Investing Billions - E63: Chris Rizik on The Rise of Midwest LPs

Starting point is 00:00:00 Cynics would say they come in, they see the low valuations, they say, wow, this is amazing. But historically, there haven't been the decade unicorns that you see on the coast. What would you say to that? There are plenty of unicorns. We've had five unicorns here in the last five years. Certainly not at the rate that they are on the coast, but given the number of deals, it ends up working out. Crunchbase did analysis, a 10-year analysis, and found moiks on Midwest companies were

Starting point is 00:00:21 on the whole higher than in any other region of the country. And while they may not be decade unicorns, less money is required to get them to exit. So the multiples work out quite well. It's fun to the best vintage to invest in where you have a little bit of traction, but you still have the hunger and you still have the alpha. For more ideas on how to raise venture capital in this market, make sure to subscribe below. Chris Reisig, I've been very excited to chat ever since Greg Wertman of SC Master Fund introduced us. Welcome to 10X Capital Podcast. Hey, David, it's great to be here with you. It's great to have you on. So let's start. What is Renaissance Venture Capital? So we're a fund of funds based in Michigan. We invest in venture capital funds around the country

Starting point is 00:01:05 and then engage those funds with what's going on in Michigan. Try to introduce them to deal flow here, but also introducing them to major companies that could become potential customers for their portfolio. Tell me about your LP base. I started Renaissance back in 2008 and that we teamed with an organization called Business Leaders for Michigan. And it's an organization, a CEO organization with CEOs of the largest companies in the state. Our initial fund back in 2008 was 10, either Fortune 1000 or major private companies who were interested in our model. We can talk about that, but it was 100% corporate investors. And that's morphed over time. Over time, as we've grown and gotten to additional funds, we've brought in others. But that initial base was 100% corporate.

Starting point is 00:01:50 Corporations have different cultures, different ecosystems. How do they interact with the startup community in your experience? It really is company to company. Some corporations have really strong innovation teams and then strong desire to engage with startup companies. I would say for others, it's more aspirational, but it's pretty difficult because it's a cultural thing that's different than what they do. With the rise of venture capital-backed startups and this whole fast-growing startup scene around the nation, really, particularly in the 90s and forward, suddenly major companies were finding that the true innovation was happening outside their organizations. And then the question came, how do we deal with that?

Starting point is 00:02:32 How do we embrace that and bring some of that innovation in our corporation? How do you feel about the innovator's dilemma? Famous book by Christensen several decades ago. It's on the bookshelf of every top tech CEO at this point. Do you feel there's been an evolution of large tech companies being able to grow innovation internally, or is it still the innovator's dilemma where incumbents are going to be disrupted by new entrants? I think it's always going to be the latter. What we've seen in AI is, right, they're disruptors. They just get bought early on. And so that

Starting point is 00:03:05 constant flow, which if you go back far enough, it was major historical companies that were buying the innovative startups. And over the last decade plus, maybe even close to 20 years, it's been large tech companies buying small tech companies. And so while large tech companies certainly work to have innovation within their organizations, a lot of what they do for innovation is acquisition, and they tend to be pretty good at it. Zuck doesn't get the credit that he's due, whether it's buying Instagram at a billion dollars or WhatsApp at, I believe, something like $20 billion. I agree with you.

Starting point is 00:03:40 Large corporations have had it difficult to innovate. Even Google, which is known as being an innovative, has had trouble innovating. What they've gotten really good at is faster acquisitions. So the top organizations are very good at acquiring fast, overpaying for something that has a massive growth rate. It's in their DNA, as you mentioned. The founders running them typically understand how quickly growth compound. I think that's right. I think that's right. It is easier for an organization like that to assimilate young tech companies than it is for a more traditional organization to assimilate, where, again, the culture of innovation may be a few decades further away for a lot of the traditional organizations. Is it harder being in the Midwest? It's not the same hotbed of innovation as say Silicon Valley. Is it harder to sell your story of working with startups being in Michigan? I would say when we first started back in 2008, that for sure, people come a long way. I mean, Michigan was a large company state

Starting point is 00:04:41 back in 2008 when we started. You had traditionally auto companies, major companies that had hundreds of thousands of employees, and it had been that way for two generations. The sea change over the past 15 years, everything from students graduating and wanting to work for startup companies or tech companies, all the way to major companies dealing better with the idea of working with startup companies. There's been a pretty big sea change, and it's not just in Michigan. You look all throughout the Midwest, and that has happened. I would say we continue to be a few years behind the coasts, but that gap between what goes on in the coast and what goes on here, that's narrow,

