Investing Billions - E61: Erik Iverson and Mike Partsch on WARF’s $3B Endowment Strategy

Starting point is 00:00:00 What's the purpose of venture in your portfolio? Financial return, for sure. You know, that is the fundamental fiduciary obligation we have, but we refer to it as a double bottom line. We want that financial return on that venture, but also we want those venture funds to be looking into Madison to see what kind of technologies we're spinning out. So really that's the dual objective, primary financial, secondary syndicating with us. For more ideas on how to raise venture capital in this market, make sure to subscribe below. Eric and Mike, I've been really excited to chat ever since

Starting point is 00:00:31 Gary from NVNG and former CIO of Wharf made the introduction. Welcome to 10X Capital Podcast. Thanks for having us here, David. Good to see you again. Yeah. Thanks for having us. So let's jump right into it. What is Wharf? Wharf is a technology transfer office for University of Wisconsin-Madison. We've been around for 100 years. Unlike most, we are separate from the university. We're our own entity, so we have our own balance sheet that we manage and leverage. And you currently have $3 billion AUM. Tell me about that portfolio.

Starting point is 00:01:01 Yeah. The majority of that money is worse money. It's unrestricted. Let's say that's about $2.5 billion. The other monies are either restricted because we've committed pledged grants or it is other organizations' money. What we've elected to do is outsource the vast majority of the management of that money through a group called Murder Trust down in Chicago. We follow an endowment model. Typically, it's a blend of equity and fixed income. We have

Starting point is 00:01:31 about 65% of the total portfolio is in equity, about 15% is in debt. And then we've held back in-house 20% of the total portfolio that we've deployed in private equity. If I'm doing my math, roughly $600 million in private equity. Tell me about that portfolio construction. We flipped the model on its head by putting the vast majority into venture. We've got about 75% of that $600 million in venture funds, about 15% and buyout funds. And then a smattering of private debt, but it's largely venture funds. And that sounds like a very large number. Why 75%?

Starting point is 00:02:16 It is a large number. Our strategic application of those private equity funds is to really try to leverage our relationships with those funds. We try to get in at top decile, but certainly top quartile funds. We're in the Versants and the 5AMs and the flagships, largely in the life science side. And we're doing that to help Mike Parchop, who's with us today, who's our chief venture officer. And we've allocated amount of money to his group to deploy towards spin-out companies from the University of Wisconsin. And what's the purpose of venture in your portfolio? Financial return, for sure.

Starting point is 00:02:49 That is the fundamental fiduciary obligation we have. But we refer to it as a double bottom line. We want that financial return on that venture, but also we want those venture funds to be looking into Madison to see what kind of technologies were spinning out. So really, that's the dual objective, primary financial, secondary syndicating with us. Last year, you had the record number of startup dissolutions. Are you not concerned that venture returns are a thing of the past? I've been involved with venture-backed

Starting point is 00:03:20 startups or as a VC since the early 90s, 1989 actually. And so their venture is not for the thin-skinned or the weak-hearted. It's a necessary part in any well-balanced portfolio. It's a high-risk, high-reward asset class. And so if you want to be able to leverage it to provide those higher returns, you need to be able to weather the down cycles as well. We've had a number of down cycles in the last 20, 30 years. Venture does return. It rebounds quite often in a stronger manner. Some of the largest companies we have in the tech sectors these days were founded in the down cycles following the boom-bust cycle. So I expect that Venture will return. And I actually think that right now is a very good time to be investing in venture.

Starting point is 00:04:08 And you've been in this class since the 1990s. Is there always this negative correlation between how hot an industry is and its return? I hate to make a generalization that it always happens, but anytime you have an extremely inflated asset class, a lot of hype around it, a lot of influx of dollars, you're going to get higher valuations. The dollars come in because returns are outsized. The dollars then bring less sophisticated investors, valuations get inflated, too much money chasing too few good deals, and then you end up having a subsequent crash. So this cyclical pattern happens every seven to 12 years, I'd say.

Starting point is 00:04:47 We're going through one right now. You'll see a lot of first-time funds not raise second funds. You'll see a lot of senior venture capitalists retire. And then things will get hot again. You know, I would say, David, where we've tended to focus our funds just to add a little bit more color to this or flesh on the bones, is the majority of the funds we're investing in are life science related. And we do have some within the software space, a little bit in the ag space, but I would

Starting point is 00:05:15 say we're very top heavy on the life science. I'm not entirely convinced that venture is scalable, and particularly with the amount of pressure we have in the market right now. So our sweet spot looks for about the $300 to $500 million funds. And then we look for those recurring funds like what Dorsen does and others that we really bet pretty heavily on. Wharf is a 100-year-old entity. And because we're in the privileged position of being able to take the long-term perspective, so we

Starting point is 00:05:44 have capital to continue to deploy. It's our own capital. We can be patient with it. And it will allow us to ride through the rough periods and actually be able to maintain or step up our direct investing in these downtimes such that we can maintain a strong portfolio until the cycle turns around and we start seeing that liquidity again. There's a push and a pull reason why I think we're so bullish on the life sciences. Life sciences to me encompasses not just the biotech, the therapeutics, the drugs, etc., but also the diagnostics that help detect disease in humans, the software that helps you determine what are the best treatment regimens, medical devices, etc.

