Investing Billions - E35: Ben Gallacher of Cannonball on "Value per Dollar Invested" and How it Predicts Fund Performance

Starting point is 00:00:00 And to be honest, I think one of the reasons Fund Ones performed so well historically is because those individuals have been so close to the ground that they aren't predictors. They actually see today perfectly clearly. And I think that that allows them to understand what needs to be built today and who needs to get funded today. And I think the closer you are to an operator and the further you are from being just an investor allows you to see today very clearly and therefore execute on maybe the next new trend that deserves a percentage of the fund's investments as an edge case. Well, Ben Gallagher, I'm excited to chat.

Starting point is 00:00:53 Ariana Thacker gave a very high recommendation. So let's go ahead and get started. Sounds great. Thanks for having me. And hopefully I can live up to the expectations. Let's jump right in. Tell me a little bit about how you came into being an LP today. Yeah, listen, my journey started on the other side of the table. I started a business at a school called Performance Phenomics, ultimately ended up pivoting and it's now a business called

Starting point is 00:01:17 Voxel AI. And we're just finding a soft landing for that business right now. So I started again as a founder on that side, raised an up round, down round, replaced the CEO. So got to see that side of venture. And then, yeah, I've stepped into a role at a family office where we've been investing in the asset class now for the better part of seven years. Seven years in the venture and emerging manager space is like 25 years normalized across other industries. What have you learned from your colleagues from doing this for the past seven years? Yeah, I think the biggest thing for us is just to keep an open mind. I don't know if

Starting point is 00:01:57 there's an asset class that changes at a higher clip than venture capital, both on the startups that are being funded, the areas that people are spending time, how people are thinking about structuring funds. And so for us, it's just trying to stay open-minded and maintain a level of curiosity that perhaps what we used to do is not necessarily the best strategy on a go-forward basis. How has that strategy evolved? Yeah, it's a good question. I think initially we wrote checks. Well, first of all, we wrote a lot of checks into direct companies as a family office. And I think for us, a big learning is that there's a serious amount of adverse selection associated with going direct as a family office, just speaking for ourselves. I think what you realize is that the VCs that

Starting point is 00:02:44 live and breathe this all day, every day, just have access to different networks and different pools of capital and different founders than a family office does, who's potentially doing it off the side of their desk. So our first transition was really to start investing in fund managers. And we started to do that more from 2017 into the kind of 2019 area. And now we're exclusively investing in funds. And so that's been a big shift for us. And I think like, as far as our strategy goes, the way we think about venture is we see it as an uncorrelated asset that's got the ability to really return multiples on the dollar for us. And we see duration really as the opportunity set

Starting point is 00:03:22 there. We just have the ability to wait longer and let the capital compound over time. We chatted offline a little bit about spinouts, and you mentioned that venture capital has significantly more spinouts than other asset classes such as private equity. Why do you think that's the case? Yeah. It's something that I talk a lot about. Listen, I think private equity firms just inherently have more scale than venture capital firms. I think if we use like Vista private equity as an example, they've got almost 90 billion under management. I think they have close the big multi-stage VC firms have that many folks in-house or that much as far as assets under management. And so the thing is, is that that really scales at private equity. More capital under management, therefore more management fees, more resources on a year over year basis. And ultimately the ability to really scale those resources because they're investing in potentially bigger companies, larger cash flows, and so they can use those portfolio support resources in different ways.

Starting point is 00:04:29 In 2021, I think the average PE fund size was about a billion dollars just for a reference. So I think that's really where we think about the spinouts being much different from being incentivized to stay at one of those firms and be a part of the growth of that asset class versus spinning out and going on your own adventure. Is it also the case in private equity firm, I have some business school classmates that are making literally seven figures in salaries, you don't see many, even partner level at large firms get that kind of, do you think there's an incentive just because of the base difference between venture capital and private equity that's led to the proliferation of more venture spinouts? Yeah, I think that's exactly it. I think that