Starting point is 00:05:22 certainly over the past 10, 15 years. You have a demo day. It's called Undemo Day. Talk me through that. Yeah. So the idea behind Undemo Day was we've all been to these demo days where you've got 100 investors in the audience and there's the dog and pony show with companies coming up one after another doing their five-minute pitches. And our idea was to kind of flip that around. So in the fall, we have an in-person on demo day where we will schedule literally six to 800 one-on-one meetings at Ford Field in Detroit with the Detroit Lions play. We take over the place. And again, sort of flipping it around, the startups have their own tables and the VCs come to them rather than the sort of the big

Starting point is 00:06:01 dog and pony show. And then you have all these one-on-one meetings. And it just tends to be a real high quality affair. Cynics would say, obviously they come in, they see the low valuation and say, wow, this is amazing. But historically there haven't been the decade unicorns that you see on the coast. What would you say to that? There are plenty of unicorns.

Starting point is 00:06:17 We've had five unicorns here in the last five years. Certainly not at the rate that they are on the coast, but given the number of deals, it ends up working out. And there are a lot of great deals, even if they're not deck of unicorns, that are going to lead to positive results. Crunchbase did analysis, a 10-year analysis, and found the moiks on Midwest companies were on the whole higher than in any other region of the country.

Starting point is 00:06:44 There were fewer companies that get funded here, but the ones that get funded tend to do overall at least as well as or better than those on the coast. And while they may not be decade unicorns, less money is required to get them to exit. So the multiples work out quite well. A lot of VCs will talk about obviously power laws, but also these uncapped asymmetric bets where it could go to infinity. But if you look at portfolio construction from a fund to fund level, but from a GP level, you know, the important thing is delivering the three to five X consistently. It's not delivering a hundred or 200 X every five integers. That's a nice to have.

Starting point is 00:07:18 That's not a need to have. So as much as people talk theoretically about these uncapped returns, they're not critical for having a thriving fund. It's a great point. It's a great point, David. So now I put on my fund to funds hat. I'm looking at two funds. They're both Forex funds. One of them had 60% loss ratio, but had one or two big hits that got them to Forex. Another one has a 20% loss ratio, but they're hitting those threes, fours, fives, sixes regularly. And that is definitely where I'm going as a fund of funds, because it's tough to bet on grand slam home runs saving a fund that has a high loss ratio. You mentioned you do go early, you invest in fund ones and fund twos. What makes you say yes to a fund one?

Starting point is 00:08:01 So we'll invest in a fund one. We won't invest in a manager one. So where we've done fund ones, they're existing managers with referenceable track records that may be moving from another fund, starting their own, typically because they have a strategy that's different than where they were at. So for instance, we invested in a fund where there was a partner in an East Coast fund that wanted to do more advanced manufacturing and material science. So, started a new fund.

Starting point is 00:08:30 A couple of guys started a new fund with this area of expertise, but they had an identifiable and referenceable track record from their old fund. I was a GP in two funds before I started Redisense. I know what that first couple of years is like as a VC and the mistakes that I made. So I really prefer to invest in people who've kind of gone through that learning curve, whether as an apprentice in another fund or even with their own first fund before we got it. If there's a lot of strengths in a manager and a fund one, do you give them some slack to change in fund two or what's your philosophy on that? That happens a lot to family offices too. So yeah, we do give some slack.

Starting point is 00:09:10 If there was a thoughtful change and we can see, we ask every manager that we talk to, once we get deeply into it, tell us about the mistakes you made. And I would much rather have a self-aware manager who says, yeah, I made this mistake and this mistake and this mistake. And here's what I've done to address that in the next fund. I mean, that's really powerful. In many ways, David, it's not that different than the conversations you have with a startup founder. You know, if a startup founder is so busy on the sell that they don't admit mistakes,

Starting point is 00:09:41 they don't admit weaknesses like you do with a CEO startup, we're doing some testing as we're going through the conversations. I would say I invest in both the dot and the line. It's important that somebody's starting from a high level of competence, but it's also important what the growth rate is because I'm essentially investing for five to 10 years down the road. Somebody is very early on their trajectory of skill sets, but they're growing very fast. That's not going to help me on that company. That's going to be a next company. But if somebody is kind of mid-tier, but showing no growth, that's also not going to help me. Do you look at that in your fund managers? Are you always investing in the dot?

