Investing Billions - E123: Should LP’s invest in Venture Capital? w/Gregor von dem Knesebeck

Episode Date: December 24, 2024

In this episode of How I Invest, I connect with Gregor von dem Knesebeck, Co-Founder and Managing Partner of Blue Future Partners. Gregor shares the story of building a successful fund-of-funds focused on venture capital, emphasizing brand building, portfolio construction, and navigating the unique challenges of venture investing as a family office. This episode provides insights into venture capital portfolio strategies, the power law of returns, and best practices for fund allocation. A valuable listen for emerging fund managers, family offices, and anyone exploring fund-of-funds strategies.

What's the best practice for allocating the venture asset class if you're a family office? I always, when I talk to people, go with three pillars. You'll have part of your money in fund-to-funds, you'll have some in funds, and you'll have some direct. And depending on where you start your journey, you'll either have, you'll enter one route or the other. The one persona we typically encounter with our LPs is somebody starting out and tipping his or her toes into the space with the fund-to-fund.

Then they use the access they can generate to go into funds, and then they become very excited and they want to go directly. Another persona is the persona going direct, burning his or her hands because they did one of five, 10 investments in a very short period of time and then Jio. So everything you can be doing wrong on home buyers, on Jio, on not looking at vintage diversification and so forth, people typically do on direct investing. I think one of the big issues with family offices that invest in venture capital is they have the wrong intuition around other asset classes like private equity, where

venture capital is power law driven. So I think this is quite an overlooked discussion point in the industry of managing family and the business. And when you start out on a business, on a venture kind of firm, I think it takes you 10 years and it takes all of your energy. If you have kind of young family at the same time, it's a strain, which you probably need to get right. So probably if I hadn't known that before,

I would have again timed it a little differently, then you kind of learn along the way. But that's probably one very personal kind of consideration on understanding when you start what it's gonna entail. What is it like to start your own firm, like Blue Future Partners? Walk me through the founder story and what it's like to run your own firm. So I was co-founder, so I co-founded with my brother Philip. When we sat down with the manager, one of the first funds we actually invested in, in the US in New York, we sat

down with him and he said, if you don't have a brand and you don't have a digital presence, you will not succeed in venture capital. And this was really eye opening. I recall how we sat down over lunch in 2013 and that kind of gave us the idea to actually build the firm around it and do a lot of activities to actually create a brand. And so we focused a lot on not in scaling people at the firm. It's not about headcount, but it's about brand reliability and everything you need as a good LP to build that firm.

How do you go about building a great brand? I think it's something which happens over time. And then you need a lot of luck as well. So I think brand and venture capital, especially as an LP, you're judged by the investments you've done in the past. So in the beginning, you haven't done any investments, therefore it's a chicken egg problem that you can't really escape.

I think there are a lot of new components in what you can do kind of for branding purposes. So we have a bunch of initiatives on the kind of GP and LP side, which now help us to more systematically build a brand. But it's about breaking in. And if you look at the C-Fund managers, they often thrive if they have done a very good deal everybody talked about and suddenly you're on the map and then you need to prove yourself

long-term, which is an even more difficult part than actually breaking in. How did you solve the chicken-eg neck problem when you started a decade ago? So for us, we were very fortunate that we had a trusted kind of circle of LPs that very early on for our fund one, which I'd call a fund zero today, kind of by size, took the leap of faith with us and said, okay, let's try this. This happened because we had been co-investing in that circle in other asset classes before. And they said, okay, we'll give them a shot and try. From the family office. It's family office and it's other high-net-worth individuals and family offices, founders and

so forth that had a good experience with us as partners in other asset classes. And then we moved on to venture together. So we had the trust of people saying, hey, try this. On paper, we understand what you're trying to do now shows that you can do it. And then for fund two and fund three, it was way easier to convince them and scaling up. What percentage of assets do you think a family office should have in the venture asset class? It really depends on what they do. So if you look at it top down, you'd say typically the one third, one third, one third rule. If you have private markets or private allocation of a third, then within that probably a large

