Investing Billions - E76: How FirstLook Picks the Top 10% of Venture Funds

Starting point is 00:00:00 I think people sometimes naively get into this business and think that founders are their customer and kind of ignore how important it is to communicate, to have sort of a professional dialogue with LPs. Let's talk about terms. You see hundreds of these co-invest. What's the 20th percentile and 80th percentile of the terms that GPs provide to LPs for co-invest? Josh, I've been excited to finally sit down and get you on the podcast. Welcome to the Tonic Scavel podcast. Thank you. Great to be here, David. Appreciate it. Great to have you. So what is First Look Strategy? First Look is a hybrid kind of multi-strategy venture capital firm. And so what we mean by that is we invest about a third to 40% of our capital into a portfolio of emerging venture capital funds, which we define as folks on kind of fund

Starting point is 00:00:52 one through four. And we are disciplined around $50 million fund sizes and below. We want to build in each of our funds, we want to build a portfolio of about 15 to 18 of those managers. And with the other kind of 50 to 60% of our capital, we will invest, we'll make direct kind of co-investments into companies that break out of those portfolios. After our managers exhaust their follow-on reserves. What are the best deal dynamics that get you excited around a co-invest? It's when our manager kind of led the pre-seed round and was the first check into the business. Maybe they took a board seat, maybe they didn't, but they got, you know, enough of an ownership state that they were, you know, the most important or a meaningful

Starting point is 00:01:29 investor to the founder and sort of help them kind of start that journey. In that scenario, the manager that we are an LP and typically has a really strong relationship with the founder and can kind of bring us into the company early enough that we can start kind of getting our own, building our own conviction level in the business. So that by the time that the round comes together and there's a tier one kind of multi-stage or growth stage firm leading the series A or series B, we feel like we have enough of a handle on the business to kind of make a decision quickly. What do you do in order to set yourself up to process Co-Invest? This is kind of how we differentiate, right?

Starting point is 00:02:07 After we commit to a manager, I mean, literally within the next day or two, we are kind of doing a deep dive into their portfolio, my partner, Ankit and I, and we are sort of, you know, kind of taking note of the companies in there that we particularly are kind of interested in. We'll reach out to that manager fairly early in the,

Starting point is 00:02:27 in the process after, after becoming an LP and saying, you know, just, just to let you know, these are sort of the four or five things that, that, that we're interested in and, and, you know, any information you can share, we'd love to start getting our, getting our hands dirty and learning about the company. And if the manager feels comfortable, you know, we'd love to meet the founder and, you know, get our, wrap our

Starting point is 00:02:45 hands and wrap our heads around the business. Try to be helpful if we can try to add value, whether it's through, you know, introducing them to, you know, potential customers or folks in our network that, you know, might be accreted to the business in one way or another. It's a much more, I guess, proactive process rather than kind of being reactionary and scrambling when a deal comes together. Let's talk about terms. You see hundreds of these co-invests. What's the 20th percentile and 80th percentile of the terms that GPs provide to LPs for co-invests? Great question. I mean, you know, well, I'll say the, on the high end, right? I don't know whether this is 20 or 80 percentile, but, you know, if it's a really, if it's a really kind of hot oversubscribed deal and a manager can, you know, they've got,

Starting point is 00:03:30 they've got more interest in that allocation, right? You know, they can charge two and 20 in an SPV for, for that to get access to that deal. We really try to avoid those, right? Because our, you know, because of our kind of way our fund is structured and our fee structure, it gets kind of onerous to RLPs if suddenly they're paying additional two and 20 on every direct deal we do. And so on the other end, obviously the best scenario is for us to go directly to the cap table. That's a little, I think those deals are a little more unique and hard to come by because the type of things we're looking at, typically, the Series A or Series B lead needs to get their ownership. And obviously, if it's an interesting enough company, there's probably going to be demand from other LPs in the managers we invest in. So that's, I guess, a little more rare.