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Starting point is 00:10:59 with Deal today. Both. You nailed it. What's really frustrating, it's not atypical for us to start talking to a manager when they're too small for us or too early. And we love tracking them to see the growth, the line that you talk about. It's frustrating, particularly if you like somebody personally, to see they kind of flatlined and making the same mistake over and over again. When you look at a fund and you look at fund one, you look at fund two, you look at fund three,

Starting point is 00:11:30 each time the most money went into companies where they lost money, it shows what is one of the most fatal flaws you see in venture funds, and that is making emotional decisions on where to do follow-ons versus double it down on what are truly your best companies. We all have egos, and nobody likes to lose a company, but the lesson that we all learned, and my gosh, I learned this when I was a GP the hard way, is there's a limited amount of capital and continuing to try to save companies that aren't worth saving so that you didn't lose them never works out as well as taking sort of this cold, hard look and saying, where can I optimize this next dollar that's going in? Even if you save that company and returns a 1.52x, it's still by definition worse than

Starting point is 00:12:24 the incremental dollar. So even if it works, it's still by definition, worse than the incremental dollar. So even if it works, it's still a flawed model. What are some other mistakes that you made as a GP? So I did not go through the apprenticeship. I had a CPA background, I had a law background, and I'd done deals, but I was not a VC. So I probably came in really early on with a bit of imposter syndrome, like other folks do. I may have underestimated my abilities a little bit. And what I found is being in meetings and you're in meetings with founders who are like doing the sell and there are things they said that didn't make sense to me. And I would probably get a little caught up trying to catch up with them and thinking, okay, they're saying something that makes sense. This is me. The fact that it doesn't make sense might

Starting point is 00:13:09 be my problem. And what I came to find out over time is if it didn't make sense to me, it's probably because it didn't make sense. And so I shouldn't invest in it. And then the second part was, if it doesn't make sense to me and that's on me, I still shouldn't invest in it. So I think it took years and confidence to realize there's a lot of things said during the pitch that don't make sense or that my experience says are just wrong. And that confidence to call that, it took years for me to get that. And I wish I would have had that confidence earlier. That was a big one. The second one is death by a thousand cuts. You put a little bit in the company and they're always six months away

Starting point is 00:13:51 from being six months away. And you just keep doling, doling, doling. Next thing you know, they haven't gotten where they need to be and you've used your dry powder on it, the decision to cut it off that you should have made 18 months ago, only now you've blown more money. And that's another typical- Stringing along an entrepreneur, which is what I would define that as, is selfish and it's egotistical because you're giving them false hope. It's kind of like dating somebody and continuing the relationship long after you know that's

Starting point is 00:14:21 going to be done. For those who know that, it's that way. There's certainly ego involved. I mean, I will say, I think most of the firms I deal with who do that, they honestly believe that there's a shot, but stepping back, if they were looking objectively at it,

Starting point is 00:14:37 if they were looking at it as a new investment, they wouldn't look at it that way. The emotion of having been in it, and it's ego, it's not malice, but there's ego involved and there's our sort of God complex, our belief that we can fix this, we can make this right, gets the best of us. You mentioned the apprenticeship model. There's two different schools of thoughts. There's the operator turned VC, the Mark Andreessons, the David Sachs's of the world. And then there's the apprenticeship model, the John Doors of the world.

Starting point is 00:15:10 What are the pros and cons of an operator turned VC versus a VC associate turned VC partner? I mean, I've been in too many boardrooms where nobody in the board had ever been an operator and they're VCs who've never been operators. And the ability to truly help the company can be pretty limited. If you're talking about building the sales team, or you're talking about product development, or product market fit, or those things, it's sometimes tough if you've got people who've never been operators. So certainly the operator VC has that head advantage, particularly if the person's been through a few startups and has experienced a lot of things. On the other hand, going from the associate up, sometimes those are blind spots,

Starting point is 00:15:49 but if they've been trained well, while they may not have lived those experiences, they can also get to that point. The worst two scenarios are operators who didn't have VC experience at all, didn't even deal with it as VCs. And so they made some first year mistakes or associates who were simply doing research and now they step into a lead role without ever having really experienced firsthand, even by curious, the problems of growing a company quickly. I think operator turned VCs are much more valuable at the earlier stage where you need to provide a lot of value and maybe VCs that have been apprenticeship for 10, 15 years might be better stock pickers of sorts. And maybe that's kind of the bifurcation of where the returns have been.