Starting point is 00:05:11 ultimately, there's a couple tailwinds that I think are going on that private equity is capitalizing on. And I think part of venture is capitalizing on. But on the private equity side, I think concentration of capital is a really big thing. I think that, you know, as the sovereign wealth funds have deployed more into alternative asset classes, I think, you know, Blackstone has really benefited from that. KKR has benefited from that. In my backyard, you know, Brookfield has really benefited from that. And I think a big portion of that is that they're, you know, they can pay their people really well. All of those companies have public stocks that they can incentivize their employees with. And so when you think about spinning out of a Blackstone or a KKR or Brookfield, I mean, the risk reward ratio, I just don't know if it adds up, especially because when you leave, you need to go and

Starting point is 00:05:54 raise so much money. Whereas in venture, you see a lot of these emerging managers leaving their jobs at even a multi-stage platform, or they were working at a growth stage startup and they can raise five, 10, $15 million funds and now they're in the game. And so we see that as a feature, not a bug. And we see that as a real opportunity within venture. The economies of scale of private equity firms, as they get bigger, sometimes those returns could grow. Not always. In venture capital, it's almost inversely correlated. The larger the fund size, the worse the returns. So you do deal with a lot of spin outs and I think that's a common theme

Starting point is 00:06:27 alongside the very top LPs. What is it that spin out emerging managers that have their first fund? Maybe they were five to 10 years at a traditional venture fund, venture capital fund, and they decided to spin out. Now they're on fund one. What is it that you have

Starting point is 00:06:45 to coach them on? What is it that is lacking in their experience? It's a great question. I think that it's helpful to differentiate amongst the emerging manager population. You mentioned somebody spinning out from a platform business, think Benchmark, A16Z, Sequoia, one of those. And then there are folks who used to be operators. Maybe they've run angel syndicates. They've come from a growth stage startup, any number of backgrounds. When I think about the GPs who are spinning out from the platforms, I do think sometimes they underestimate everything that goes into the actual operational side of the fund. And so when you think about these bigger platforms, likely they have somebody who's on investor relations,

Starting point is 00:07:29 raising the capital, managing back office work, dealing with sub-docs, legal docs, wires, approvals, capital calls, you name it. And what they've really been focused on is sourcing, winning and supporting portfolio companies. And so when you kind of take a step back, it's obviously not, or it's common sense, I should say, that they're going to have to manage all of that themselves, potentially with one other partner. And so one of the things that we try to drill down on with them is just how they think about time allocation. And so I think they do have advantages coming from the institutional backgrounds, because generally speaking, they can get in front of institutional LPs, which is really

Starting point is 00:08:02 important factor and something that I think some of the other emerging managers have a harder time doing. But that time management piece on managing LPs, managing portfolio companies, sourcing, winning, and then still supporting the actual operations of the business is a difficult task at times. How should emerging managers allocate their time when it comes to their business? I think that for a lot of emerging managers, they spend a lot of time raising capital. And I do think that if you have the ability to raise an amount that you know you can get to and close on that amount and then kind of parse through going, okay, we've raised the money that we need to execute the strategy that we've agreed upon. And now let's go out and work on actually running the business and sourcing and executing on our strategy.

Starting point is 00:08:50 I think that that's likely the best approach from a time allocation perspective. Spend your time raising money, hit pause, and now spend your time deploying that capital. Because I think to do these on a rolling basis where you've got a percentage of the capital and then you're continually trying to raise money, source and invest, it's really distracting, really difficult. And I also think you don't necessarily know what number you're going to end up with at the fund level. And so it might change how large a check you're writing in the beginning and to the end of your fund. And so I don't think it ends up being emblematic necessarily of a strategy that you set out to do, which in some cases can be hard to explain when then you go out to raise fund to on why you were initially writing 25k checks. And by the end of it, you're writing

Starting point is 00:09:32 250k checks, or vice versa. Why is it that that's not a legitimate reason to write smaller checks, and then write larger checks? The devil's advocate would be that you want to make sure you have a minimum viable fund size and that you have a diversified portfolio. So why is that such a hang up for LPs? I think you're bringing up a really good point. If I'm being honest, we are not ownership sensitive. And so we're generally speaking more amenable to somebody who's written a 25k check into one startup and 300K check into another startup. I really think the question is, what did you set out to do? Did you say that you were going to be ownership sensitive? And then did you actually get the ownership that you were targeting?