majority will be private equity. And then I think given the endowment style investments, a lot of family offers try to do so to generate liquidity for the family from let's say real estate or yielding assets and then they can actually take this really long term view when they when they deploy in venture, they could then probably go larger. So I have seen families saying within my private equity allocation, I'll do 60% venture and are super comfortable doing it. I think it is can be a good strategy, let's say, depending on what your liquidity needs are in the mid to long term. You mentioned 5%. US endowments are anywhere from 10 to 20%. Yale, I think, is mid-20s. Why should family offices allocate less than the traditional endowment model? So, good one to point out. I'm not necessarily convinced they should allocate less. I was more referring to what I think they're doing at the moment. And probably if you look at this average, it'll be one, two, three percent in Europe,

depending on which country you are operating in. So I think I'd recommend everybody to grow that allocation, but you need to do it in a very sophisticated way and that will take time. So the interactions I've had with endowments in the US, I think they really know what they're doing and many family offices don't. So it'll take time for them to educate themselves. What's the best practice for allocating the venture asset class if you're a family office? I always, when I talk to people, go with three pillars.

You'll have part of your money in funder funds-funds, you'll have some in funds, and you'll have some direct. And depending on where you start your journey, you'll either enter one route or the other. So the one persona we typically encounter with our LPs is somebody starting out and tipping his or her toes into the space with the funder fund. Then they use the access they can generate to go into funds, and then they become very excited and they want to go direct. Another persona is the persona going direct, burning his or her hands because they did one of five, 10 investments in a very short period of time. And then GEOs, so everything you can be doing wrong

on home buyers, on GEO, on not looking at vintage diversification and so forth, people typically do on direct investing. Very common. And then you need to kind of unwind that, what they've done and build into a more structured mandate. Yeah, I think one of the biggest issues with family offices that invest in venture capital is

they have the wrong intuition around other asset classes like private equity, where venture capital is power law driven. One or two outcomes drive the entire portfolio in private equity. There's very few zeros, let alone even less than one X. I think you need to understand what a typical fund will be thinking. So, the most often, try and open the door to an LP and then an LP will be saying, I don't like double fee layer. What they don't look at is that if they have their own team,

they have their fee layer in-house on their own payroll, and they somehow apply different standards to it. And then most of the family office in Europe, they don't deploy large enough amounts to actually build good teams themselves because you'd need whatever, 25 to 50 million a year to venture to actually be able to do that. And if you look at the maturity of the family office space, there are a lot of family offices which are way smaller and don't deploy these kinds of money. So the second thing is the fund-to-fund industry, and I call it kind of a dichotomy,

if you go fund-to-fund and you operate a fund-to-fund, from the inside you know either you go large and then obviously returns will come down and the investor, your LP, will be stuck kind of somewhere in long lockups and mediocre returns, or you go the other route, and that's the one we chose to say, here we go small funds, and we try to actually capture this top 25, top 10% of what's going on in venture, and then we need to work pretty hard, and it's not going to work well economically on the surface,

but then in the long term it will because you'll create that outsized return. And so if we thought about this for quite a long time saying, should we run a direct fund? And we actually did a few stints on testing that as well. I personally really prefer the fund-to-fund model because I think if you look at downside and upside, the bet you're taking on a fund-to-fund model, because I think if you look at downside and upside, the bet you're taking on a fund-to-fund as an operator, so as a GP for us, is way better than a direct fund.

So double-click on what you're saying. If you're deploying 25 million a year, you could put that into a fund-to-fund pay 1%, which is 250,000 versus hiring one employee at 250,000, which is gonna be pretty junior. At 50 million, you might be able to hire somebody more senior, but you only have one person on your staff. Tell me about your portfolio construction. Within the portfolio construction, when we invest in fund managers,

we look at concentrated portfolios, and we want managers to take fairly large positions. So definitely plus 10% ownership, but it could even be 15. Some of our managers have 20% ownership in their companies. The same thing which we look at when we look at other managers, we apply to ourselves. Our portfolio is very concentrated, and very concentrated means for given fund vintage of ours, 15 to 20 lines in a portfolio. We do concentrate 80% or so of the capital around, let's say 10 to 12 names or so.

