Investing Billions - E9: David Clark, Investment Director at VenCap | What Every LP Gets Wrong About Power Laws, Adverse Selection in VC, and What % of Startups Go to Zero?

Starting point is 00:00:00 One of the things we've learned, again, doing this for 30 years is over that time, we've probably backed 110 different managers. And we found that the median return for all of those funds was less than 2x. But there was a small group of managers within those 110 that were consistently able to outperform. David Clark Good afternoon, David Clark of Vencap International, where you've been over 30 years and currently serve as investment director. First of all, I want to congratulate you on the recently massive viral post, sharing your return on over 250 early stage funds and shared by people like Jason Calacanis from All In Podcast and Paul Graham from YC.

Starting point is 00:00:46 Welcome to Limited Partner Podcast. David, thanks very much. It's a pleasure to be here. And I certainly wasn't expecting that sort of reaction when I put those posts up. Well, you're very humble and your reputation precedes you. So good try. But it's great to have you on. And you've been invested in venture capital space for over 30 years. You've seen the rise and fall and sometimes rise again of prolific funds. Let me ask you, can you share five things you've learned

Starting point is 00:01:11 about venture capital over the past 30 years that you wish you knew when you first started? I think the first thing with venture capital is it's such a fascinating industry to spend your career in because it just changes so quickly. So I feel really thankful that I've been able to see the rise and fall of a number of different technologies and industries

Starting point is 00:01:28 and almost have a frugal seat to that. You know, really, when you look at the sort of the main learnings for what we've seen over the 30 years that, you know, that I've been doing this, really it comes down, I think, to two main things. One is the power law nature of venture capital. And the second is the fact that the venture industry is cyclical. And I think everything else kind of falls out of those two key points. You mentioned power laws. We have a drinking game. You have to take a shot every time you

Starting point is 00:01:56 mention power laws on this Limited Partner Podcast. You've actually had exposure to it over 31 years. What are some of the things that surprised you about the power loss? I think it's really just how consistent it is and how much it actually drives performance for venture capital. I think we talk to a number of investors who cover a range of asset classes, particularly those who spend most of their time in, say, private equity. And they're coming from asset classes that have a more normal distribution of returns. And I think when they move into venture capital, there's normally a few kind of key things that they're really surprised by. And it can take the time to kind of adjust to that. And the main one ultimately comes down to the fact that there's just a very small number of companies each year

Starting point is 00:02:38 that eventually drive the bulk of the return that comes from the entire industry. You had a large tweet storm about all the different types of returns. Can you take the listeners through what you found over your data set of tens of thousands of companies? So this is data that is from June last year. So slightly out of date, so 12 months out of date. We're just in the process of updating the data for June 23 numbers. But because a lot of this is actually realized, we don't think the numbers will change materially.

Starting point is 00:03:11 So this is really a breakdown of all the early stage funds that we've invested in at Vencap, starting in 1986 and then putting it off in 2018. Obviously, post-2018 funds are still relatively immature, and we think it can change quite significantly. So we put the cutoff date to 2018. And underpinning this is over 11,000 portfolio companies backed by 259 early stage funds. And I think a couple of things that really jump out of this analysis. The first is that over 50% of companies fail to return capital. And again, if you're coming from a private equity perspective, seeing that sort of loss ratio can

Starting point is 00:03:51 be actually pretty scary. The second thing that really sticks out is only 1%, just over 1% of these companies ended up as fund returners. So that means companies that have returned the entire capital of the fund that backed them. And these fund returners are really the crucial thing in venture. And it's where the bulk of the value actually gets generated from. Let's dive down into the fund returners. You said 1.1%. So out of 11,000, that's, if I'm doing my math correctly, roughly 100 companies. Is there power laws within those 100 or so companies? Yeah, it does vary.

Starting point is 00:04:30 The fund returners that we've seen, I think the most significant fund returner returns something like 27 times the individual fund that backed it. And then obviously, we have a number that are just at the sort of 1x level. It's nice to see the power laws in action, but that's not anything groundbreaking. Let's talk about how you get to those power laws and those fund returners. What have you found is a leading indicator for a manager that has a fund returner? I think this is the key question for anybody that's looking to invest in venture. Because again, one of the other bits of data that we've looked at is when we analyze the

Starting point is 00:05:04 3x net funds, so funds that have delivered 3x net returns back to us, do they have any common characteristics? And one of the things we found is that 90% of the early stage funds have at least one company that returns the entire fund. So finding these fund returners is critical. And there's lots of different ways of trying to do that. You see some people who are doing a lot of seed stage investing, backing emerging managers because they feel that's the best way of doing it. One of the things we've learned, again, doing this for 30 years is over that time, we've probably backed 110 different managers.

