Investing Billions - E36: Masterclass on Portfolio Construction with Anubhav Srivastava, CEO of Tactyc

Starting point is 00:00:00 I'm too curious not to ask, what is your benchmark data on what is the typical reserve ratio for pre-seed and seed funds? Yeah, it ranges. And the range is based on the size of the fund. So for, let's say, a $25 million fund, the reserve ratio is lower, closer to 20 to 25%. For a $50 million fund, it starts to creep up to 35%. And for, I would say, $70 million and plus, it's getting closer to 50%. That is the correct way to think about it. That means these guys have solved for the portfolio size first, reserve ratio is the second.

Starting point is 00:00:38 Well, Anubhav, I've been a longtime fan of Tactic and have been looking forward to this interview. Welcome to Limited Partner Podcast. No, thank you for having me as well. I've been listening to your content for a while as well, so it's great to be here. Thank you. Thank you. And the flattery is always appreciated. In terms of Tactic, I want to talk a little bit about that, but I also want to talk about what led up to Tactic. So tell me a little bit about how you came to founding Tactic. Yeah. So I come from a pretty quantitative background. I worked in MBA. I worked on Wall Street for a few years. I was in investment banking for five years. And my last five years

Starting point is 00:01:13 were at a venture capital fund. The Hollywood Talent Agency, CAA, had an investing arm backed by TPG Growth based in Los Angeles. I worked there for five to six years. All of that in a fairly quantitative setting. And I might've spent more time than is healthy on Microsoft Excel and financial modeling. Tactic was born out of those experiences. The first version of Tactic was actually quite a different product.

Starting point is 00:01:37 It wasn't a VC specific product. It was a general financial modeling platform where you could upload any spreadsheet based financial model and it would transform that into this beautiful web-based interface where you could upload any spreadsheet-based financial model, and it would transform that into this beautiful web-based interface where you can move around sliders and manipulate the model without ever having to open the spreadsheet. We couldn't quite find product market fit on that specific use case. It was one of those things where people just said,

Starting point is 00:01:58 hey, this is really cool, but not quite sure what we do with this. But the one use case that did emanate from that was venture capital portfolio construction. We launched a model for portfolio construction, clearly as a marketing tool. And we had 400 funds reach out to us in the course of a weekend saying, we don't care about the rest of your platform. We just want this one model. And how can we manipulate this? How can we add to it? And that's what led me to eventually pivot the company into building the first forecasting and planning software for VCs that we are today. And I'm curious, your learnings from pivoting the company, do you think that that's the best way to start companies is basically to go out there and do customer development and then settle in on a specific use case? 100%. I can only speak from

Starting point is 00:02:39 my experience. Pretty much every startup is going to pivot at some point in time in the first two years. When do you pivot and when not to pivot is probably the most important question. There were four or five vectors I could have gone down on when it came to figuring out, should I pivot or not? Number one is answering the question, do I have product market fit or not? And it takes a while to eventually have faith in the fact that you don't have product market. Because we actually had sales, we had usage, but we didn't quite feel that we had to lock in. It felt like it was a vitamin, not a painkiller, things you've heard before. And we wanted to become a platform that you couldn't operate your company without. I believe pivoting is natural. I think it's almost necessary.

Starting point is 00:03:21 It doesn't have to be quite drastic of a pivot as we did. Sometimes it's just a little bit of a tweaking and reshaping of the product. And pivoting just means you're pivoting on two vectors, product or market. Those are the two things to get to product market fit. So you're either changing the product completely or you're changing your market. In our case, we did both. Most companies at some point in time have to tweak that product or market balance to get to that final product market. You broke the ultimate sin of CPG and Procter & Gamble will never start a new product in a new market. They will only start a new product in an old market or a new market with an old product. So congrats on doing that and gaining traction. Who are the basic users for Tactic? So today we work about 350 venture capital funds all over the world.

Starting point is 00:04:04 These are GPs and sometimes they're CFOs and they're investment teams. We've been around now for about 20 months, so less than two years. So the entire growth has come within this last 20 months. We work really best with funds that are inherently and innately quantitative in nature. So they actually care about number one, portfolio construction. They believe that to be a vital part of their fund operating strategy. Portfolio construction is known, we'll talk about this,, portfolio construction. They believe that to be a vital part of their fund operating strategy. Portfolio construction is known. We'll talk about this, I'm sure.