And then we take smaller bets with managers we haven't known for so long and build relationship over time. So concentration is super important. Hey, we'll be right back after a word from our sponsor. Our sponsor for today's episode is Carta, the end-to-end accounting platform purposely built for fund CFOs. For the first time ever, private fund operators can leverage their very own bespoke software that's designed from the ground up to bring their whole portfolio together. This enables formations, transactions, and distributions to flow seamlessly and accurately to limited partners. The end result is a remarkably

fast and precise platform that empowers better strategic decision-making and delivers transformational insights on demand. Come see the new standard and private fund management at z.carta.com forward slash 10 X pod that's z.carta.com forward slash 10 X pod. You're a fund a fund. So you're investing into GP. So you're one layer up. How does your time diversification play into that?

What vintages are you getting exposure to as a fund a fund? Vintage. We look at three years of deployment period, and then the funds we invest in will have a deployment period of, let's say, something between fast deploying funds, the two and a half years or so in the good days, And then you'll have funds going all the way up to five or six years. And so basically on diversification, we'd say typically you'll have seven years

of vintage diversification within a given fund with us. How do you deal with an LP that's giving you a lot of trouble? How do you practically deal with that? I talk 50% of my time to GPs and 50% of the time to LPs. I use every discussion I have with a fellow LP or potential investor to run my diligence on the funds I can later on invest in and build my network. So it's an information trading game we're in as a funder fund. So we need to basically make sure that we spend our time well. So if an LP comes up and says, so we have an investor that's

in the US and he wants to come to Europe and wants to understand who should I be investing with if I go direct to a fund, then you need to be helpful. And let's say one of your LPs has a fund position in another fund, he's not really happy with. If you have built a trusted relationship, they'll ask you a favor. You'll take a look at their position and you'll talk to the manager and try and qualify something. You'll always take something out of it. So this, I think, although it might seem just like work, I think if you play it the right way, you can actually get a lot out of it. What are some archetypes of LPs that you would want to avoid in the future?

So in the past, we've always said this and tried to say, Hey, we want long term relationships. If you are in this game long term, we're happy to engage. And I think the industry term is tourists or tourist LPs that you want to avoid to tourists. And when markets go up, everybody comes to you and says, Yeah, I want to invest. And then when the markets go down again, they stop investing. That's kind of wasting your time. Because we all know if you understand says, yeah, I want to invest. And then when the markets go down again, they stop investing. That's kind of wasting your time

because we all know if you understand what venture is, and we spoke about cyclicality, I just had this up in my AGM actually last week. It is about understanding the dot coms, and then you go down and then the GFCs, and then you go down again, and then you have the next crisis. And we don't really know when it's gonna happen. So I think you need a 20 year horizon or so as an investor and venture. It's not like five to 10. If not, you don't really know I think what you're getting into.

There's a saying in politics, last one in the boat, first one out. The ones that take the longest time to convince that are not true believers are the first ones to leave. It's important to take into account who actually believes in your story and who's underwriting you as a manager versus just trying to get into a market trend. Yeah. The other, the other lesson I've personally learned is the, the difficulty of managing small checks.

Nothing takes more time to manage than a small check, whether it's 25k into a startup or $250,000 into a fund. And no good deed goes unpunished when you bring in a small check. So I'm very vigilant on the small checks as well, not because they're small, but because they tend to be from people that really micromanage their capital. Absolutely, and they don't know the processes. If you have kind of institution grade multifamily office or family office,

they just know what you need in data, they have the packages ready, they run through an onboarding process swiftly, chasing people from capital calls with small investors can be very, very time consuming. So what's your value add to LPs as a fund to fund? So we have various activities we engage in. Just to mention one which we've done recently is an LP family office academy format where we bring in 50 LPs. We spent two days with them. We bring a lot of good speakers who know what they're talking about