Starting point is 00:16:33 You mentioned something very interesting when we chatted, the idea of an emerging fund 12. Tell me about that. Our sweet spot when we invest in funds, I would say is fund 70 million to let's say 400 million. Those are viewed as emerging manager sizes to institutional investors. We also tend to invest in teams that are still hungry. There's always the concern if you're looking at a $2 billion fund and everybody has already made mass fortunes, they've proven themselves in every way, are they going to make that extra plane ride or do the extra thing for their portfolio? And that's certainly a concern from ours, particularly since they can get even more wealthy just on management.

Starting point is 00:17:13 So, we tend to like fund managers who are at the sweet spot of having had experience where they've learned the lessons, but they're still trying to prove themselves. And that can happen typically in a fund two or fund three. However, we've seen a lot of main brand funds that have gone through wage and every fund has its arcs. And so, the founding team took it up through fund four and fund five, had a great run. And then, under that normal arc, things started to suffer. Fund six, fund seven were worse performers and maybe their eye wasn't quite as on the ball. Maybe there was strategy creep, whatever. But then the fund went through a down period. But you had these younger associates training, learning, learning during a pretty tough period. There's nothing like learning in a fund that sticks,

Starting point is 00:18:00 right? To learn those lessons. And then they get to the point where they could go out on their own and start their own new fund, or they could resuscitate a name brand. And we see that all the time. So, you'll see us in what you would call an emerging fund 12 or fund 11 or whatever, which is generational transition. They've gone through the lull and the next generation has come up and they have the same hunger that a fund two manager would have. It just so happens they're doing it in a brand that's been around for 20 years. I just had Mamoun Hamid from Kleiner on my other podcast with Jason Calacanis called Liquidity Podcast. He's done a phenomenal job basically at Emerging Fund 12 and really turning around that franchise in spectacular fashion with

Starting point is 00:18:43 Ilya and others. It's fun too, the best vintage to invest in where you have a little bit of traction, but you still have the hunger and you still have the alpha. We'll get right back to 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 10xcapitalpodcast.com. That's www.10xcapitalpodcast.com. Fund two is the perfect place to start if you've got enough signals from fund one that you feel comfortable making that investment. So for some funds, it's been fund two. For others, it's been fund three. Those are the two where we tend to come in.

Starting point is 00:19:26 Some of our best investments have been fund twos or fund twos. I think maybe our best. Fund twos. What is a good signal? What is a false signal? It's tough to get as many signals as you want from that fund one, especially because if it's 10 million, chances are you're raising fund two relatively soon. I mean, the signals we're looking for are deal flow access. Did you get into great deals? You clearly had to be an early stage investor. Were you the person, even though you knew that founders were calling, or you had this great network where you were able to get it? Two, the decisions we talked about earlier, which ones did you follow up, follow on, which ones didn't you follow? Three, you know, we just went through a period of a dozen years where everything was always up and to the right. And like, if I see a $15 million fund

Starting point is 00:20:18 that did 25 deals, it's like red flags are going off all over the place because what it's telling me is that this is a fund manager who expects things to always continue to be going up and to the right and that doesn't happen and that when tides turn, they won't be able to play defense. Everybody can play offense. My problem with that strategy is even some of your good companies are going to struggle in fund rates and there's going to be some flat rounds. There's going to be even some down rounds of decent companies. There's going to be some pay to plays. And if you haven't structured it so that you've got enough dry powder to play defense, I'm looking at you and thinking, this looks good as long as the market's good. But the market turns bad, it's going to go really, really bad for them. So, those are the types of things

Starting point is 00:21:05 that we're looking at. I think one of the big problems, at least from our view and the way we look at funds, is funds that are doing too many deals. Number one, it's tough to add value if you got 50. And this is not exaggeration. I mean, I see $50 million funds with 50 deals. It's tough to really believe you're adding any value post-transaction. And then two, you're almost indexing too much. You rely too much on others to take the ball from you. And in the down market, you're going to have a really tough, tough few years. Absolutely.