Starting point is 00:04:27 Portfolio construction is sort of a misnomer. People do this only when they're raising a fund. But the reality is construction is a constant iterative process that you do even while you're operating the fund. We work best with funds that have that same mentality, that want to maintain a live version of their fund model throughout their lifecycle. And in some ways, we've had to change the behavior of how GPs think about this as well. But yeah, we work with 350 funds, fairly quantitative funds.

Starting point is 00:04:50 These are funds as small as $50 million to the sapphires of the world. There are billions of dollars all over the world as well. 30% of our clients are in Europe, Germany, UK, Australia, and then the rest of them are in the US. And yeah, I would say we work with funds of all sizes, all teams, as long as your venture funds, you can work with us. A mentor of mine, Jong Sung Kim, who co-founded Five9, a very successful public company, once told me that you need to be close to the cash in order to succeed as a business, meaning that you have to be on the revenue side. Does Tactic really help

Starting point is 00:05:23 GPs and funds generate revenue, or is it just a monitoring tool? So on the fundraising side, we help GPs build their construction plans and eventually raise funds. So that's cash coming in. They would not be able to do that without a portfolio construction plan. And we help them in their marketing plans. You can call it revenue generating, but we're helping cash coming into the fund. On the second side, which is operating a fund, we are helping them optimize our fund performance. So how should you deploy a follow-on capital?

Starting point is 00:05:51 When should you have your next capital raised? Should you invest follow-on in this company or that company? These are meaningful questions that can meaningfully change the outcome of a fund. You could call that revenue generating or not. I mean, in the context of a venture fund, revenue generating just means performance. Am I going to get carry on this or not? I'm going to get DPI on this or not. Helping GPs get to that goal.

Starting point is 00:06:10 Do GPs use Tactic as a fundraising tool or is it strictly a monitoring tool? Pretty much all 350 of our clients use Tactic for the next fund that they're already raising. So everybody's using us for portfolio construction. That is just a given. I would say 25% of our users are using us for exclusively portfolio construction.

Starting point is 00:06:29 So they're raising their fund and they're building, they're using Tactic to build their construction plans. The remaining 75% are using us for construction and for active management. And let's talk about Tactic in terms of what it does and give me some use cases. How does the customer flow work from day one to day 365? And also, how long do you expect kind of GPs to use the tool?

Starting point is 00:06:50 TurboTax was actually one of my inspirations when I was building Tactic in terms of distilling something that's quite complicated into a workflow that seems simple. Building a fund model, managing a fund model, building a portfolio construction plan, there are 150 variables you've got to think about. But you have to do this, and some of them are very quantitative, sophisticated, legalese. You have to think about all of that to build your original plan.

Starting point is 00:07:13 So we put people, the first screen that they see when they log in is sort of a TurboTax-like wizard, where we ask them certain questions around their fund strategy, their fund structure. For example, we might ask them how much capital they're looking to raise. We ask them whether it's GP commit. We ask them about if they're planning on using a capital call line or credit, because that'll influence their capital calls. Other sections, we ask them for their macro thesis. If you're a SaaS FinTech investor, what do you believe FinTech rounds are going to look like over the next three years? And we give them market data from Crunchbase, from Carta, from PitchBook that's preloaded in the system. We then help them think through their check size strategy. What is your target ownership in your pre-seed companies?

Starting point is 00:07:49 How long do you want to follow on? How much do you want to follow on? So we ask these Q&As and we guide them towards building a construction model as opposed to just kind of giving them a form to fill out. So it's a much more hand-holding process where we're asking them these questions and then we're showing them right away the impact of answering these questions. What's interesting is what's happening is most funds, most GPs are always raising a fund. So by the time they hit their second or third year, they're already well in the process of raising their second fund. So Tactic is used to raise their

Starting point is 00:08:16 first fund, then manage their first fund. And by then they're already starting to think about the second fund. So they start to use Tactic again for that. And it becomes an increasingly secure locket because at that point in time, their entire infrastructure is basically set up on Tactic. The number one goal of fundraising for a second fund is to have a good first fund and to have a good customer experience for your LPs in the first fund.

