Investing Billions - E82: Why LPs Use Fund of Funds to Invest into Venture Capital w/ Fernando Saiz

Episode Date: August 2, 2024

Fernando Saiz, Co-Founder of Azet Capital, sits down with David Weisburd to discuss Azet Capital’s fund of funds strategy in venture capital. Fernando shares his diligence process for selecting venture funds, what differentiates the funds Azet invests in vs. the ones they pass on, and Azet’s strategic value-add to venture GPs. The 10X Capital Podcast is part of the Turpentine podcast network. Learn more: turpentine.co -- X / Twitter: @dweisburd (David Weisburd) -- LinkedIn: Fernando Saiz: https://www.linkedin.com/in/fernando-s-4732544/ Azet Capital: https://www.linkedin.com/company/azet-capital/ David Weisburd: https://www.linkedin.com/in/dweisburd/  -- LINKS:  Azet Capital: https://www.azet.capital/ -- Questions or topics you want us to discuss on The 10X Capital Podcast? Email us at [e-mail] -- TIMESTAMPS: (0:00) Episode preview (1:01) Intro to Azet Capital (2:40) Views on fund reserves and diligence process for fund investments (7:44) Evaluating emerging managers (10:40) Tools for benchmarking and selecting funds (13:44) LP relationships, co-investments, and fund of funds (17:12) Educating LPs on venture capital (20:07) Strategic reasons to take capital from LatAm (23:09) Value-add from seed stage managers (24:56) Final thoughts and closing remarks

We love venture capital. We believe it's the best asset class to invest in. If you have the patience, you understand the liquidity and the time horizon that it entails. We believe that everybody should have a peace in venture. When you compare LATAM in general, and specifically Mexican families, high net worths or family offices, the allocation that they have to venture is very, very small when you compare that to US or European families. We believe that's an asset class that every sophisticated investor or high net worth

individual should have because in our view is the asset class that best compounds in the long term. What differentiates the funds that you invest in from the first losers, from those that you almost invested in? What are those differentiations? Fernando, I've been excited to jump on the podcast ever since our friend and your partner, Pablo Gonzalez from your fund introduced us. Welcome to the 10X Capital Podcast. Thank you, David. Thanks for having me. So let's jump right into Asset Capital. What is the strategy for Asset Capital? Asset Capital is a fund of funds. So we invest in funds. Our strategy is focused on the intersection of small funds that invest early and primarily in the US. And we do that by backing emerging managers. In our case, putting some numbers behind this,

small funds would be less than $75 million. In terms of stage, we focus on seed and pre-seed. And the managers that we like to work with is the ones that are, I don't know, between their second, third, and fourth funds primarily. What are your views on reserves? So it depends on the strategy of the manager and it has to be aligned with whatever they're doing. So there are great funds that are no reserves, only like first check only, and they have concentrated portfolios and very successful returns. And there are other managers that have a reserve strategy. So we've backed both, but what we like to see is an alignment on what they are trying to achieve and the strategy they are pursuing and where that reserves fit within that strategy. What's a good reserve strategy?

So what's some strategies that work? I don't know. I've seen numbers between 30% and 60%, you know, for follow-ons and that they want to keep that reserves for the really great breakout companies and back those. Because when you also see some funds, like they are in fund two, fund three, there are some lessons learned within the way they deployed capital. Some, they started with no reserves and they regret that they didn't have enough capital. So now they start with a reserve policy. So I think it's an evolving strategy for the GPs.

Let's say you have a portfolio of 30 companies. How many companies should seed managers follow on to? What percentage? I would say around 20% of the companies, really big follow on capital on those companies because venture is, as you know, power law driven. So some small fraction of the companies will be the ones responsible for the big returns in the fund. So those are the companies that require that capital and the GPs need to be as aggressive as possible in defending their ownership and putting more capital at work

when they have conviction in those companies. What about the other 80%? Do you want your seed managers to do pro rata or to just completely starve the follow-on? I think it's going to be depending on how the company is performing. As you know, VC and early stage VCs, half of the companies would not graduate and will not get to the next round

because either they didn't find the correct market fit or they didn't grow as aggressively or they just founders break out or whatever. So those companies, I don't want the GPs to be necessarily putting capital in companies that they don't feel they're going to be a good company. They should put that capital behind the companies that are performing the best. And some companies will die in the process. And that's the reality of venture. And we're fine with that.

