will come through that too. But I think at least personally, my aspirations is I want to be a good citizen. I want to be a good husband. I want to be a good

dad. And so there's other definitions of success that I encourage people to try and make contiguous to building a great investment firm and delivering great returns. And I think our conclusion there was that it's not a consistent game strategy to necessarily always win and crush the opponent. And that things like generosity being helping people who are coming behind or, even just in a transactional relationship, making sure that the other party is also winning, is something that compounds your own success. Did you learn anything about family stuff related to money managers, whether that's like a divorce or, you know, the way they are as a dad or the way they are as a mom or just anything interesting

here that pokes out as in the data worth mentioning? Yeah, so there is data on the impact of divorce on performance. Yeah. As you can imagine and forecast, it's not good. One of the things we do at stable before we fund a founder is to, ideally, if they have a partner, meet the partner, go for dinner. I think it's so important to have a support network around you. And that can be provided by a few things.

It doesn't necessarily have to be a partner. It could be religion or it could be sports or it could be something that you feel you belong to. But when those darkest times, when returns are really poor, there's an old aphorism that you should always back a marriage. founder. And that's something that I loved about getting married. I didn't realize this a priori. But after I got married, and I love these surprises because in life, things I didn't predict are huge teachers. And one thing I was like, wow, I have like 20 or 30 percent more mental bandwidth after I got married. And that was basically, I was spending 20 or 30 percent of my time looking for a great life partner. And I was so lucky to find them. And that was a huge bonus.

I think that's something super underrated about getting married is that people don't tell you what a better investor that probably makes you if finding a life partner is something very important to you, which it was for me. Obviously, some people might not think that's the case and then they'll have to find extra bandwidth on another development of their life.

But I do think there's this harsh trade-off that is not spoken about. It's a bit taboo because it's sad and harsh to some extent, which is every hour you're with your family or with your kids now as a dad is an hour you're not investing. There's very little substitute for hours because all those hours compound, be it your knowledge or your network or your analysis,

whatever your edge is in investing. And here I'm sort of bringing it back to investing, but I think it applies to life and whatever your mission and calling is. But I think that's an important thing to think about. And for me, a balance that still retains a happy, stable life at home, but also a good relationship with your team is actually really important. And I don't always find that consistently. I do think there is a price and a cost to pay. And people don't talk about it a lot because it's a high cost. A lot of really successful people, you see that it comes at the cost of not spending time with their wife or husband or not spending enough time with their kids. But I do encourage people to try and find a balance through some structure. When I've seen founders struggling, not being

judgy is really important. That's one thing that the market is bad at, as I mentioned. It doesn't encourage true feeling revelation. I tend to share my own life journey or issues and security. It's a two-way street. You need to earn the right for someone to be truthful and show their vulnerabilities. And in the investing world, because it's all focused on money and returns, it's a bit difficult. But I think that's one of these learnings of talking to really successful people that maybe if your returns go from 19 to 18 or your wealth goes from like $7 billion to $6 billion, but it's not linear. Like you spend a lot more time with people you loved, I think that is probably quite powerful. Well, I don't want to inundate your inbox, but I do highly encourage anyone considering

starting a firm to call you in stable. I've learned so much from all the nuance about how these businesses work, and I've run two of them. So I've been in it, but even still, there's just so much additional detail that you've taught me that I think is so incredibly valuable. And it's so cool that you've carved out an investing niche that's so distinctive. And I think it's notable that you started that such a young age. I'm finding this a lot recently that like the firms that look the most interesting were started by very young people. And that's maybe just compounding, right? I think so. Yeah, of course. It's like you're not smarter or anything you'd like have more years in a way. And that's why these big legends sometimes as well, you'll notice they all live quite long

lives. Yeah, sure enough. Yeah. You have to be honest with yourself of attributing your success to like what factors. And I think just starting early, you have more time to get it right. It wasn't like you were this sort of genius. Well, I'm forced to go to my traditional closing question. What is the kindest thing that anyone's ever done for you? So I gave this a lot of thought. I love that it's predictable as opposed to all your other questions, which make you think really hard.

And it's not super original. I think I find most people or many people go here, but I think it has to be my parents. And one thing that was really meaningful in my life, unfortunately, my dad passed when I was 18. And while he was sick, he died of cancer. the only time I'd seen him cry was when I'd gotten into Oxford for university, where I went to undergrad. And then the second time I saw him cry was when I came back home and found out that he was sick. And I was like, Dad, don't cry. You know, you'll be fine. And he's like, no, I'm not crying for me.

I'm crying for you because, you know, I might not be here. And becoming a dad has been a really amazing experience because for me, kindness has this element of self-sacrifice, but also willingness to be uncomfortable. So, like, telling people the truth are uncomfortable things I think is quite kind like when you forecast something or predict something being kind actually means being willing to say something tricky between both of you and then my mom after my dad had passed and I was at university at the time she was like whatever happens I'm going to be okay I'm an only child my mom's an only child so she doesn't have a lot of help she's like you need to go live your life and now as a parent I'm like wow that's amazing I want my children to be with me forever like I don't want them

to leave home and so that for me is really the kindest thing to put others first in that way is true kindness. Eric, thanks so much for your time. Thank you. Great to be here. If you enjoy this episode, check out join colossus.com. There you'll find every episode of this podcast complete with transcripts, show notes, and resources to keep learning. You can also sign up for our newsletter, Colossus Weekly, where we condense episodes to the big ideas, quotations, and more, as well as share the best content we find on the internet every week.