Starting point is 00:10:17 Did you say that you wanted a diversified portfolio of startups? And then did you ultimately hit that target number? I think LPs really love clarity. And I think that clarity comes from easy to understand metrics. And I think that that comes from like, what is your say-do ratio, if you will? Did you say that you would do this? And then did you actually follow through and do that? Approaching 60 of these interviews, one of the things that seems that LPs are very sensitive to is exactly what you outlined, which is, did you say what you were going to do? And the interesting thing is that emerging managers, by the time they have truly quantitative data, or at least empirical data, statistically significant data that shows whether they are a good or bad manager, they're on fund four. So the next question becomes

Starting point is 00:11:11 then how do you make decisions on fund two, fund three, fund four? And it seems to be a largely driven by, are you on strategy? Did you say what you're going to do? Did you treat LPs correctly? Did you act ethically? And then also some leading indicators, as in what do your portfolio CEOs think about you? What do your co-investors think about you? wrong in a fund one. I mean, part of becoming a seasoned emerging manager who gets through kind of fund ones through fund threes is your ability to stay curious and really be honest about what you know and don't know and seek help. I think the reality is your LPs obviously want you to be successful. I think other emerging managers in the ecosystem want you to be successful. And so I think that for some of the GPs, that's a really good thing to remember when times are tough. If I was to inject my unsolicited opinion into this argument, I would say with any optimization, you want to be very careful what

Starting point is 00:12:17 you are optimizing because every optimization has inherent trade-off. And the optimization around, did this individual 100% stay on strategy? Was there creep? Could be taking away otherwise high alpha managers from the table. That being said, I think something that LPs efficiently optimize on are communication, ethics, doing what you say you are going to do, at least in good faith. And I think there's a nuance there. I think you're hitting on something that David

Starting point is 00:12:51 Rubenstein said, and I can get fact-checked if this was David Rubenstein or one of the other platform builders in the private equity space. He said mediocre returns and excellent client servicing is really all you need. And I think that that's a little bit what you're highlighting, which is, you know, as an LP, if you're looking for outsized returns, I think you do need to be a little bit flexible. Let's talk about your diligence process. I think you have a great diligence process and I think you really get to the core of what drives Alpha. Tell me a little bit about your diligence process. We actually take a very similar approach to the way VCs look at founders.

Starting point is 00:13:25 They often talk a lot about founder market fit, and we're really looking for the same. You know, what pool is that manager swimming in and why are they going to win within that ecosystem? You know, whether that's do they want to own a certain geography, something like the Midwest, or do they have a deep technical capacity? Do they have a differentiated network and sourcing mechanism that they want to flex on? We also spend a ton of time asking ourselves, you know, how did we meet this person? We swap ideas all the time with other LPs, whether that's fund-to-fund, single family offices, some of the multi-stage firms who have fund-to-fund vehicles. And I think context is really important. Obviously, references are extremely important and off-sheet references come from connectivity.

Starting point is 00:14:07 It's just reinforcing for us when we can hear the same people over and over and over again that be recommended to us. Today's episode is sponsored by Badaw Insurance Group. Badaw Insurance Group is run by my close friend, Amit Badaw, who insures me both personally and at the corporate level. Most people are not aware of the inherent conflicts in insurance, where insurance agents are incentivized to send their clients to the most expensive option. Amit has always been an incredible partner to me in 10X Capital, driving down our fees considerably while providing a premium solution. I'm proud to personally endorse Amit and I ask that you consider using Badaw Insurance Group for your next insurance need, whether it be DNO, cyber, or even personal car and home insurance. You could email Amit at amit at luxstr.com. That's A-H-M-E-T at L-U-X hyphen S-T-R dot com.

Starting point is 00:14:59 Thank you. I think you asked one of the most interesting first principles questions, which is you ask on your reference calls on a dollar by dollar basis, how would you rank your investors on your cap table? Tell me a little bit about that and tell me about how people react to that question and what you found through that diligence process. That's actually turned out to be a really interesting question because I find specifically founders are very, very honest about how their venture capital firms are performing for them. And so on a dollar for dollar basis, we find that founders are just quite blunt with us on who they see as really value add investors. We have different questions that we ask colleagues, other LPs and founders, and I'm happy to kind of run through those if it makes sense. Yeah, let's talk about those.

