Investing Billions - E49: Top Tier Capital Founder David York on 30 Years in Venture

Starting point is 00:00:00 And that's why you have to have a good portfolio construction strategy. You will have chaos. We see that in various different ways, but you really see it in the secondary market where you price your whole trade around the performance of the two of these high-value companies. And it's the third and fourth one that drive most of the outcome, not the two that you're pricing around. Why is TopTier a better partner than other fund-to-funds or other LPs?

Starting point is 00:00:19 We definitely try to help our partners build their businesses. We help them think about capital. We help them with recruiting. We help them think about how to manage their cap tables. I've helped several firms restructure and gone through litigations with them, come out the back end in a much better spot. And that's primarily because... As the founder of Top Tier, do you worry that the DNA that you inject in the company will be lost in future generations? Well... For more ideas on how to raise venture capital in this market, make sure to subscribe below. David, I've been looking forward to this interview since Rebecca from Node intro'd us last

Starting point is 00:00:51 year. Welcome to the 10X Capital Podcast. Thank you. It's wonderful to be here. Really, really excited. I'm really excited as well. You started in 1993. Tell me about how you started top tier capital. Top tier actually started in 1999. I started in this industry in 1993, just to be clear, but our original history in the financial services industry goes back actually to 1984. For better or for worse, I'm an old dude, but seen a few cycles. Premise was access to Silicon Valley, providing institutions things they couldn't get access themselves to. And then over time, we've grown the firm 100% focused on venture capital. We today buy funds globally.

Starting point is 00:01:30 Again, majority of that is here in Silicon Valley. And then we also do secondaries in those funds. And then finally, we do direct investments alongside our managers in a co-investment format. So tell me about your portfolio construction. In our fund of funds, we use somewhere between roughly around 20% of the fund to fund portfolios capital to provide cash flows as we allow the venture capital funds we've committed to incubate. On the front end, we're buying secondaries to get cash flow going in the portfolio as well as mitigate the J curve. And then we do co-investments to add

Starting point is 00:02:02 capital in multiple years, three or four, kind of between years three and five. And then we do co-investments to add capital in multiple years, three or four, kind of between years three and five. And then by then the primaries are really starting to work, the primaries being the fund commitments. And as those start to work, they kind of carry, if you will, the portfolio through the back end. If we do everything right, we should double or triple our money. Are there directs made to minimize the J curve? If you think about buying a fund, it usually takes six plus years before you start to see really decent liquidity in venture capital land. And if you're doing a seed fund, which is quite a large population of investors, those funds could take 10 to 12 years before you start to see liquidity. So we came up with a strategy of adding secondaries to create both multiple lift, taking into consideration the discount you're purchasing them at,

Starting point is 00:02:47 as well as if we purchase the secondaries correctly, we should get some reasonably quick liquidity. So if you look at our history over the last 20 years, our average fund-to-fund commitment ends up being at peak about 75% drawn. You're getting DPI back before you call the capital? Yeah, exactly. Why not have different funds for each strategy? Well, and that's what we've done. So to grow the firm, if you think about venture capital

Starting point is 00:03:13 and access and primary fund commitments, there's only so much capacity with the best managers. So if you're going to raise a billion dollars and wanted a concentrated portfolio, you couldn't buy 50 million of each manager very effectively. The smaller funds in particular, you wouldn't be able to get 50 million in those things. And the bigger ones, those tend to have a different return profile and over time sometimes are too big. What we did was to grow capital.

Starting point is 00:03:38 So today we manage a little over 8 billion. To grow capital, we've essentially grown horizontally, David, as you suggested, so we've added product, the focus that's taken that whole cashflow concept of mitigating the J curve, and we have a product exclusively focused on that. We call it our velocity product. And the intention there is to get basically our costs back

Starting point is 00:03:58 in less than three years on our secondaries and generate a multiple of north of three times. Then we've also added product around the seed activity where people want pure long-term equity accretion and aren't as worried about cash flow or duration. Four years ago, we added a product to focus on Europe as we've had quite a bit of success in Europe. In addition to that, we felt Europe was undervalued versus Asia in a way that that would become a more attractive place to deploy capital in the venture space. What are the forces behind why Europe is currently undervalued?

Starting point is 00:04:30 Some of it's cost of doing business. For better or for worse, it is pretty bureaucratic versus the U.S. There's always been a thought that Europe's a nice place to visit, but not necessarily a nice place to do business unless you get to critical scale. What's happened over the last 30 years is we've had a slow, sort of continued growing homogenization of the workforce. So if you're a college student in Poland or a college student in France, you're not worried necessarily about working locally. You're worried about working at the best company.