Starting point is 00:08:37 So I think that's a big aspect of it as well. You mentioned something curious. You mentioned an iterative portfolio construction model. Tell me what you mean by that. Philosophically, portfolio construction has, of course, always been done in spreadsheets where you put in numbers and you land at a particular outcome. GPs have also been almost conditioned to think about construction in terms of very simple terms. What is my portfolio size? What is my reserve strategy? What's my check size strategy? Construction is a lot more varied than that. A good example of this is people come in saying,

Starting point is 00:09:07 we want to raise a $100 million fund with a 50% reserve ratio, 40 portfolio company, and it's an early stage fund. Sounds pretty good. But as soon as you start to move around things a little bit, if the $100 million becomes $60 million fund, then that 50% reserve ratio may not work because you might have to give on something else. The idea of iterative portfolio construction is to create a flexible model where you can iterate through

Starting point is 00:09:28 multiple parameters to eventually land at the things that you really care about. So what should you care about? For an early stage fund, the number one thing that, in my opinion, and I'm saying all of this with the experience of having worked with a lot of these funds, and it is subjective, the number one thing a seed stage fund or early stage fund should be thinking about is the size of their portfolio. How many companies, how many shots on goal do they have? No matter how great an investor you are, you are still subject to the power locker. That is something you have to understand. And so having enough shots of gold is a paramount metric to track to. How you get to that, you can get to that from a variety of strategies, whether it's check sizes, whether it's reserves, whether it's recycling. And so that's what I mean by iterative is you are iterating on all of these different vectors

Starting point is 00:10:07 to eventually land at the correct portfolio size. And your check size strategy is also balanced. So is your result strategy. A lot of GPs sometimes are not able to prioritize what is important versus the rest. So they might think having a 50% reserve ratio is more important than having a 35 company portfolio. In my humble opinion, that's the wrong way to think about it. So having that priority of variables and then iterating on the less important variables to make sure that your first variable lands where you want it to. Part of that is also the evolving portfolio construction. So things happen, you could only map the world to such precision. What have you seen change from the portfolio

Starting point is 00:10:46 construction that a fund starts out with, with their final portfolio construction after their investment period? We see this all the time because we're able to track actual performance versus projected performance. So what we've seen is in the last three to four years, funds that set out, especially early stage funds, funds that set out to invest in this market massively underestimated how expensive the market was going to be and how much they would have to put in to get to that same check ownership. So we have actually seen a deviation in terms of, especially seed stage investors, what they assume the round sizes and valuations to be and what they actually were. In the last nine months, we've seen a correction. Things have kind of gone back to

Starting point is 00:11:22 base level, but we did see that a lot of capital was deployed at a very high valuation and eventually that had impacts on the portfolio size a lot of them were over deployed they did not quite have the same number of companies that they should have so there were pacing impacts to it as well which eventually has downstream impacts so when the nest the next one might be the other thing that happened was recycling we saw most fund managers overestimate the impact of recycling almost Almost every LPA now has like a 25% recycling feature, 25 to 30%. They all assume, yeah, we're going to get a 25 to 30% bump in our investable capital. The exits were just not happening or they were happening too far, too late in the game, way past our investment horizon. They were not quite able to get to those exits to even be able to have the opportunity to be able to recycle that capital. I eventually came across a statistic where like 75 to 80% of the funds in the world in the last 10 years have not been able to reach their recycling target. And LPs know this. And that just shows eventually that you want to be a bit more conservative when it comes to those recycling targets. So yeah, check sizes, recycling, those were the two big

Starting point is 00:12:22 things I'd say where things have quite meaningfully deviated. So you mentioned recycling and also check size and ownership. Tell me about how a fund would navigate that. Yeah. So most seed stage funds that we work with try to follow a 10% target ownership. So when they're getting into a seed company, they want to have at least a 10% ownership at entry. That 10% could then eventually escalate up to 15% in a reserve scenario. I would say in the last nine months, that initial 10% has also gone up to 15%. We're now seeing seed funds try and get to almost a 15% ownership. In terms of how the impact of this is, you're of course trying to get to a 10% to 15% ownership of the seed round. In your A round, you're then making a determination if I want to follow on into this company or not. And that's a whole separate discussion to be had. Should you follow

Starting point is 00:13:07 on or not? There's many ways to think about it. But if you are following on, the most common approach is to just do your pro rata, in some cases to do a super pro rata, to try and maintain that ownership level. Recycling only comes in the game when you have an exit during your investment horizon. And most funds, as I said, are not able to get to that. In terms of how that plays out, there's two types of recycling. There's management fee recycling, and there's straight up exit recycling. They both are very similar, but they can be sometimes confusing. Exit recycling is quite simple. You're just saying, here's the amount I can recycle in addition to my committed capital. And every time you get an exit, you put that away towards either a new investment or a follow-on investment instead of returning back to the old piece.