Starting point is 00:15:52 So for founders, we always try to get context on how they initially met and what their first impression of the GP was. If they've invested in the founder, and it's a reference for somebody who's maybe, you know, was invested in at the pre-seeder seed and now they're at an A or B level. We try to understand if what they do for founders is scalable in their opinion. Like, are they super, super, super hands-on or do they have, you know, more of an approach of helping them get to their series A and then they back off and let the bigger investors take over at that point in time. We also ask them if, you know, you had to narrow down what their biggest strength was, what would that be? We also try to drill down on what their biggest blind spot is.

Starting point is 00:16:31 And if you had to add the GP to your team, would you add them to your team? And in what capacity would you do? And then the last question that we ask founders is on a dollar for dollar basis, where do they rank on your cap table? And that's actually turned out to be a great sourcing mechanism for us. Because if there's somebody that we haven't heard of that they rank as a top VC fund, and it's, you know, a new emerging manager, it's a great chance for us to reach out to that person and try to, you know, have a conversation with them to learn about what they're building. Out of curiosity, when you ask this dollar for dollar question, do you reveal who exactly you are diligencing? Yeah, it depends. But it's been the case before where they know who we're diligencing

Starting point is 00:17:08 and they put investors in front of them. I would call that a double negative signal. I'm going to invent a word, but that has to count exponentially worse than the most negative signals. You also, speaking of introducing and hearing about people, exponentially worse than the most negative signals. You also, speaking of introducing and hearing about people, I've heard, of course, Ariana was kind enough to make the introduction, but I've heard of you and Cannonball from several other LPs and how you guys are very collaborative.

Starting point is 00:17:39 But more specifically on the diligence process, how do you leverage other LPs to diligence a manager? Give me, on a granular level, how you go about doing that. Generally speaking, we want to talk to LPs who have already invested in the fund and also figure out from some of the other LPs that we know if they've seen the fund and why they may have passed if that's the case. I think most LPs are solving for really different things. As an example, some co-invest, we don't anymore. We want to understand how they got to yes.

Starting point is 00:18:13 And then more specifically, who else did they look at as a comp in the space, whether that's a similar sector, a similar geography of investor, and how did they think about those teams or individuals? We do spend time with other LPs outside of family offices, whether that's fund to funds and even some of the multi-stage firms, as I alluded to. And I think that there are so many managers out there for us. We really use this as a top of funnel. And so that's, I think we're trying to meet and always increase our top of funnel. And so we really see this as being collaborative within the ecosystem, both from an LP perspective, you know, giving people other ideas and also receiving ideas. When you're looking to build a relationship with other LPs, what is the best ways that you are able to drive value to that relationship? And what is the best ways that you are able to receive value from that relationship? I think unlike any other asset class venture, it really, you know, takes a village. It's like the children's book, Stone Soup, you know, where everyone has to bring something to the soup,

Starting point is 00:19:16 so to speak. And so for us, with that in mind, it's about really understanding what those LPs are looking for. And again, I think this is a really important point that I can't stress enough. If you're an LP who co-invests, you likely have a preference for an investor, a GP who is more concentrated, because that does two things for you. One, they're going to have larger ownership positions in startups, which means that at the Series B where you might co-invest, likely they have larger pro ratas that you can take advantage of. Another thing that's associated with this is how that helps us think about managers

Starting point is 00:19:57 that we meet who are really concentrated because we know that might solve two things for them. It might be a GP that they want to invest in or somebody that they want to partner with to potentially co-invest with. And so we just really are not dogmatic about the LPs thinking the same way as we do. In fact, we're the opposite. We try to meet with other people who have completely different points of view than us. Let's double click on your strategy when it comes to choosing emerging managers. You look for, and I quote you, collaborative check writers. What does that mean?