Starting point is 00:04:57 And that best company might be in Germany. It might be in the UK. So it's a lot more mobility in the workforce. Hubs are really becoming very established. If you think about gaming in Helsinki or with Spotify's success, a lot more mobility in the workforce. Hubs are really becoming very established. If you think about gaming in Helsinki or with Spotify's success, there's quite a bit going on in the entertainment world

Starting point is 00:05:10 in Stockholm. UK and Paris have become one of the world's leading hotbeds for artificial intelligence programming. Valuations are typically 20 or 30% lower. And there was a period around 2016 where they were probably half the U.S. valuations. Many skeptical people would say that Europe is cheaper because the returns, the exits are cheaper as well. What would you say to them?

Starting point is 00:05:32 I wouldn't disagree. Europe's biggest Achilles heel, I think, at this point is the capital markets. The most successful companies in Europe are still going public in the U.S. And that trade, from a European point of view, is actually a more comfortable trade than from an Asian point of view. And so I think that will continue. I think NASDAQ will be a beneficiary of tech startups coming out of Europe. Europeans, if they could do anything to help themselves, would try and sort ways to build a better capital markets. What would you say to Charles Michel, former prime minister of Belgium and president of the European Council?

Starting point is 00:06:04 How would you encourage him to improve economic development in Europe? Get the alignments correct around incentivizing employees and employers, primarily around taxes, long-term capital gains. One of the things that made Silicon Valley work early was economic incentives for employees by giving them options and equity value in the companies. In Europe, that's been a highly taxed activity. It's getting better, both Germany and France and the U.K. And I think recently the Netherlands have all adjusted their taxes, but it's not nearly as motivating as it is still here in the United States. So I think that's one of the biggest problems.

Starting point is 00:06:38 It's like QSBS, but the equivalent for Europe. Yeah, QSBS is fantastic for private investors, especially over the last 10 years as companies have gone public. Every dollar put into venture capital results in 10, 20, whatever number of dollars in the economy. And the world's figuring that out. I mean, one of the reasons that Germany and now France are putting up capital to help companies get started is because they do see the benefits of the economic growth from technology startups. And the same thing now being pushed through in Japan.

Starting point is 00:07:11 Korea has been there for a while. You mentioned the globalization of Europe in terms of it being a monoculture in terms of tech. Has COVID been the main accelerant? What has accelerated that over the last five, 10 years? COVID certainly hasn't hurt. Yeah, it allowed entrepreneurs to hire somebody in the Baltics that they might not necessarily have done so because they could allow people to work remotely. And I think that's helped them to explore talent in those regions.

Starting point is 00:07:38 If you go to the history of Silicon Valley, I mean, things started percolating here in the late 50s. After a lot of the research that was coming out of the Second World War, I mean, Europe as an EU is 40, 50 years old now. And so you're starting to get comfort 20 years ago, your parents would want you to work down the street and now they want you to work in a company that's thriving. So it's just time, David. And then some of it is success. I think originally with Skype and then recently with things like Spotify, it shows that a little country like Sweden can distribute music to the world and build the thriving. I think Stockholm, if I'm correct, has the third largest per capita startups on the planet after Silicon Valley and Tel Aviv. Correct.

Starting point is 00:08:20 Very successful firms there too. Is there alpha in having a very good brand as a fund of fund? And why? As it relates to top tier, the branding has been built really based on our efforts to be good partners and to do that consistently over a long period of time. That then creates a flywheel of deal flow, both at the co-investment level, as well as at the general partner level and in that flywheel we always also try to be good partners we don't buy everything we see but most people leave our meetings feeling that they got value from them some of it's our advice some of

Starting point is 00:08:55 it's our practical approach we're incredibly transparent i came from a very intense customer service industry investment banking and i was just sort of surprised how capital really being investors and money didn't really empathize with the person across the table. Zero sum game. Yeah. And I sort of felt, gee, that's ass backwards. He's trying to build a business too. And so he should at least have a very good view of one, how we feel, but two, maybe things

Starting point is 00:09:21 he might need to work on. That's been going on for almost 25 years now in a way that it builds a ton of goodwill, and it's been consistent across the firm and our employees and how we structure our legal contracts, how we conduct ourselves in negotiations, et cetera, in a way that's really, really valuable. The persistence of top quartile, University of Chicago just put out a study, I believe it's 47% continued to be in the top quartile. So on average, you would expect 25% are random. It's actually 47%. So I think you got the right name.