You focus on funds, two, three, and four, sub $75 million, down to $20 million. Within that category of funds, tell me about your diligence process and tell me about the life cycle of diligence. What are you diligence first? And then what are you diligence next? We focus on four things at first. The first one would be the strategy of the fund. So what are they trying to accomplish by putting capital at work? This will mean what type of companies are they backing? what type of founders, what are the sectors they are focusing on. Here is where we would like to see why the GP believes that that strategy is unique and why that strategy has high potential. Then the second piece of our analysis would be the GPs themselves. So we want to understand what have they done? Who are they?

And more specifically, what have they done that is relevant for this strategy that they're pursuing as fund managers? Are they able to win? What's unique? What are their strengths? Have they proved them in the past, et cetera? This follows with track record,

which is definitely something that we look into. For some emerging managers or first fund managers that we've backed up, sometimes it's hard, but we need we look into. For some emerging managers or first fund managers that we've backed up, sometimes it's hard, but we need to look into, have they been angel investors? Have they done investors for other funds or larger funds? And now they are doing their own boutique. So we need to see how they have been successful in the past on not only putting capital at work,

but being able to generate great returns to themselves, their investors, or other funds that they used to work in the past. And again, this track record needs to be relevant for the specific fund strategy that they are pursuing now. It's less relevant if they were great investors in, let me say, PropTech, and now they are launching deep tech VC funds. And lastly, and I would say it's very relevant for us, is the personal fit that we feel with the GPs. This is a long-term commitment. We want to be very, very careful on who we choose to work with at the personal level. And we try to understand that through several conversations with founders that they backed up, with investors that they have worked

with, with peers in they have worked with, with peers in other companies if they were founders or their co-founders. We really want to understand at the personal level who they are and why we would want to work with them in the long term. And after those four or five factors, you basically go into confirmatory diligence phase where you're checking the box on operational due diligence? Yes, that is correct. And that will entail, as I alluded, some conversations, several conversations with people. If we feel we need to speak to another founder, we will do that. And then all the basic more legal, you know, checking that what they had on the deck is real and speaking with people and getting all those checks again confirmed. How do you look at it from a hierarchy? It seems like

first you look for the criteria. Does it fit your mandate? Does the fund fit what you're trying to do? Second, whether there's an edge. Third is whether that edge is based on their previous track record. And then fourth, basically the cultural fit. How do you accelerate your diligence in a way to make yourself more efficient? Yeah, I would say the other is correct, David, that that kind of fits nicely with the flow or with the process that we have when we diligence the funds. Getting fast to a conversation with the GPs and with the people that the GPs have worked with, it's a way that you can accelerate your diligence. You can spend hours and hours doing some desk work and trying to understand the strategy and doing benchmarking analysis and their track record, whatever. But for us, as fast as we get in touch with the GPs and the people that can speak and have known them for quite some time is the best way to get into a conviction mode or

second phase of diligence. And this could take months or this could take years because sometimes the cycles don't align, but we want to meet great funds anytime because as I said, this is a long-term game and you want to be meeting all the great people so that you can invest alongside them. You're investing a lot into emerging managers. Oftentimes they don't have DPI. They might have a 1.3X from a couple of years ago or 1.4X. A, what does that even mean to you? And B, how do you double click on that track record and ascertain whether there's alpha in that manager? Numbers don't lie and we need to compare as much as possible those numbers with other relevant information that we can have, public related information or talking to other managers or based on our own experience in how those similar managers perform. We look

also on how they got to those numbers. What was the portfolio construction and what has been the changes in value in the companies that they've invested in that is reflecting that number? We also want to see the traction of the companies themselves. One is the valuation that the company is having, but you want to see how those companies are companies themselves. One is the valuation that the company is having, but you want to see how those companies are performing. So we spend some time with a fund manager seeing what has been the evolution of the companies that they backed up.

Are they growing? How they compare to the competition, et cetera. And the other thing is there's always some, another track record that you can, or that we want to see from that emerging manager. They, some were angel investors and they have their personal portfolio, how they have invested that portfolio. Some of these first time fund managers were also investors at another franchise at some point. So we want to see how they invested with another fund and how they compared to the rest.