and deep dive on and deal sourcing, deal execution, term sheet negotiation and so forth. Just no selling, just providing content. I think that's a super important one, both kind of for building the network, but then also for them. And that's the second part we do apart from events and formats is providing a network with other LPs. As I said, we spend day to day in meeting other LPs. Our LPs typically don't because they're family offices. They spend whatever 10 percent or so of their time in venture. And so they benefit highly from meeting other LPs, being able to talk to them, build friendships and

relationships that later on can utilize. So we're basically like the kids throwing a cool party, we have to room, we get into drinks, and then everybody else can take it from there. What's the biggest early mistakes you made as founding BlueFuture Partners? So one of the mistakes we've been dealing with is what I said earlier, the cyclicality of really understanding what you go into on timing.

So it is very difficult on the fundraising side and delivering your product if you get the timing wrong, right? So you don't actually, the last two years, if you spend the last two years, let's say on the road, trying to fundraise, you wasted a lot of time and you wouldn't have been very successful on it. And so it really depends on when you started your vintage and how long the fundraise was. And that's one of the things with hindsight now, I would have timed the vintage a little bit differently. And the second thing is understanding the nature

of our complexity of a global approach, which we took in the beginning. So we said, we're gonna deploy 50% in the US, 30% in Europe and Israel and 20% rest of the world. That's a very difficult proposition for investors to digest because they don't really know where to put you. And often they'll say, hey, I covered the US myself,

in Europe I'd be joining you, right? And vice versa. So I think, and we are actually making this adjustment for our fund for coming up. We won't go for global, but we'll go for kind of regional mandates with some kind of international component to it. The irony on that is that as you niche down you get access to larger LPs because there's only you have to be a certain size to put 20 million dollars in European

venture versus global ventures. You get a different quality of LP paradoxically. What do you wish you knew before starting BlueFuture, partners? So it's the greatest love of my life to a certain extent because I love technology and I know how fruitful it is. The interactions you have every day, right, with people is so rewarding. And the other hand, it's so challenging at the same time. So I think being, if I had been more aware of the long-term strain and stress you're putting

onto yourself, I could have made a way more decisive decision. So I think this is a quite overlooked discussion point in the industry of managing family and the business. And when you start out on a business, on a venture kind of firm, I think it takes you 10 years and it takes all of your energy. If you have kind of young family at the same time, that's a strain, which you probably need to get right. So probably if I hadn't known that before, I would have again timed it a little differently,

but then you kind of learn along the way. But that's probably one very personal kind of consideration on understanding when you start what and what it's going to entail. The personal sacrifices. What would you like our listeners to know about you, about Blue Future Partners or anything else you'd like to share? Venture is a great asset class and the last four years have been extremely rough. And I think we are seeing kind of light

at the end of the tunnel. We're not sure whether it's going to be one year, two years, or five years, but it will get better again. And I would really hate to see a lot of talent, which is in the industry now, to leave and actually miss out on the greatest opportunity coming up, especially if I look at Europe, what's going on here, we have huge kind of tailwinds from regulatory point of view.

European Union is really trying everything to get Europe back on the feet and reinvent itself. So from that point of view, I think really the whole industry, I really want to encourage everybody to kind of stick in or hang in and keep going. It'll get better again. On BlueFuture partner level, I'm super open for both kind of GPs and LPs. Kind of two things we're doing. So on the GP side, we just co-initiated a GP accelerator program alongside with Mountside Ventures out of London. And we offer kind of up to 20 per cohort and GPs, 10 week program in person combined with matchmaking with LPs. So we kind of put out a program to support kind of fundraising activities from fund managers. It's kind of one of the initiatives.

You can find that at program.vc.25. And on the LP side, we're kind of very kind of active in engaging with the community and running academies and so forth. So if you just get onto our website, you can find kind of what's going on at the time, reach out to us. We're super happy to engage. We're not always fundraising, but we're always engaging with LPs. Greg, this has been great to chat. David, thank you so much.