Starting point is 00:06:19 So life sciences in general, we're quite bullish on because from the push side, as Eric said, on the pull side, we have these large unmet needs. Cancer is a huge problem in this country. Eric said, you know, two thirds of our portfolio is healthcare. Well, within that two thirds, half of that is all related to cancer, whether it's cancer drugs, new cancer devices and detection modalities, diagnostics, et cetera. So there are these large market opportunities where you need to have patent protection in order for you to maintain pricing controls over your assets. And that's the pool side of the equation. So we have both the push and the pool that's steering our portfolio largely into the healthcare sectors. Can you distill how exactly AI is driving

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Starting point is 00:07:49 Some people think I'm an AI because I produce so many episodes. This is an AI enabled podcast now. So your value is quadrupled. Correct. You know, like everything, there's a little bit of hype, maybe a lot of hype behind AI. But if you scratch below the hype, there is real process-changing technology there. It will change how we do everything, much like the internet. In the near term, the use cases, I think, are going to be more simple, more mundane. You're finding that

Starting point is 00:08:19 drug companies are not using AI to design new drugs, but they are looking at AI to help them sort and classify patients to help streamline the efficiency of clinical trials. It doesn't sound as sexy and exciting when you get into that level of it, but that's where AI is actually being applied right now. In the future, you're going to see a lot more applications as they perfect the technology. I think a lot of people have heard of tech transfer, but not many people know exactly how it works. Can you walk us step by step on how something is spun out out of the University of Wisconsin? When you talk about a spin out, that's normally the technology that was developed on campus is placed into a new startup company. The company is not spun out of the university itself. So in this particular case, what usually happens is an inventor on campus, a researcher, could be a graduate student, could be a postdoc, they come to Wharf with an invention, a disclosure. We take that disclosure, determine the market potential there, the potential to

Starting point is 00:09:17 file a patent and get an issue patent. We file IP around it, and then we start looking for whom we can license that technology to. If the inventors decide that they think they would like to start a company and we support that initiative then we can let them license that technology into a startup company a new C corporation that they create typically they recruit an entrepreneurs we'd like to see a seasoned entrepreneur someone who's been down that path before starting a company is very hard we like to find entrepreneurs who have been down that path before, bring them into the company as well. And then we start the process of fundraising. We typically will invest and we try to bring syndication partners along with us. So we are

Starting point is 00:09:53 leveraging additional dollars for every dollar we invest, as well as the additional expertise and the Rolodexes of those syndication partners that we bring into our portfolio companies. You have an interesting relationship with GPs. You're both an LP and then you bring them on as a co-investor. Tell me about the life cycle of your relationship with a GP. We have an in-house private equity team led by Mike Wagner. He identifies top decile, top quartile venture funds, especially those that are innovative in how they build their portfolios out.

Starting point is 00:10:24 He works with partners at those funds who are willing to look at our deal flow, help us with making introductions. We're able to tap into that network of people that is orders of magnitude greater than those that we have in-house. And so you multiply 20 GP positions or LP positions in new funds, multiply that by 20, and we've got a large network that we can bring to bear for our portfolio companies. Given that you are strategic LP and you want your GPs to come on campus and be collaborative, do you worry that you're adversely selected? I've been a GP at a venture fund, and you want to work with your LPs when they do have a situation like Warfaz where they can bring investments of interest.

Starting point is 00:11:06 But to be honest, if you're a good LP, you're not going to invest in GPs who are going to do possibly questionable deals just to satisfy an LP. If we think it's a worthy investment based on the professionalism of the team, we will bring those ideas to the GPs with no expectation that they will invest, just that they will take a look at it. We could easily poison some relationships if we inundate them with ideas on an ongoing basis, trying to leverage our LP positions. We're very cognizant of that. We're not going to do that. What are the advantages and disadvantages of being in Madison? We'll get right back to the interview, but first, to stay updated on all things Emerging Managers and Limited Partners, including the very latest data on venture returns and insights on how to raise capital from limited partners, subscribe to our free newsletter at university is just rockstar good. The stuff coming off the campus, truly world-class. We get 400 new invention disclosures a year alone. I mean, we file on 200 plus patents, maybe not quite that many, but let's say about

Starting point is 00:12:18 50% of the disclosure rate. That's just a huge number of dimensions that run everything from life sciences to engineering, imaging and animal health, agriculture, computer science, physics. It runs the gamut. And so it starts there with the university. Then the Madison itself, it's a beautiful environment. It's the population of people. The drawbacks is we're in the middle of the country, small town Wisconsin. Tell me a little bit about sourcing new relationships. How are those sourced? How