Starting point is 00:13:47 Management fee recycling is a slightly different concept where you are still recycling from your exit proceeds, but you're only allowed to recycle up to the amount of management fees you've earned to date. So there's a cap in terms of how much you can recycle. Just one point I'd like to say that I did not cover earlier was, when it comes to reserve strategies and how much you wanna allocate capital, one thing a lot of GPs sometimes forget to factor in is graduation rates. So you might start off saying,

Starting point is 00:14:14 I want a 50% reserve ratio. But what that 50% reserve ratio really means is you're almost expecting 100% graduation. You're expecting almost all of your companies to graduate, and then you have the chance to follow on, and then you can get to a 50% reservation. The reality is graduation rates are far lower than that. Pre-series A to series A, graduation rates are closer to 30%. So only a third of your company is going to make it to the point where you have the world to do a follow-on. And do you want to take that into

Starting point is 00:14:40 account as you're thinking about the results, resource? Is that that 30% benchmark? Is that internal data? Are you citing outside sources? Both. I'd say both. We are definitely, we started off using external sources, the CV insights funnel, some of the page book data as well. Over time, we have now gathered our own critical data point where we can supplement that.

Starting point is 00:14:59 So we're starting to see vectors across or different flavors of that graduation rate by sectors or by geographies. But it eventually lands at about a 30% median. So you mentioned something really interesting. You said the follow-on ratio should be an output, not an input. What did you mean by that? Yeah, so this goes back to what is the most important variable an early stage investor should be solving for in portfolio construction? And my belief is that should be the number of investments, not the reserve ratio. If

Starting point is 00:15:25 you've solved for the number of investments, and let's be clear, by that I mean I'm talking about a critical mass of about 35 to 40 companies. That is enough shots on goal where if the power law works for you, you could have a couple of companies that are outliers and can return the fund. If you're solving for that first, then let the chips fall where they may in terms of reserves. If you're trying to solve for a 50% reserve ratio and 35 to 40 companies, you may not have enough capital, which is why sometimes people say your fund size itself is your portfolio construction strategy because your overall committed capital is a function of these two variables. So yeah, reserve strategy to me is a secondary variable. It's an output, not an input, because once you've solved for check sizes and number of

Starting point is 00:16:05 companies, your reserves is an answer, not an input into that process. I'm too curious not to ask, what do you see? What is your benchmark data on what is the typical reserve ratio for pre-seed and seed funds? Yeah, it ranges. And the range is based on the size of the fund. So for, let's say, a $25 million fund, the reserve ratio is lower, closer to 20 to 25%. For a $50 million fund, it starts to creep up to 35%. And for, I would say $70 million and plus, it's getting closer to 50%. That is the correct way to think about it. That means these guys have solved for the portfolio size first, reserve ratio is a secondary there. Preston Pyshko You seem to imply that first checks are

Starting point is 00:16:44 form of alpha and follow on are a form of beta. Would that be a fair characterization? And this is a very interesting topic on just follow-ons and how you think about it. One of the things we've learned in terms of how a quantitative way to think about follow-ons, because follow-ons can be done based on your relationship with the founder. You love the company, you love the founder, and you kind of want to back them. What we've seen is a quantitative framework revolves around multiples. So you actually calculate your multiple on initial investment, and then you calculate your multiple on follow-on investment. And the multiple on follow-on investment is really an opportunity

Starting point is 00:17:16 cost analysis on what the return looks like on the next marginal dollar of investment into the company. In order to even do this stuff, you need to first build out a company-level model that shows likely exit scenarios, what that looks like based on TAM, based on execution strategy. Once you have a line of sight in two upside-downside cases, you can then start to figure out, okay, if I were to invest in the next round at these terms, what would the likely expansion of that share price look like for the next $1 I'm putting in the company? Yeah, I think there's not enough critical thought that goes into follow-on. I also have to admit, I kind of set a trap for you. I don't actually believe that all follow-on is beta. I think there's a lot of alpha and it all depends on

Starting point is 00:17:54 one factor, which is how much information asymmetry does the existing investor get from having that as a portfolio company? It's a famous fund, Hustle Fund, that's essentially their core strategy. They do a small check, they run tests, and then they do a larger check later on. But I think every venture fund, if they're worth their fees, has a good relationship enough with founders to know which founders to back. And interestingly, the more you reserve, a few things happen. Of course, your ownership in the company goes up. Return the fund comes down. Your multiple, your MOIC is going to come down as well. Every follow-on dollar yields less than your initial investment. So your overall multiple comes down. And those two are somewhat counter balancing each other. So you're defending that investment, yes. But at the same time, you might be trading off some TVPI and eventually some DPI because you've reserved too much in this follow-on.