Starting point is 00:20:28 That sounds like a bumper sticker PR statement. We have a bias here. We're generally speaking, looking for more diversified portfolios. And so I think that just leans into this collaborative check writer approach. And so we have like a bit of a core belief that I still think that the best founders want to be backed by the best, you know, branded VC firms. I do think it's rare. It's not impossible

Starting point is 00:20:55 by any stretch of the imagination. I can think of a bunch of examples off the top of my head. But it is rare where an individual spins out of a firm and can immediately go compete to lead checks. First of all, it's hard to raise that much money out of the gate. And second of all, it's like now you're competing in a league that's very, very different than trying to put 100 or 200K into a $2 to $5 million round, let's say. And so we're totally okay with emerging managers starting small and getting into the game. And so being a collaborative check writer, I think it allows you to punch above your weight class. And admittedly, I think it also allows you to answer the question on a dollar for dollar basis. How do you rank on the cap table?

Starting point is 00:21:35 If you only wrote a 100K check, you really don't need to do that much to provide a lot of value to the founder because they're not really expecting a whole lot when you've written a 100K check because oftentimes there's been a lead there. And I also think for us, it's a really scalable strategy. So if you started with a $10 million fund and you're investing 100K checks on average, if you go and you raise a $20 million fund for a fund two, I can underwrite and think through how you might get 200K checks into those firms. What are sustainable sources of alpha for emerging managers? You're either a believer in one of two approaches, which is you kind of lean into that concentration bucket or you lean into Jamie Rhodes' thesis on more diversification and what Virtus is up to. I think we probably fall closer to where Jamie sits. And part and parcel with that is I think

Starting point is 00:22:31 that it's a really sustainable approach. When I think about sources of alpha, I think it's really hard to constantly go out, find 10 to 20 winners, get the ownership that you need in those and out-compete. I don't think it's unreasonable to think that people could access founders in networks that have been shown and proven to produce outliers and get access to 50 to 60 startups that allows them to have some level of diversification and kind of lean into the randomness that's associated with venture? The biggest ideological lines are between concentrated versus non-concentrated portfolio allocation. I know it's riveting. And the reasoning from both sides seems to be pretty interesting. So first of all, I think there's fundamentally a principal and agent problem. If you are bringing in, I had Fernando, first Guatemalan VC, go after Guatemalan, very conservative family offices. And he really

Starting point is 00:23:34 believes in a diversified approach to make sure that he could deliver that, call it 3x plus DPI over and over and over again. I think that is very good product market fit for that market because the worst thing you want to do is go into a market and muddy the water for all of venture capital for decades to go. The second aspect becomes a principal agent problem, which is as an agent, you want to deliver consistent, smooth out returns. As a principal, in theory, you want to maximize alpha. So if I'm the principal, I have a 0.8x return, then a 15x return on the fund. I should, in theory, be happy. Say that in theory, because in practice, I do believe, and from personal experiences

Starting point is 00:24:21 of doing things like co-invest with that very same outcome. People generally are not 7.5x return happy. They're a little bit less. Going back to emerging managers. So you've met the emerging manager. You believe that they have a sustainable form of competitive advantage, sustainable form of alpha. Tell me in granularity, what is the process? What would you like to do? Do you want me to throw you into a data room with 100 different

Starting point is 00:24:51 files immediately? Tell me about the gold standard and how you want to get to know a manager and how you want to get to diligence a manager from a data room perspective. Yeah, it's a, it's a good question. I think for us, um, we try to be respectful of, of GP's times. Uh, you know, like at the end of the day, we talked, kind of kicked off the podcast talking about this, which is, you know, there's, there's not a lot of time for a solo GP or even, you know, a two or three person team. And so, you know, we feel like our first meeting is roughly 30 minutes. We try to burn through a bunch of our questions, which is, you know, basic stuff, portfolio construction, how they think about reserves, you know, where, you know, what's their strategy? Why is their strategy answer with default that, you know, between 20 and 30 companies in the 50-50 reserve strategy, that's most of what we see because it's enough diversification and also enough ownership to drive alpha. Okay. You clearly disagree with that heuristic, which I agree with your disagreement.