You alluded to spin outs, somebody that might've been at a Sequoia, Andreessen Excel, pick your top fund, and now launching their own fund. How do you figure out attribution on deals? We've done a couple of this, have a couple of these cases, and we need to speak with the people on their previous fund and see how was their real involvement in picking, investing, and helping those companies. So that's a diligence that we need to do with their prior fund to get a sense on how was that. And the other thing is we speak to the founders that they have backed when

they were at those other funds. So they will really tell you, you know, David was really fundamental in the success of my company. He not only backed me, but he helped me. He was a mentor. He was a coach. And now if I were to start another company, I would get capital from him in his new fund. So that's kind of the things we want to hear from the founders and the entrepreneurs as well.

I think one of the biggest things that LP's diligence and spin outs is whether it was the platform or whether it was an individual. And absent of any data that it was the individual, it basically by default almost is that platform. Sometimes founders and rationally so are looking for just the signal. They want people to know they're backed by Sequoia and Andreessen. It might be hard to continue that track record as an individual manager. Totally. What benchmarking data do you use in order to figure out kind of true benchmarks for different vintages? So, I mean, the usual, I would say we use a catchbook, frequent, verges, when available. Again, it's not a perfect, perfect game.

Public comparables, you know, the amount of information that you can get for public companies is sometimes more than what you need. And I think there's some analysis paralysis in public comparables. In private, you do what you can or the best that you can with the information that you have, which is not perfect. It's outdated. It relies on the limited partners. You need to trust what they are reporting

because sometimes it's not audited. So there's a lot of noise in that information, but at least it gives you some sort of parameters or ranges where you can start putting some funds and compare track records. Between those three tools, what does each tool uniquely bring to the table? Why would you use Abergis if you have a pitch book in Prequin? Why would you use any of the three tools? I don't know if they're unique. What we try to do is get different input from different data sources so we can come up to a better solution. You guys are very selective in terms of the funds that you invest in. And what differentiates the funds that you invest in from the first losers, from those that you almost invested in? What are

those differentiations? It's a great question. I would go back to our four-step process and the strategy, where are they playing, why we believe they can win, have they done this in the past, and do we feel comfortable working with these people? And there are some great funds that we have not invested in with great track record, with unique strategies, but either we didn't feel comfortable working with them or you didn't feel comfortable working with them or you didn't feel, you know, that click when we had those interactions. So it's a matter of, for us,

we need to check all the boxes and that will leave some great funds in the table, but we're fine with that. We want to invest in the best, but also the ones that we believe will be great long-term relationship because in the end, I mean, venture is measured in returns. And that's a fact.

So it's an investment. People should care about returns. But it's, if not one of the longest asset classes that you can invest in. And if you're investing in a fund of funds that is doing venture, it's going to take a long, long time. So these relationships matter and matter a lot for us. So again, going back to the personal component, some funds are great in numbers, track records, strategy, uniqueness.

And we sometimes don't feel that they are the right fit for us or for our investors. So we try to be very active in terms of investors investing in those funds. We want to participate in the co-investment opportunities and we do that often. We also want to help the portfolio companies with our local resources in terms of connection expansion. So for that to happen, you really want to work with the people that are backing those companies and you need to have a great relationship with the funds. Is that the main benefit for LPs to have a relationship with their GPs, co-invest? I would say it's one of them, but not all the limited partners take advantage of that.

If you ask randomly to a potential investor into a fund, I would say nine out of 10 would say they want co-investments. But in reality, speaking with the managers, maybe two out of 10 would say they want co-investments. But in reality, speaking with the managers, maybe two out of 10 really do those co-investments because sometimes you need to act really quickly. You don't have perfect information again and just people don't react. So I think it's an advantage, but it's an advantage that not all the limited partners

are actively benefiting from. Let's take a step back for a second. I spoke to Pablo a little bit about why you came up with a fund-to-fund product for the Mexican market. Can you talk to me about that? We've been doing this for quite some time. When you compare LATAM in general and specifically Mexican families, high net worths or family offices, the allocation that they have to venture is very, very small when you compare that to US or European families. And it kind of makes sense because US started venture capital, you've had great stories of success, public companies, unicorns, etc. So people

feel more comfortable on that. When you see the numbers, returns are there. So the big allocators, you know, endowments, pension funds, they tend to put more capital at work in alternatives and venture within those alternatives is taking a larger share every time. That is not necessarily the case in Latam and specifically in Mexican families. And we believe that's an asset class that every sophisticated investor, high net worth individual should have, because in our view is the asset class that best compounds in the long term. You need to do it correctly. It's hard access, selection, diversification. So there are a lot of things that make venture hard, but that's where we launched that because we are true