Starting point is 00:04:21 Middle of the fairway is kind of somewhere between 0% or 1% kind of management fee to sort of pay for the setup costs of the vehicle. And then, you know, somewhere between, let's say 10% is kind of, I would say the median. You really go sub $50 million for your emerging managers. You have a very specific mandate. Tell me about your LP base. We're, you know, we're really fortunate to have a great group of LPs, a lot of which are folks that we've known for quite some time in our personal lives and our careers. So I guess we have three different buckets. One side, we've got individual high net worths, and that's a mix of corporate executives and

Starting point is 00:04:57 CEOs from Fortune 100 companies. We've got founders that we've backed in our prior roles that have had kind of successful exits. We've got other GPs that we've co-invested with, other GPs that we've invested in their funds as LPs, and then kind of colleagues and mentors from different places along our career path. And so we've got senior portfolio managers from hedge funds and private equity firms. And then we've got a handful of kind of family offices that are sort of quasi-institutional, I would say. And then the third bucket is kind of multifamily offices and RIAs. Are there conflicts of interest in your business in the LP space? When we set out to build this firm and the business, it was kind of one of the first

Starting point is 00:05:40 things we talked about. So we're a hybrid fund, right? And so we make, we make LP commitments into managers and then we make direct investments. And so we were, we had to be really careful about the kind of parameters we set and, and kind of how that got out into the market of what we were looking for on the, on the direct investment side. And what I mean by that is we basically said, we're never going to do a pre-seed or a seed stage deal directly because we just felt like if we were, we never wanted to be viewed as competitive to the managers that we were talking to and trying to potentially invest in. And so that's why it was just sort of off the table kind of immediately. You know, we don't want to be talking to a manager and asking them what they're seeing in terms of deal flow and then

Starting point is 00:06:20 having them think we're going to go and kind of go around them and try to get into a company. We met during the Milken conference in Los Angeles, and you told me a little bit about your background. You have a fascinating story. My grandparents, so my mom's parents are Holocaust survivors. They were both in Auschwitz. They were Polish Jews who survived Auschwitz and came to the U.S., moved to Boston. There was sort of a small kind of Jewish contingent of folks from that era that moved to Boston. And then my mom and my father met, they were high school sweethearts. And my father went to actually a Catholic high school in Boston. And so it was a Jew and a Catholic, and they were high school sweethearts. And I was their firstborn. And my mother actually

Starting point is 00:07:03 passed away giving birth to me. So I never had the pleasure of meeting my mom. But my dad ended up getting remarried when I was about seven or eight years old. My stepmom was and is fantastic and raised me as one of her own. And then when I was 18, my brother and I lost our stepsister or my stepsister. Tragically, she had gone for a run. She was an incredible athlete, played high school volleyball and softball, ran track, and she would go for a run every morning before school and sat down on a park bench and her heart stopped. Basically, it turns out she had a condition called hypertrophic cardiomyopathy. It's called HCM. It's kind of a same thing that if

Starting point is 00:07:51 you're an NBA fan, there's been a number of guys in the league that had to kind of suddenly retire because they were diagnosed with it. And it turns out that it was a hereditary condition that her father had passed away from. So my stepmother's husband had passed away from as well. So yeah, so it was, you know, it was a lot kind of growing up. Does that change as an investor? Good question. You know, I think it's obviously had a profound effect on my entire life, not just obviously in my day-to-day investing. I mean, I think anyone that goes through personal tragedy and has lost an immediate family member or a loved one that's really close,

Starting point is 00:08:30 especially at a young age, I think can relate to this. But it definitely changes you as a person. I think it makes you appreciate how fragile life is and how fragile life can be when you kind of go through, uh, something like that. It just sort of, it just sort of hits a little different. Um, and I think it makes you appreciate, um, you know, the personal relationships that you have. It makes you realize that, that, you know, uh, things can be taken away from you at any moment,

Starting point is 00:09:00 uh, you know, when you least expect it. And so, yeah, I think it makes you appreciate the relationships you have and the friends you have and the, uh, family and people that you know, when you least expect it. And so, yeah, I think it makes you appreciate the relationships you have and the friends you have and the family and people that you love, just maybe in a little bit of a different way. And so, you know, I think for what we do for a living, and David, you do this, right? It's like, it's very much a relationship driven business. And someone might push back and say, yeah, but isn't every business, isn't every industry, you know, built on relationships. And I actually think it in this asset yeah, but isn't every business, isn't every industry built on relationships? And I actually think in this asset class, it actually is different, right? I spent five years investing in public markets at a hedge fund.