Starting point is 00:26:03 So let's talk about a gold standard on follow-on. What is a good follow-on strategy and how should GPs even approach follow-on? What are the best practices? Yeah, you're right that I disagree with it. I think this is again comes to the point that I made earlier, which is I think venture has changed from 10 or 15 years ago to where it is today. There are a lot more VC funds out in the world competing. And so I just don't think offering reserves at 50-50 and 20 to 30 is where things should live today. As you know, we lean into this collaborative check writer and a more diversified approach. And so for us with reserves, really the question that we ask is, do you think that you should spend more time investing that reserve strategy into net new startups? Because the truth is that you're never going to have a chance to buy more ownership than with your first check. So I think out of the gate,50 reserve, or even when there's 70-30 or 60-40, there's this idea that there's signaling risk to the founder, that if you don't a follow-on check. And so I think it allows the GP to think more honestly

Starting point is 00:27:26 about where that startup is at and if they want to double down on them. And I do think that it allows for more selectivity on the double down phase. Is there really a signaling risk for a 10, 20, $30 million emerging manager not following on from pre-seed to seed? Have you ever seen a round not come together for that signal? So like, no, I'm with you on this. Although I think it's in the GP's

Starting point is 00:27:51 head on like, should I be following on? And what if this ends up being the winner? And I do think this ends up being a big hindsight question. You go and raise your next fund. And let's just say it's fund three, because you've now got more data to your point on fund one. And you say, well, if only I had more reserves in fund one, I would have followed on into my winners. And I just don't know if I believe that. I think that there's this element that it's so hard to see it at the time. And I think it's easier to see these things in the past. Obviously, there are cases where people really understand metrics that they need to look for. But to me, Series A investing and Series B investing is just so fundamentally different than pre-seed and seed investing. And so for us, that's why we prefer this kind of like net new check or at least a net new underwriting process for the next round of investment.

Starting point is 00:28:43 It shouldn't just be we follow on into everybody. The worst possible heuristic or the worst meme as an LP is the concept of defending pro rata. It was originally created to defend against pay to play provisions. And now it's been some catch all for not doing any homework and not applying any thought to future rounds. But I do want to get into more granularity. Let's say you have a portfolio of 40 into somebody that's doing the first check into pre-seed. Let's say they do have a 50% reserve, just to keep it simple. What would be the gold standard for follow-ons? How much of that?

Starting point is 00:29:22 First off, how many of those 40 companies should they invest into the seed round on average? Yeah, it's a really good question actually, because my default answer that I want to give you is like, I think they should change their reserve strategy, if I'm being totally frank. So let's say 30%, what would you change your reserve strategy to? Yeah, I think 30%, I think 70-30 is right. I still think you need to buy ownership with that first check and have a level of conviction. And then I think from there, you have to give the managers some discretion on where they invest for that next 30%. I do not think it should just go across every single startup. I think they need to lean into their conviction between what's happened between pre-seed and seed and use that 30% accordingly.

Starting point is 00:30:10 For us, we invest in funds. We don't do directs. I think we've learned that we're not very good at investing in directs. So we have to put a level of trust in the manager that they understand what it means to invest in directs and what signals they're hoping to see by the seed. And can they use that to invest on maybe a higher dollar amount, might not buy them as much as their first check did, which is our preference, but it at least gives them a chance

Starting point is 00:30:32 to double down into what they believe will be their winners. So let's say 14 million goes into a first check. You have 6 million to allocate across 40 companies. First of all, on average, what percentage of companies should emerging managers follow on on? So you have 40 companies. First of all, on average, what percentage of companies should emerging managers follow on on? So you have 40 companies, should you be doing 10 follow on checks? Should you be

Starting point is 00:30:51 doing 20? Clearly, you don't want to be doing 40. Should you be doing four? This is a really good question, you know, because I wouldn't say that we have a hard and fast rule on this. If I'm being totally honest with you, I don't have a best practice that I tell the GP, like, listen, if you were to think about this, you should be investing in four companies with the rest of your reserve strategy and really getting concentrated on those. I think like my gut response is to say,

Starting point is 00:31:17 leave yourself some optionality to be more concentrated with those follow-on checks. And so what is that 25%? Is that 30% of the companies? I really don't know, but I think it's a really good question, Dave. I mean, that's something probably I need to do more thinking on myself. We could start with worst practices. So first of all, let's establish some bad practices. We'll make some progress. One bad practice we both agree on is investing into all 40 companies.