Starting point is 00:09:51 Our fund managers and our investments like it a lot because they go home and tell their wife and kids that they got a commitment from top tier and our competitors find it annoying because it's presumptuous. We continue to, which gives us brand appeal in a variety of different ways. So you highlighted something we've never talked about,

Starting point is 00:10:08 which is how you treat GPs when you say no, it's an underreported thing. But when you do say yes, why is top tier a better partner than other fund of funds or other LPs? We help our partners build their businesses. We help them think about capital. We help them with recruiting.

Starting point is 00:10:23 We help them think about how to manage their cap tables. A lot of our peers do the same. I suspect we're probably more intentional there. We're constantly there trying to help as opposed to holding the poker cards close to our chest. So when people are going sideways, we can give lots of advice. I've helped several firms restructure

Starting point is 00:10:42 and that's primarily because, you know, odds are there's two or three LPs in that mix beyond ourselves that we've introduced the fund to and helped them build their capital base. And we've just done this religiously in a way that builds that goodwill. And then you've been working around venture capital since 1993, over 30 years. You've seen a lot of funds come and go. What do you see in the firms that are able to handle generational transfers effectively? There tends to be a thoughtful leader that understands that holding all of the capital and or economics is not a long-term success story. The two most successful firms that have done multiple generational transfers have been Sequoia and Accel, and they were very aggressive on transferring leadership to younger generations early. If you go back to Don Valentine and Mike Moritz and Doug Leone and then Doug transferring at Roloff recently, Jim Breyer was early at Accel in the late 90s when Art Patterson and his partner, Jim Schwartz, stepped down.

Starting point is 00:11:47 Jim transferred to the current team relatively early. Jim's still investing, but it's all part of that cultural activity. One of the ways that works is some of the older folks are still allowed to stick around and invest in the funds. And I think if you allow the transitioning partners to keep themselves in the game a bit, I think that makes it a lot easier. In the small handful of transitions that I've seen, it's been started 10, sometimes 15 years before the transition happened. That's my point. We really enjoy actually helping firms build and helping investing in some of these younger funds. It's been a lot of fun.

Starting point is 00:12:21 As the founder of TopTier, do you worry that the DNA that you inject in the company will be lost in future generations? No. I've always kind of tried to coach along the way. I guess it's now five years ago when we went from a managing partner model to a management committee model. And that's been now really operating relatively very smoothly for the last three to four years. We'll, from that model, start to transition some of us off the management committee over the next three to four years and some other folks on. And we think that's the right way to run our organization. Fund to funds, the analogy I like to use is kind of a Sherpa to bring people into the asset class.

Starting point is 00:12:58 Let's say I started an endowment and it's $50 billion. I've been investing in mostly public stocks. Now I want to go into alternatives. How would you advise the institution that is going into the venture asset class first start that process and how should that evolve? It depends on kind of the macro allocation approach you want to take. But, you know, historically, that number, the private equity exposure in an endowment of that size was historically around, at the low end, kind of 5% was in privates. That's grown today, that now is approaching 20%. And so if you're running a $50 billion program,

Starting point is 00:13:33 like you described, venture's hard to put to work at that scale unless you have some help. And there's two ways to do that. You can hire a consultant. The consultants, those folks will advise you on managers that they like you can also hire a fund of funds and the fund of funds can get money to work for you quickly and then help you do this actively help our lps then decide over time what they want to buy directly to lower their effective costs, if you will. How does that relationship go with LP? So let's go back to this $50 billion endowment.

Starting point is 00:14:09 Is there an implicit kind of co-invest and I put in $50 million into top tier, I'll get $50 million and co-invest? How do you navigate that relationship? Historically, that investor is just getting started. The way we've tended to navigate it is we give a lot of touch. We set up a consistent call, if you will. Zoom's a wonderful thing. You can do monthly, quarterly calls.

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Starting point is 00:15:25 In our book, yeah. Both? Well, both, yes. Okay, excellent. I didn't know that. But two great examples. I was going to say they're highly oversubscribed. What is the allure of spin-outs, and why do you see alpha in spin-outs? We've tried to basically track alpha.