Starting point is 00:09:35 And it's very different, right? If you want to invest in Apple, you don't need Tim Cook's permission, right? You just go on and put an order in electronically and you buy the stock, right? And what we do is very different, right? You just go on and put an order in electronically and you buy the stock, right? And what we do is very different, right? You and I both sell a commodity. We sell our people to be the most fungible commodity in the world, right? We sell capital. And so you need to build relationships and you need to convince people to work with you and to take your capital and that you're going to be a good partner. These are 10-year partnerships and, you know, you spend a lot of time together and we want to work with good people. And I think when you, when you have gone through, you know, something like, like I have and lots of people

Starting point is 00:10:12 have, it just makes you appreciate the relationships you have. When it comes to building relationships, how much of it is competence and how much of it is trust? I think competence is a, is table stakes, in my opinion. I think you need to be, you know, we are kind of, the diligence we are doing is to sort of make sure that there's no cracks in your competence, right? And then beyond that, it does come down to relationships. And so, you know, we've looked at hundreds and hundreds of managers to make a relatively small number of investments. Let's say we've looked at 400 managers, right? And let's say that follows a pretty normal distribution. That's 400 in the past year, give it a take. That means about 100 of those are going

Starting point is 00:10:55 to be top quartile for that vintage, right? We've made five and soon to be six and seven investments. That means we're passing on 90 some odd managers that are top quartile and we're passing on 30 to 35 managers that are top decile. And so there's a lot of great people that do this that we meet that we know will be successful that we just unfortunately have to pass on because we are constrained by capital like everyone else is. And so then it does come down to personal relationships. These are long, long partnerships and it's got to be, you know, you want to work with people come down to personal relationships. These are long, long partnerships.

Starting point is 00:11:28 And it's got to be, you know, you want to work with people you want to work with. How common is something like trust and honesty in the emerging manager space? Is it something that most people have or is it a very big differentiator? When someone doesn't have it, it's a pretty easy pass, right? And there are times, I would say for the most part, people are good, trustworthy people. And, you know, it's, it's about, you know, trust, but verify. And that's what our LPs pay us to do. And that's what we take very seriously. But, but yeah, I mean, it definitely has happened where, where we've kind of looked at, looked at something or a manager or a fund that we thought was interesting. And then as we kind of continued to pull the string and do our work, realized there was, you know, a red flag or another red flag and,

Starting point is 00:12:08 and kind of through reference checks or otherwise figured out that, um, you know, someone wasn't, uh, being upfront about something. How many reference checks do you typically do on list and off list? Lots. By the time something gets through and we make an investment, we've probably spoken to anywhere between, I would guess, 30 to 50 people about that manager. And you mentioned that you passed on a lot of top quartile managers and even some top decile managers. What makes you say yes to a manager? We over-index toward founders, former founders and former operators. We over-index towards folks that have some sort of investing experience, whether that's institutionally or a healthy enough angel track record where we can start to get a flavor of what their style is like.

Starting point is 00:12:54 We are looking for managers that we feel have some sort of unique edge in sourcing. And that can come through lots of different ways. It can come by way of being a domain expert in a particular sector. It can come because you built a big company or business in that sector. It can come because of a regional focus. It can come through lots of different ways. But we want to see an edge in sourcing. We want to see a history of an ability to return capital to investors. And then we really want to see that the manager has really kind of significant skin in the game. And that's different for everyone.

Starting point is 00:13:35 And it's not about a percent, right? It's not like industry standards says one or two percent should be the GP commit. And but that number, that quantum can be different from person to person. We want to make sure that this is, you know, outside of your family, the most important thing in your life. And we want to know that you are, you know, as personally invested as you possibly can be in this so that this is kind of your, you need this to work is what we kind of like to frame it. So we're trying to measure, we're trying to measure hunger. Um, you know, we want to see, you know, we, my partner and I both work late nights. Uh, it's just the two of us right now at the fund. And so there's a lot of hats to wear. We're building our own fund ourselves. And