believers of the asset class. We've done it, we've had success investing in some great funds, not only in the US, but also in other regions in the world. And that's why we believe this is, if not the best, one of the best ways to get access and exposure to venture through a well-diversified, well-thought portfolio, trying to get into the best funds out there that invest early, which we believe is where you should put VC dollars at work. You know, it solves most of the problems that a traditional investor would face. So that's what drives us. That was the motivation behind Asset. And we've been successful so far because when you explain it this way to people that

are either already investing in venture or they want to try venture, it makes a lot of sense. The likelihood of losing capital, it's very, very low. You're not leaving much of the return on the table because you're selecting some of the best niche of funds. So it's a strategy that works for many types of investors and more so in a region where it's a very early beginning of the game. Congratulations, 10x Capital podcast listeners. We have officially cracked the top 10 rankings in the United States for investing.

Please help this podcast continue climbing up in the rankings by clicking the follow button above. This helps our podcast rank higher, which brings more revenue to the show and helps us bring in the very highest quality guests and to produce the very highest quality content. Thank you for your support. How important is it for you to educate your LPs given they're used to cash flowing like real estate and private credit? I think that's 90% of our job when we interact with potential LPs, because some of them have heard about the asset class. Some of them have invested in the past and have had really bad experiences. So we

also want to get rid of that negative halo that some folks have experienced while investing in either only one or two companies or doing only one fund and then not doing that again. So we feel responsible in terms of also educating our investors in, is this the right asset class for you? You need to be aware of the illiquidity of the asset class. You need to be aware of the time horizon. But there's a lot of beauty and a lot of great things in terms of your supporting entrepreneurship, your backing innovation. You know, when you invest with funds that do really early stage investments, you're the first one to see where the innovation is happening. So those type of positives more than outweigh the negatives that the asset class could have in terms of liquidity and the length of the timeframe. So yeah, we need to educate them a lot. We need to set the right expectations also.

As you were saying, most of the first alternative investment for Mexican families would be real estate. And that is cash flowing. If you do it right, you can sell it in a couple of years and you'll get your capital and some profits if you do it right really fast.

So we need to educate them in venture. And also some of the investors that have backed us or our limited partners, they are also strategic owners or directors in companies in the region. And they also want to know what's happening and what the innovation could do to potentially benefit their businesses

or even a potential threat. When we speak with them, we share that they need to be close to what's happening in their industries. And with a fund of funds that, you know, let's put some numbers behind it. We end up having 20 funds that do on average 30 investments. There will be about 600 companies in different sectors that if you are a retail leader in LATAM, you will see some fair share of companies that are doing interesting things in retail and you want to be there. You don't want to be there late, not only in terms of knowing

what, again, could benefit your business, but you don't want to be away from what could become your next big competitor. Yeah. Sometimes the safest place is on the back of the dragon when it comes to technological innovation. Venture capital is known as an access class, meaning that the top funds oftentimes pick the top LPs and top funds oftentimes have a luxury of choices between many different LPs. What are the advantages of taking capital from LPs and LATAM? Tell me a little bit about the region. Tell me about some of the strategic benefits of taking capital from LATAM. Yeah, this plays to our geographic reality. So I would say two things.

The first, we not only invest in US funds. I mean, that's kind of our, we're US centric. And that makes a lot of sense because as I was saying, US is still the most mature VC market, the most liquid. Most of the entrepreneurs want to go there and start the companies or sell into that market. So we definitely have a fair share of US based funds, but we also invest in other regions. And we do that not because we want a specific quota or we want to set a specific percentage of non-U.S. funds.