Starting point is 00:18:43 So let's say we take the same portfolio of 30 companies. So I think there's some practical considerations because in reality, the issue is that by fund two, you only have leading indicators, not lagging indicators. You don't have track record to go out and fundraise. So if you put in 25, 30% into a company, let's say it ends up being 100x, you're still going to be penalized in the fundraising market, probably also by fund three. So the first constraint is you have to put in a constraint of roughly 15 to 20 say you have 30 companies. Let's say 10 of them might be breakouts and ultimately three to five will be breakouts. When do you deploy? I don't believe that you wait to de-risk the assets in series A, series B, series C, because on a expected value, you want to be piling into them if you think they might be a breakout as early as possible.

Starting point is 00:19:44 Sometimes even doing things like preempting extension rounds, trying to de-risk an individual asset as the price goes up exponentially if it actually does break out is counterproductive to an already diversified portfolio with concentration limits. It depends on the market. In a tough fundraising environment, if you're actually seeing companies able to raise the next round, that is a massive validation for what the company has done, where they're going, and that you should follow on because you're actually getting external validation as well, that this company is able to move the ball forward despite the market conditions. Having said that, in the inverse,

Starting point is 00:20:17 where the market conditions are great, fundraising is easy, your graduation rates are higher, that's when the challenge comes. That's, you could over-deploy your reserve. Because a company, just because if it raises the next round, doesn't quite mean it's a good investment still, just because of fundraising environment. There's a forced ranking, I think, in general, in business investment that's very healthy.

Starting point is 00:20:37 You can't subject yourself to lazy thinking or wishful thinking. You know that you can make maybe one or two 15% concentrations total in the entire fund. And when you look at it from that end, you have that you can make maybe one or two 15% concentrations total in the entire fund. And when you look at it from that end, you have to really be sure that this is one of your breakouts. What is the future of Tactic? There's a lot of wood to chop in terms of even becoming best in class.

Starting point is 00:20:56 What makes us good is that we learn from our clients. We work with the likes of Sapphire Ventures, Atomico, Connect Ventures in the UK, Mac Ventures in LA. In fact, Mac is an investor in us. They helped us build that initial portfolio construction plan. And so that is something we want to continue doing. We work with these really quantitative funds that give us information on how they're operating their funds. And we crystallize all of that into software within tactics. So there's still a lot of wood to chop in terms of what we eventually want to be. The

Starting point is 00:21:22 type of stuff that we want to do shouldn't even be possible to do in spreadsheets. And we're getting close to that. What do you think the best practice is when funds should do secondaries? And I think this comes down to your view on the market. This is, again, very asset specific as well. But if your view on the market is that the valuations are only going to be trending down. So yes, you're giving up some TVPI today by selling the company. But frankly, that TVPI could go even lower if there were to be down rounds in the next 12 months. And in that case, it's actually accretive for you to realize that sale today, save some of the capital, realize some DPI, as opposed to holding on to that investment. So it comes down to an asset level evaluation because you're evaluating the company. Should you still continue holding it?

Starting point is 00:22:03 A very simple way to think about it is if the company were to do a follow-on round, would you participate or not? What would you like people to know about yourself, about Tactic, and anything else you'd like to shine a light on? Now, I just want to let everybody know that whether you're a small manager, an established manager, Tactic is for everyone.

Starting point is 00:22:19 We have a free trial. Just go to tactic.io. You can model your fund, add investments. The one thing I'll point out to you is we're more than just a portfolio construction model. Yes, you can use it for your fundraise. We're of course known for this, but the real problem we're solving is that once your fund is deployed, you need a way to manage what's happening within that fund and not just tracking, but actually forecasting. Reach out to me directly. If anybody has questions,

Starting point is 00:22:42 I'm at on above at tactic.io. I'd be happy to do a personal demo for anyone. I press LPs on their follow-on, on which funds they follow on specifically. And they always say the number one question, especially by fund two is, is the GP doing what they said they were going to do? And when you double click on what does that mean, that's portfolio construction.

Starting point is 00:23:02 And I really appreciate you jumping on a call, jumping on the podcast and sharing with the audience. Thank you, Anubhav. My pleasure, David. Thank you so much for having me. Thanks. By popular demand, the 10X Capital podcast has officially launched our newsletter

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Investing Billions - E36: Masterclass on Portfolio Construction with Anubhav Srivastava, CEO of Tactyc

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