Starting point is 00:14:16 you know, we, we want to see like, if we're emailing you at midnight, you email us back, you know? Uh, and you know, so we're just trying to get a measure of like, you know, how, how, how much do you live and breathe this? How do you measure skin the game outside of GP commit? It's not easy. You got to ask some personal questions to people that, you know, I think if they're, if they are, if they trust and if you built a relationship and there's trust there, I think they're, you know, they're, they're happy to be honest about it. You know, we, we've invested in someone that had kind of a significant exit, right. Through a company that, that, that they were sort of very early employee yet. And so that was one of the things that we, we kind of really dug in on is, you know, this person has made, you know, what I think many people would call life-changing money. And so, is this person

Starting point is 00:15:06 going to be hungry to do this next with their career? But the amount of capital that they were putting up into this fund, the subsequent fund that we did not invest in, the fund we did invest in, the next two funds, the commitment was a significant portion of his liquid net worth. And so that got us really comfortable that, you know, that he was all in. 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,

Starting point is 00:15:44 subscribe to our free newsletter at 10xcapitalpodcast.com. That's www.10xcapitalpodcast.com. Let's take a step back. Walk me through your diligence process. Let's start with kind of top of the funnel, right? So we'll get, you know, we'll get an introduction, either, either myself or, or my partner on keep will take a first meeting. We rarely do them together. We want to see, because we just sort of think like that's the most efficient way to kind of call things at the top of the funnel, right? If one of us is not going to get there for one reason or another and we know it, then

Starting point is 00:16:18 let's just kind of move on. And because we have a unanimous investment committee, we both have to agree to a deal before we do it. And so assuming it's a kind of yes, let's move it to the next stage, then the other one of us will take a call. And so after that, we kind of come back together. We do this once a week and we sort of go through the managers we've spoken to the prior week and we sort of make a yes, no. Do we want to move this on to the to sort of the next step? If it's a pass, we will we'll just sort of let'll just let the manager know it's not the right fit for one reason

Starting point is 00:16:47 or another. If it's a yes, then we want to get on another call. If there's other partners at their firm, we want to get everyone together. Our process can take months. We want to get to know people pretty well before we make a decision. And so we'll get on a second and a third call. And after that, we're get on a second and a third call. And, you know, after that, we're asking for a schedule of investments. And so now we're digging into the deals they've done,

Starting point is 00:17:09 either in a prior fund or an angel portfolio. And we're kind of poking holes in this and we're coming up with a list of questions. We'll, you know, talk about this deal that didn't go well, or talk about, you know, when you did this, you know, what was the thesis here? And then, you know, how did that play out? And, you know, they ended up raising, you know, two more rounds. And then we saw that you sold some in the secondary market here. What was the thesis here? And then how did that play out? And they ended up raising two more rounds. And then we saw that you sold some in the secondary market here. What was the rationale behind that? And looking back, would you have made that decision again?

Starting point is 00:17:36 And it's really just trying to get a sense of how they view the world and what their kind of personal particular style of investing is. We are sort of old school. We say it's a requirement to meet in person. And so we want to either get on a plane or so much. Aki lives in Chicago requirement to meet in person. And so, you know, we want to, we'll either, we'll, you know, get on a plane or, or so much. Aki lives in Chicago. I'm in LA. So we're on airplanes pretty frequently. So we're happy going and meeting a manager where they are. You know, we want to, you know, share a meal, get to know each other. You know,

Starting point is 00:17:59 I think it's just a different, you get a different kind of feeling about someone when you meet them in person, it's a different energy. So we want to sort of make sure that, you know, on both sides that it sort of works for both of us. Once we're getting serious about potentially making an investment, we start putting our own list of references together. We're calling them, we're, you know, emailing folks and trying to get a sense of, you know, they're the managers, not just investing acumen, but they're who they are as a person,

Starting point is 00:18:24 their ethics, that kind of stuff. And then we start putting our memo together. And so we build out and we put together kind of pretty lengthy memos. We index it against sort of other funds that we think are similar in the types of deals they're looking at, whether it's by sector or vintage, we try to get a benchmark of their investing history against others in that same category. And then we sort of, once we've gone through that process, which usually takes, you know, anywhere from two to five or six months, we just put it to a vote. And if we both say yes, then it's a yes. How do you provide value to managers that you pass on? We introduce them to other investors. We think that's sort of the best,