Starting point is 00:31:44 I think one of the dirty secrets of venture capital, I've said it over and over again, is that the best way to diligence a company is to be an existing investor. This does not excuse poor diligence. There's another favorite diligence question I love, which is what will I find out at the first board meeting? But you're not telling me now.

Starting point is 00:32:03 It is theoretically impossible to do complete diligence. So the question is, how are you able to get to 95, 99% diligence? But there are certain things that you could only find out in practice. And that's just a reality. I know a lot of people don't want to hear that. The next question becomes, do you actually get more information in the six to 12 months between a pre-seed and a seed investment? And my answer is you get significantly more information. So if you do get more information and if you're able to really diligence and have better information, the next question becomes out of your 40 startups in six to 12 months, how many of them will you be able to group as very top performers

Starting point is 00:32:46 as breakouts? I mean, this is when it goes into philosophy is, first of all, what is my job as a GP? Is it to distribute alpha or is it to distribute smooth out returns? If it's to distribute smooth out returns, then you take a more conservative strategy around, let's call it top 10 or top 20. If it's to deliver alpha, the only question is how aggressive do you want to do? And this is where I think you want to put in the guardrails and the bumpers of being an institutional investor. And no matter how high conviction, you should never be really more than 10, 15% of your fund in any one startup for many different reasons. If it's truly that great, it doesn't matter. Returning a 30x fund versus 120x fund isn't going to change anybody's life, and it isn't

Starting point is 00:33:36 going to get you significantly more capital from LPs. So I think at that point, once you've identified the basket of breakout companies, I think you should more or less be either equally distributed among those or have some probabilistic or some confidence level distributed around those with a constraint of a 10 to 15% position. What do you think about that? First of all, I love so much of what you just said there. I do agree with you on this. And the point that I agree most with is this idea that you're not going to raise more money based on your fund being 100x or 30x based on how concentrated you get. And I think you're only applying more risk to yourself as the GP on your ability to raise a follow-on fund because that is ultimately what you're trying to get to. You're trying to raise fund after fund after fund.

Starting point is 00:34:30 And so if you deliver 3 to 4 to 5x net returns or 7 to 8 to 9x net returns, ultimately, you're still going to go out and raise the same amount of capital. LPs are still going to be extremely impressed and are still going to want to back you and support you. And so that is, this goes back to one thing that I try to coach the GPs on. And when I try to convince people to be more concentrated, who are more diversified rather, who are more concentrated in their initial strategy is, I'm like, why are you personally taking so much risk? I understand there's a lot to gain from a 10X fund and the 20 or 30% carry on the other end of it. But there's a lot to gain from a 10X fund and the 20% or 30% carry on the other end of it, but there's a lot to benefit from having four funds that you've managed over time and the survivorship bias that's associated with you have been around for a long

Starting point is 00:35:17 time to LPs. And so that's, again, just something that we really try to help. One thing that's interesting is that it is the exact wrong intuition of who you want to invest in. I'm right now sitting in Scott Painter's house, in my opinion, one of the greatest entrepreneurs in Silicon Valley history. He's raised over $2 billion in venture capital. He literally takes out loans on his houses to double and triple down on every single company. This guy is a maniac in the most possible way. It's a perfect way to kind of segue and come close to the end of the interview. We talked a lot about building a business versus building a fund.

Starting point is 00:35:59 What does it mean to you for an emerging manager to build a business? Yeah, this is a really great question. And the irony is that it's one of our red flags. It's also, I think, an outstanding thing for the GP is we are really not looking for people who are platform builders. Because I just think they ultimately scale out of where we are hoping to see big returns in smaller funds and really sustainable and durable strategies. When I think about building a business as a GP, the first thing that comes to mind is maintaining the fact that you are a steward of capital. I think this is something that venture could learn from private equity. They have a lot of functions that help them do this. And I think a lot of GPs focus on the fact that they need to