But we do that because we believe and we've seen there are some great funds in other regions and that will become even greater funds in the future. We want to get into the best funds regardless of where they are based. And going back to your question in terms of why a fund would want Latin American or Mexican capital. For this new fund, we've committed capital to 11 funds. In all of them, we have been the first Mexican investor, and in most cases, the first Latin investor. So the funds that we are working with now, they don't have that reach necessarily. And as I said, we have developed strong connections with our investors. We have strong connections in the region with strategic companies and potential customers for

the portfolio companies of these funds. And I always say that the diligence is both ways. Great funds do very good diligence on their LPs and good LPs will do great diligence on their funds. Because again, it's a really long-term relationship. And capital is, I mean, it's fungible. It's just, it's a commodity. If a fund is in a favorable position of being able to diligence their LPs, what should a fund manager be diligencing

from their prospective LPs? That's a great question. You don't want an LP that is, you know, taking a lot of your time because what we want the GPs to be doing is focusing on helping their companies and finding the new companies that would be investing. A great LP would be taking care of the time of the GPs and when they take time from them being valued at and how they can be evaluated. So in my way, a great LP and specifically for smaller or emerging managers would provide some feedback based on his previous investments, his previous relationship with other funds, best practices, or, you know, I mean, the kind of reporting that you're providing

could be improved. Those feedbacks, when you share them with, I mean, candidly and with, you know, honesty, they're very well received. And that helps GPs. The other is, if you say you want to do co-investments, do it. That's the other thing, because it's a waste of time. And they spend a lot of time sometimes. And also don't spend 30 hours and not do the co-invest. Exactly. Or do a lot of diligence and they say, I mean, yeah, you get the point.

That's another one. The other one I kind of alluded on your previous question is how can you help our portfolio companies? Speaking of value add, you invest in the pre-seed and seed and you're in 11 funds. So you see quite a lot of iterations of this. What are some common forms of value add that you see in the top seed managers provide their portfolio companies? Yeah, I would say, I mean, the basic is they're providing capital and some sort of, you know, knowledge in the space or in the sector that the company is doing. I mean, these are sector specific funds, but even generalists need to provide some value to the companies they're investing. The very best GPs that I've

worked with and I've seen working with founders are, in a way, they become like mentors or coaches to the founders. Entrepreneurship is a really lonely, hard endeavor. The founders are making tough calls, are sometimes losing an important customer or losing an important team member, and they feel lonely. And great GPs, they're not going to tell the founder how to run their company. They're the experts, but they will ask the right questions. They will make the right intros. They will push in a positive way the founders to become the best version of themselves. They act sometimes as, you know, shrinks or psychiatrists, therapists, this human component setting aside the, you know, the business metrics or the team performance or revenues,

whatever. Sometimes a founder, the only thing that needs is a candid, open and honest conversation. I love to be a thought partner. I oftentimes, I start with the assumption that the entrepreneur has the answer in his or her head. He or she just needs to talk about it and needs the right questions to prompt out the right answer, just because they're so in the weeds of their own company. They likely already have the answer or sometimes they just need encouragement. and needs the right questions to prompt out the right answer, just because they're so in the weeds of their own company, they likely already have the answer or sometimes they just need encouragement. I also want to thank Alex Edelson originally for introducing us. What would you like our listeners to know about you,

about Asset Capital, anything else you'd like to shine a light on? A couple of things. I mean, I know a lot of your listeners and viewers are in a way already savvy about venture capital, but we love venture capital. We believe it's the best asset class to invest in. If you have the patience, you understand the liquidity and the time horizon that it entails. We believe that everybody should have a peace in venture. Funds of funds, again, provide this solution for investors that traditionally had not access to VC.

So VC was originally seen only from the well-connected rich people in the US. And that has changed. That is changing again. And that not necessarily means that smaller investors could not access the greater or the greatest funds out there. So encouraging all the listeners to put some capital at work in venture if they have not done so in the past. If they have done so, I also believe you need to be exposed constantly.

This is going to be great vintage, 2024, 2023, 2025 are going to be great vintages. And thank you, David, for the opportunity. Really enjoyed the conversation and looking forward for some more. I enjoyed it as well. And ABD, always the opportunity. Really enjoyed the conversation and looking forward for some more. I enjoyed it as well. And ABD, always be deploying. You know, Venture is an asset class

that has returned more than 20% on average since the 1970s on a compounded basis. You don't want to outsmart yourself and try to pick which years it's going to be 25%, which years it's going to be 15% and just continue to deploy and the asset class will reward you. Fernando, I really appreciate you jumping on the podcast.

I spent a semester during my business school in Mexico City. So I'm itching to go back. So I am inviting myself. So I'd love to sit down in Mexico City. And of course, you're very welcome to come to New York at any time and look forward to continuing conversation. Looking forward, David. We'll host you here and you'll have great food, great company and great time. I would love that. I would love that. Thank you, Fernando. Cheers.

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