Starting point is 00:19:07 you know, that's what everyone, I think, is. Is that not a negative signal? I don't think so. As long as you're honest. We both talk to other L a manager, you know, I'll send it to, you know, four or five other folks that are that are in my network that, you know, you sort of kind of get your tribe and, you know, you know, who likes what. And, you know, send it over and say, hey, we're starting to do the work on this. And it so far seems pretty interesting. Would you like an introduction? And most of the time, I mean, again, this is what our LPs pay us to do, right? And so most of the time,

Starting point is 00:19:55 those people want these introductions and you never want to force it on someone. I always say, if I'm passing along a potential manager for an LP to look at, I would say, no obligation to meet them, but here's why I think it's that you know if i'm if i'm passing along a potential manager for an lp to look at i would say no you know no obligation to meet them but here's why i think it's interesting um and if we if it's after we passed i'll just say you know here here's why we couldn't get there um but you know we don't have a crystal ball and you know we might be wrong but you know these are the things we really like i know we spoke pre-interview that you're looking for an mba student uh as first

Starting point is 00:20:22 part-time and potentially full-time yeah it's funny's funny. We are, so it doesn't have to be, we've kind of broadened the scope a little bit. It doesn't have to be an MBA student. I think we're sort of at the point where we're we want to think about someone that, that wants to be here full-time. We want someone that, you know, first and foremost, we want someone that kind of buys into the strategy and wants to be here and help us build for the longterm. You know, we talk all the time about how do we get to fund 10. So we, you know, we want

Starting point is 00:20:48 someone that kind of buys into that, that vision. First of all, first and foremost, we're looking for someone young and hungry. We are looking for someone that we don't really care where he went to school. We care more about kind of why you're here. Why are you interested in doing this? Why is, you know, why is venture, what about it attracts you to this asset class? And why do you want to do this for the long haul? We gravitate, I think, towards folks that come out of some sort of traditional either banking or consulting kind of background and then have some sort of experience in the asset class, whether it is at a prior venture fund or at a, you know, at a venture backed company in some sort of operating role. And then beyond that, you know,

Starting point is 00:21:31 we're just looking for someone hungry that we sort of vibe with. What do you wish you knew before starting First Look? That's a great question. What do I wish I knew? I don't think what I appreciated about this is kind of how you're always, the fundraising actually never stops. Even after you close your fund, it's still, you know, you're still taking those meetings and you immediately have to start thinking about getting to that next fund. And it's presumably going to be a little bit larger. And so you, you presumably you're going to need someone to write an even bigger check than they wrote in kind of the prior fund. And so you have to sort of think about the balance between getting too caught up in fundraising versus doing a job in investing.

Starting point is 00:22:12 And so just trying to figure out that balance and how you structure your days and your weeks and your months so that you don't let one side of that equation get kind of too heavy at any one point. What percentage of time do you counsel emerging managers to spend on LP or LP relationships? First of all, I think the best managers understand that the LP is their customer. And in many ways, founders are their product, right? Like in any business, you need to focus on both things. You need to focus on your product, and you need to focus on your customer. I think it's sort of whatever works for your own personal style. And there's, there's going, there's always going to be ebbs and flows, but I don't think, I think people sometimes naively get into this business and think that, that founders are their customer and, and kind of ignore how

Starting point is 00:23:02 important it is to, to, you know, to communicate, to, to have sort of a professional dialogue with LPs and to be sort of transparent and upfront and all that stuff. And so, yeah, I mean, we don't kind of advise anyone. Everyone should do it their own way and how they feel comfortable doing it. But I think the most important thing is just to remember that when you are a fund manager like ourselves, it's like our LPs are our customer, right? This has been a very enjoyable interview. Appreciate you jumping on and look forward to sitting down in LA or New York very soon. I likewise, likewise, David. Really enjoyed it. Thank you. Thank you for having me. Thanks for listening to the audio version of this podcast. Come on over to 10xCaval podcast on YouTube by typing in 10xC Podcasts into youtube.com and clicking the

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Investing Billions - E76: How FirstLook Picks the Top 10% of Venture Funds

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