Starting point is 00:36:56 add partners to their following funds to help scale up what they're doing. And I think one of the things that goes underappreciated is really high quality CFO or COO, somebody who can help on the back office side who really has a good understanding of operations and has no scope creep on what their role is going to be as a partner. For us, one of the things we try to spend a lot of time on from an operational due diligence perspective, if there is multiple partners, is how is compensation structured and how is the relationship between the two GPs or three GPs? Because what we really, really, really don't want to have happen is one of the GPs leave during an investment life cycle. I think that it's not necessarily going to be clear if that GP was the person who provided

Starting point is 00:37:40 all the value, who did all the greatest sourcing. And so I think having these, you know, when you think about building a business, having this in mind around operations is an extremely important piece to scaling. When a GP leaves and they are not the provider of alpha, they might have been hurting the franchise. Is that a good thing? I think, you know, you kind of highlighted this a little bit, Dave, which is it's unclear on who was providing all the value for a decent amount of time, right? These are long tail assets. And so we're not necessarily going to know if that individual

Starting point is 00:38:17 is providing value or provided all the value until probably the next couple of funds that go on. I do think there's maybe a more interesting question, which is if one of the GPs leaves to start a company, does that actually provide more value to the firm as a whole? And in my opinion, I actually think the answer to that is yes. Because, you know, I think a lot of people look at venture and make this assumption that these individuals who are investors are predictors of the future. And to be honest, I think one of the reasons fund ones perform so well historically is because those individuals have been so close to the ground that they aren't predictors. They actually see today perfectly clearly. And I think that that allows them to understand what needs to be built today and who needs to get funded today. And I think the closer you are to an operator and the

Starting point is 00:39:19 further you are from being just an investor allows you to see today very clearly and therefore execute on maybe the next new trend that deserves a percentage of the fund's investments as an edge case. And as we both know, the tails are what drive venture. We had a fascinating conversation with Alex Adelson from Slipstream, one of the sharpest thinkers in the space. We talked about the four values, four drivers of alpha, sourcing, picking, winning, and value add. And we both agreed that value add, unfortunately, is not the highest driver of alpha and that's sourcing and picking. And to go to your point, when you have an entrepreneur, not only is he sourcing, he or she is also picking better.

Starting point is 00:40:06 So I think that the intuition makes sense. Ben, you've been an incredible guest. Even after I butchered your last name, Gallagher, you didn't even tell me. Zoe messaged me and let me know. So I really apologize about that. I want to give you the time, Ben, to talk about yourself, Cannonball Capital, anything else you'd like to shine a light on in the LP industry. What would you like people to know? Yeah, I mean, obviously appreciate you giving me the floor and the time of day when Ariana reached out to me. I literally messaged her back and said, I don't think he wants to talk to me. So I appreciate you giving me this opportunity. We're pretty quiet at Cannonball. There's no website. You're not going to see it on my LinkedIn. But now that David has corrected my name, it is Ben Gallagher. Feel free to shoot me a DM on LinkedIn. One of the things we pride ourselves in is trying to take every meeting. And so for us, that's really important, I think,

Starting point is 00:41:10 to give back to the ecosystem, especially for those people who are just starting out on the emerging manager journey and don't necessarily know where to turn as far as more institutional LPs go. Try to be productive and helpful on that front. And so, yeah, just really appreciate the time, David. Well, Ben, I appreciate you jumping on the podcast. I appreciate you investing the time, helping clarify and really bringing a lot of valuable insights to the community. I hope to meet in person soon

Starting point is 00:41:41 in better lighting and better circumstances and better geography. So looking forward to meeting up soon. And thank you for jumping on the podcast. Hey, me as well, David. Thanks again. By popular demand, the 10X Capital Podcast has officially launched our newsletter powered by Carrier Labs, a full-service content marketing firm that's partnering with us on the newsletter. In our weekly newsletter, we will keep you updated on all things emerging managers and limited partners, including industry trends that are critical to know

Starting point is 00:42:09 as an LP, VC, or founder. To subscribe to our totally free newsletter, please visit 10xcapitalpodcast.com. Again, that's 10xcapitalpodcast.com. We thank you for your support.

Investing Billions - E35: Ben Gallacher of Cannonball on "Value per Dollar Invested" and How it Predicts Fund Performance

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