Starting point is 00:15:42 So inside firms, there are individuals that drive a lot of the success. They a lot of times want to go start their own organizations. And so we try to pay attention to that. In the case of Wesley, I mean, he's been very successful over a very long period of time. And we've known him, oh gosh, six or seven years before he actually spun out. And the same thing is with Tomas. I think I met Tomas, I don't know, almost 10 years ago. What is a way that you provide the most value to spin outs in your portfolio? Venture is a long marathon.

Starting point is 00:16:14 And there's an intention sometimes with folks that want to go off and start their own organization to think that they drove a lot of the economic value that they created in the portfolios where they sit. And a lot of that value you could allocate to them, but a lot of it you need to allocate to the franchise. And so sometimes people spin out because they think it's all about them.

Starting point is 00:16:37 And lo and behold, it wasn't. It's about a collection that made that work, right? The franchise, the partners, yourself. The biggest risk of spin outs is wanting to conquer the world and realizing that, boy, it's a lot harder than I realized. We've, for better or for worse, helped people edit their LP allocations so that they can understand kind of who's long-term, who's not, and who's a tourist,

Starting point is 00:17:00 and what's reliable and what's not. Outside of fund-of-funds, who are the best types of LPs to have on your cap table? I really think it's about the people at those institutions. I remember in 2003 when all the endowments went from 80% venture to 10, and some of our guys would come and say, we had 45 endowments

Starting point is 00:17:17 and we only know two of the individuals. I recommend thinking of your capital base in thirds. And I think a third should be institutions like ourselves, you know, that are motivated to build firms and organizations around the success of your outcome. A third around foundations and endowments, and then a third around, you know, pensions or the like. Family offices, some are very constructive

Starting point is 00:17:43 and some are very flighty. I found a lot of the new entrants today are driven by, you know, folks that have been successful over the last 20 years and want to put money to work in a new category, but they're really using excess capital to do that as opposed to the core of an allocation. And so when the core of their wealth starts to deteriorate, they pull that capital back and then all of a sudden this person who you thought was a reliable LP because they were so wealthy really isn't.

Starting point is 00:18:09 And so that's one thing to be worried about. It's not unlike politics. Last one in is first one out. You mentioned a third, a third, a third fund of funds, a third foundation endowments, and a third pension funds. Can you unpack that a little bit more? Why would you recommend that? I'll talk about each one. Fund of fund space, that includes things like OCIOs.

Starting point is 00:18:26 That includes consultants like Mercer and Cambridge. I mean, the problem is if you get half your fund in one of those consultants, which represents maybe 20 LPs, if they decide not to put a buy recommendation on you for the next fundraise, half your fund is gone. So you run that risk. The fund of funds like ourselves or the OCIO investors, we're motivated to make good decisions, but we're also motivated to find more capital to keep investing. So we're in this investment genre, if you will, until we're not, which in most of us is 34 years. If you look at some of our peer group, we're going to be around. So that's a reliable, you know, capital source. The endowments have, you know, a whole bunch of

Starting point is 00:19:11 different things they're doing and have, but they have a very long hold because they're looking for essentially long multiple. So their duration is infinite, which makes them attractive for venture. Why pension funds? Is it just sizing? There's that, but it's just a reliable source of capital. I mean, 401ks have kind of changed that here domestically, but in places like Europe and Asia, if you go and look at the sovereign wealth activity in Asia in particular, I mean, Korea's pension system has way too much cash for domestic investment.

Starting point is 00:19:43 Japan's the second largest pension system in the world. Now Japan has got its own issues. That's a complicated market. But Australia has got a huge pension community. I mean, it's a category that has capital in it and is trying to figure out how to get good long-term returns. And so today, there's more buyers of that ecosystem for venture than there has been in probably 20 years.

Starting point is 00:20:04 You mentioned you have $8 billion under management. What have been your best practices for building relationships with your LPs? When we started the firm, we kind of came up with this notion there were two customers. There were investment clients and there were investor clients. Our investors are LPs. So we are, again, very transparent. We spend a lot of time educating them. We do workshops all the time.

Starting point is 00:20:24 We are either through of time educating them. We do workshops all the time. We are on, you know, either on either through webinars or in person and try to become their reliable information source as well as performer in the venture capital category. Early on, we had several very large investors in the sovereign wealth area in a way that kind of anointed us as an acceptable manager of capital in that category. And so we have a handful of sovereign wealth funds that we work with. Is that the key to unlocking new asset classes? You get that kind of lead investor, that anchor investor, and then other people start to take a look at you? It doesn't hurt. I can say that much. I think it's patience. I always tell people when you're getting turned down, no is not now.