Starting point is 00:21:43 You've been at Renaissance for 15 years. You were a GP previously. What do you wish you knew when you started in your career? In my career, Renaissance or back at the GP? I think we talked about when I was a GP, what I learned. Yeah, you transitioned from GP. You've been at Renaissance for 15 years. What do you wish you knew when you started at Renaissance?

Starting point is 00:22:01 So I guess the things that I wished I knew when I started Renaissance were number one, the thing I talked about earlier, which was that co-investments as sexy as they are, you know, I think it's a tough thing to do. And particularly if you've built a team that is good at fund to funds, you're always relying on somebody's due diligence, somebody else's due diligence for the co-investment. That was probably the biggest lesson I learned. I guess the other one would just be, be patient. Be patient and really work your network to try and get access to the best funds. I think we did a pretty good job of that.

Starting point is 00:22:45 There are funds that will just hit you like over email and you always want to be respectful and talk to everybody. But I guess I would say a lesson is be patient, create a network, work your network and keep the bar really high. Don't get caught on people you like. Some of the best people you like, you want relationships that are going to be great long-term relationships. So you don't want to really invest in people who tell are jerks. On the other hand, you can't put too much stock in people who are just nice people, but are hitting, are forcing you to contort yourself to invest. The desire to help people could be a weakness,

Starting point is 00:23:27 unfortunately. You mentioned how you source deal flows. What percentage, if you had to guess, what percentage of your deal flows through it's cold versus through known parties? I would say through cold, it is, I can tell you, it's probably exactly 2%. It just doesn't happen cold. Everything comes through referrals. And it's probably, you know, David's not probably not that dissimilar to the stuff that you guys do, you know? So we help create this national network of fund to funds, people we knew, and we share deal flow, we share due diligence. Chances are, if we're looking at a fund, one of our friends is investing. It also comes from our existing funds who we talk to all the time and they'll tell us like,

Starting point is 00:24:14 this fund that we co-invested with, they were great on the board, great to work with, really smart. And that means a lot to us. Our LPs also refer. For some of our LPs, we are the screen. You know, they get pitched by funds all the time and we might screen a fund before they look at it or they might say, you know what? Renaissance is our play. Anytime we get somebody who pitches us who we like, we're just going to say that to Renaissance.

Starting point is 00:24:35 Well, it's phenomenal what you've built in Michigan and inspired in the Midwest and Southwest as well. What would you like our listeners to know about you, about Renaissance and anything else you'd like to shine a light on? Yeah, I mean, I think the notion that there are underserved geographies of the nation where there's really a lot of talent and there is a lot of technology growing there. There are sometimes cultural issues that we talked about

Starting point is 00:25:04 with sort of big company versus small company places. But the idea that there is a lot of talent all over and that really great startup communities can be built anywhere in the country where there's talent and there's technology being developed tends to be close to university towns. 15 years in, the reason I'm pleased I can go around the country and talk about this is it's not just theoretical. We could show, okay, we've got 15 years of evidence that this is actually the case. And it isn't as big a risk as you think to do something in a geography in the middle of the country. There really are opportunities to do that. And I think the biggest thing that we can do is show that there's 15 years of facts that support that, that this isn't just aspirational. Absolutely agree on all those fronts,

Starting point is 00:25:59 100%. And I've actually never been to the big house. So I'm looking forward. I'm inviting myself to Ann Arbor. We need to go to a game. I would love to sit down with you and happy to host and look forward to hosting you in New York City as well. That would be fantastic and would love to have you there.

Starting point is 00:26:13 And I mean, this would have been the right year to come. Last thing you asked about, David, was anything about me. And that's I have my own startup company that I started in my kitchen 20 years ago. So if anybody's a music fan. Yes.

Starting point is 00:26:23 What is the URL? SoulTracks.com spelled T-R-A-C-K-S. And it is, it's grown into now the largest soul music content site in the world. And so, you know,

Starting point is 00:26:36 this weekend I'll be spending my Saturday writing about music. You're raising the bar. Every fund of funds should have now a startup hyper-competitive market that is the LP market. But thank you, Chris.

Starting point is 00:26:46 Thanks so much. And I look forward to seeing you soon. Thanks, David. Great job on the podcast. I think it's a real service that you're doing. Thank you, Chris. On the YouTube version of this podcast, you could see the graphs, visuals, and key takeaways that accompany every episode.

Investing Billions - E63: Chris Rizik on The Rise of Midwest LPs

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