Starting point is 00:12:49 do you develop that relationship and anything else that happens before you meet a manager and the first investment? Mike Wagner leads that. We're a very loyal group where we're in multiple funds, the flagships, the Bursons, the Columns, the Fraziers, the Bessevers, Ampersand, multiple funds. So we really do pick the large funds and develop our relationship with GPs and stick with them, multiple funds. We also leverage our relationship with Northern Trust. 50 South Capital is their private equity arm, and we're developing a relationship with them and seeking some of their advice and support to identify additional funds, but also to balance our portfolio appropriately. As we structure transactions, there are some relationships that we're building, whether it's with Arch or Deerfield or others, that we really,

Starting point is 00:13:36 instead of leading with an LP position and asking them to take a look, we lead with a deal structure and get to know the GPs through a relationship and syndicated investment, and then begin to explore whether we could become an LP in their fund. Through offering them a look at a deal? That's how we establish the relationship. Deerfield is a group that we co-invested with in a stem cell project a number of years ago, that grew into an established relationship. Now we've co-invested with them in three different deals. And we're now considering them as a potential GP to add to our private equity portfolio. What unique information do you get by starting from that

Starting point is 00:14:18 angle of offering a deal to a GP? I've been either an entrepreneur or a VC through a number of these down markets. And when everybody's doing well and everybody's making money, it's easy to have good behaviors. Whenever things are challenging, you see people's true character show up. It's good in those times to be able to see how VCs behave, how do they treat the companies, are they able to keep themselves focused on an aligned interest among the company and the venture funds and the investors. It's a great perspective for us to interface, co-invest with, syndicate with some of these GPs. And that allows us to have a perspective on how they behave over the long term. You mentioned we just had a bull market followed

Starting point is 00:14:56 by a bear market in 2022, 2023. What are some of the bad behavior that you saw in the bear market that really kind of ticks you off? Seeing valuations come down should be expected. So that doesn't tick me off as expected. You're seeing some increase in liquidation preferences. That can be expected. Some of the strangest behavior I saw was by a firm. I won't name the name.

Starting point is 00:15:20 But they're asking for guaranteed annual dividends to be paid out moving forward and with a ridiculously high interest rate. To the GPs. Yes, to the GPs. Haven't heard that one. Yeah, it was a little shocking. Well, you know, Mike, it's interesting. There seems to be an uptick of taking advantage of the difficulty of raising capital and insider rounds forcing parts of the syndicate into a very awkward, if not difficult situation. And we've had a few of those. And on one level, the game is what the

Starting point is 00:15:52 game is. And you got to move your chess pieces as kind of the game is played. But at the same time, venture is all relationship. If you kind of force the game to be played way more harshly than you should, when things do become better, everybody's going to, let's be a little bit careful. Let's play the game, but don't be a jerk or too harsh in the process because we're all going to be around for a while. Yeah. I've seen two flavors of that. You see the pay to play round where there's a 10 to one cram down of shares, which is very aggressive. And then you see another play to play around where the preferred shares are converted into common, which I think is reasonable. We're seeing some of that currently in our portfolio. And we're hoping to see things

Starting point is 00:16:35 stay reasonable and not get too excessive. It dovetails back to your question about Madison. Venture itself is a small community. Life sciences, biotech is a small community. But when you talk about Madison, a town of about half a million plus people, there's a lot of success. And we need them as good partners. We need them as part of our C-suites and some of the companies. We need them as advisors. We start screwing around with those personal relationships in a pretty small town. And Mike and I will be run out of it pretty quick. This has been a fascinating conversation and I think it's really interesting to unpack the opportunities and the challenges of a large LP in the Midwest. What would you like our audience to know about the two of you, about Wharf, about anything else you'd like to shine a light on? I would like everybody to know that we are working

Starting point is 00:17:25 extraordinarily hard, very strategically to support this phenomenal university. And everybody should know that this university is developing outstanding technologies across a spectrum of areas from energy to life sciences to agriculture. And don't fly over us. Don't stop in. I'd like to add to that, for those potential venture investors out there that I haven't contacted yet, Wharf Ventures functions just like a traditional for-profit venture fund. We have very rigorous due diligence. We use fairly standard NBCA terms. We are motivated by financial returns on our investments. Bonus interview question. You mentioned you have 17x co-invest on your portfolio. That sounds

Starting point is 00:18:10 very high up there. What is your edge? Some of it is because we have some great technology. It's very exciting technology. Eric alluded to it. There's a fusion company we recently invested in that had a $100 million financing round. There's a quantum computing company that came out not long ago that had a $60 million financing round. So these are very hot areas that attract a lot of capital, and they're very capital intensive. And so it requires a large amount of dollars to be invested alongside our capital. And so I think that's one of the reasons why the numbers are large. Also, we have a large amount of life sciences in our portfolio, and life science deals are more capital intensive than, say, SaaS or, you know, creating apps

Starting point is 00:18:47 or whatnot. Well, Chris Presto from Swib invited me to a Badgers game and a Packers game. I'm going to hold him to it and I'll make sure to stop by and maybe we could all grab lunch as well. On the YouTube version of this podcast, you could see the graphs, visuals, and key takeaways that accompany every episode.

Investing Billions - E61: Erik Iverson and Mike Partsch on WARF’s $3B Endowment Strategy

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