Starting point is 00:21:08 What's the longest it's been between the first time you met somebody and the check that they wrote into top tier? It varies, but it's on average kind of three to eight years. Yeah. And so you've got to be patient about getting in business, patient, building a business. But if you get it to a certain critical mass, it becomes pretty sticky. When you get the check, it scales. It starts to, yeah. So as we mentioned, you've been in venture since 1993. You have one of the most long durations in the asset class. What do you wish you knew when you started? When you're young. So in 93, I was in my early 30s. I didn't realize

Starting point is 00:21:40 how important the quality of people dictated the quality of the outcome. And I think at that age, you always think you're just smart enough. That's a given, but it's very, very important that people are really important. In other words, starting a firm, starting to invest with an LP, all of the above, it gets down to people. And then the other thing was just being confident in the tech cycle. You know, people talk about Moore's Law and things of that nature, but one of the beauties of our business is we endlessly reinvent ourselves. As far as investment opportunities are concerned,

Starting point is 00:22:11 if you went and penciled out where the semiconductor was going in the early 80s and what that was going to evolve into, what we're doing today doesn't seem so crazy or so inventive. And so, because I do think as investors, we get so wound up on near-term outcomes that we miss a lot of the long-term opportunity. And the best example is our trillion dollar market cap companies.

Starting point is 00:22:37 Understanding how ownership works. If I had to step back and really sort of pencil out what works at scale and what's clear works at scale is having enough ownership. And if venture capital, for better or for worse, isn't structured that way, your ownership is never going to be at the same scale as if you buy a business. Because at the buyout level, you own anywhere from 60 to 100 percent. And so if you go back into the late 90s or if you go through this recent COVID period, ownership is paramount to success at the end of the day. It seems like I'm the last person in Silicon Valley that understands why it doesn't scale. One theory that I have is that a certain GP will only have a finite amount of A-plus opportunities.

Starting point is 00:23:18 One of the things that goes unreported is everybody has their A-plus companies, their A-, their As, their B+, and maybe below that they don't invest. But nobody thinks every next company is Facebook. So there's a finite amount of these really top tier opportunities, for lack of a better word, and then everything else dilutes those opportunities. It's absolutely right. The problem is when you get started, you don't know. If you do a lot of math, I mean, at the end where the fund returners are, are really in

Starting point is 00:23:42 two or three standard deviations out. The craziest stuff in the tails, if you will, is really where you get your best performance. And that's why you have to have a good portfolio construction strategy. Yeah. To plan for the chaos. Yes. Predictably unpredictable. Yes, exactly. You will have chaos.

Starting point is 00:23:59 We see that in various different ways, but you really see it in the secondary market where you price your investment, your whole trade around the performance of two of these high-value companies. And it's the third and fourth one that drive most of the outcome, not the two that you're pricing around. Well, David, this has been an absolute masterclass. I've been able to pick the mind of one of the greatest minds in the space. What would you like our ever-growing listenership to know about you, about TopTier, anything else you'd like to shine a light on? Thank you. So a couple things. I think we're sitting in front of one of the larger tech reinvention cycles

Starting point is 00:24:33 that we've ever seen in our lifetimes. We have a confluence of a ton of stuff coming together to create this, from compute power to the cloud computing network to open source, in a way that we think most of the tech stack gets reinvented in the next 10 years. And so we're super bullish on where we sit. The correction has provided us an entry price much more attractive than it was three years ago

Starting point is 00:24:56 in a way that it's a great time to be a dollar cost buyer. And so buying portfolios like we do is kind of a cool thing. We're very excited about the things that technology is going to help in the world from climate to healthcare to how we run our lives. So there's lots of things to be excited about. And so I appreciate you taking the time to spend the morning with me. Thank you for imparting your knowledge of over three decades and for being so generous and hope to see you soon in person. Our pleasure. Thanks, David. Thanks,

Starting point is 00:25:29 David. Take care. By popular demand, the 10X Capital Podcast has officially launched our newsletter powered by Carrier Labs, a full service content marketing firm that's partnering with us on the newsletter. In our weekly newsletter, we will keep you updated on all things emerging managers and limited partners, including industry trends that are critical to know as an LP, VC, or founder. To subscribe to our totally free newsletter, please visit 10xCapitalPodcast.com. Again, that's 10xCapitalPodcast.com. We thank you for your support.

Investing Billions - E49: Top Tier Capital Founder David York on 30 Years in Venture

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