Starting point is 00:05:41 And we found that the median return for all of those funds was less than 2x. But there was a small group of managers within those 110 that were consistently able to outperform. And the reason they were doing that was because they were the ones that were consistently able to find these sort of returning companies, these top 1% of exits. And I think that the thing that, again, when we looked at those individual managers, it was that consistency of doing it. And so for us, the biggest predictor of whether a manager has a higher than normal likelihood of finding a fund returner is, have they done it before? It's intuitive that somebody that has had a fund returner is more

Starting point is 00:06:20 likely to do that. But then you're really glossing over fund one, fund twos. And a lot of the guests that we've had on here really focus on emerging managers, smaller funds. There's a lot of empirical data that shows that small funds outperform larger funds, earlier vintages outperform later vintages. How do you reconcile that? Yeah, I think there's also quite a bit of data that says they underperform as well. So what we've seen from our analysis is that if you think about it, the best performers in any vintages are likely to be the small funds that are able to find one of these top 1% companies. I think the challenge

Starting point is 00:06:55 from an LP basis is how predictable is that? And are they the same managers that are able to do that fund after fund after fund? We know when it comes to the established managers that their predictability is relatively high. So for example, we have a portfolio of about a dozen core managers and 90% of all the capital that we've invested since 2010 has gone to just those 12 managers. And what we find when we look at the performance of the funds that we backed from those core managers is that around 50% of their funds are top quarter and less than 10% are bottom quarter. So what they've been able to do is to capture the upside from investing in venture while minimizing a lot of the downside.

Starting point is 00:07:38 And I think when you look at the data for fund ones and fund twos, our emerging managers and small funds, yes, you see more managers at the top end, but you also see a higher proportion of them that underperform as well. The consideration perhaps you have to make as an LP is what's your risk appetite? Do you want to try and find that needle in the haystack knowing that it might be only one in 10 managers that delivers that sort of performance and hope that the upside you get from that manager actually compensates for the poor returns you're likely to get from the rest of the portfolio? Or do you take the approach that we have, which is that actually we'd much rather

Starting point is 00:08:16 have that predictability and consistency of performance. And it might mean there's certain parts of the cycle where we slightly underperform. It might mean that we miss out on the very best funds of any particular vintage. But when you look at it on an aggregate basis, actually the performance we get from those managers is incredibly consistent and significantly outperforms the industry. I know LPs don't like talking about numbers and performance, but I think it's helpful because there's a lot of opinions out there. I'm always keen to sort of understand how those opinions are underpinned by data. And so when we look at our performance from our core manager portfolio, it's in excess of 3.5x.

Starting point is 00:08:54 And that's consistent, you know, whichever time period you kind of cut it over. So I think, you know, for us, what we're doing is still accessing the best performing funds, maybe not the very top percent of that, but we're doing it in a way that massively reduces the risk of investing those underperforming funds. And so on a blended basis, you're actually able to deliver strong and consistent performance to our investors. For some de-risking, you're willing to sacrifice some of the power law, I guess, fund returns where you're getting the 15, 20x on a $5 million fund. I think that resonates a lot with the LP community. Much of the LP community, I like to remind people, are looking to preserve their wealth,

Starting point is 00:09:33 are not always looking to double and triple and quadruple down, especially when you get into future generations. You also seem to imply that there's some survivorship data in the emerging manager data out there. Looking at some of the reports that have been published by the likes of Cambridge, and we also have a good link with Tim Jenkinson from the Oxford Business School, who's obviously produced a number of reports on the VC industry that look at the data from Burgess. And I think when you look at both of those, Cambridge say, yes, there's a higher proportion of emerging managers at those top 10 funds of any vintage yet, but they also make up a higher proportion of the worst performing funds as well. And I think when we look at the Tim

Starting point is 00:10:14 Jenkinson data, what we see there is certainly for fund walls, it's a relatively even distribution on a quartile basis. So around 25% of Fogwalls are top quartile, around 25% are Q2, 25% Q3, 25% Q4. So I think the challenge is whether or not the emerging manager program can ultimately, over the course of an entire cycle, generate the performance that we want to see from the industry. I think one of the challenges is that a lot of investors have only been implementing that strategy for the last five to 10 years, and have been doing it through a long-term bull market. It's a bit like getting advice on how to run a barrister by somebody who's only ever run a 5K. You need to see the entire cycle of how your

Starting point is 00:11:03 strategy performs through that entire cycle as the market goes up, as well as the market corrects. And I think one of the benefits we have is obviously we've been doing this for 30 years and we've seen how those managers perform as the market corrects. In a downturn, everything's correlated, but it's how they come out of those downturns and actually can see that portfolio is really accelerating and create values that I think really distinguishes them. So I do think our strategy will slightly underperform where the market is very hot, but is it going to be your small emerging managers that outperform? I think the big question for me is how do those managers then perform as the market corrects? And we'll probably find that out in the next 12 to 18 months. You certainly earned 30 years of performance, 3.5x. That's phenomenal. I think it's the envy

Starting point is 00:11:50 of everybody, including at the Yale endowment. You focus now on a small core, 40 or so core managers. Let's talk about that. And let's talk about persistence. What is the source of persistence of returns and venture on a manager by manager basis? We have a core portfolio of 12 managers, but those 12 managers will raise multiple funds. So it's about 50 funds across a three-year cycle from those 12 managers. Tim Jenkinson has some interesting work on persistence as well. And one of the things that he comes out with is that persistence in venture capital is real, it exists, and it doesn't

Starting point is 00:12:25 exist for things like private equity. I think if you have a fund that is upper quartile, then the chances of your next fund be upper quartile are significantly higher. I think it's around the 45% chance, but we could share the actual research data with people if they're interested there. And so I think, what that's telling you is persistence is real, certainly for the next fund. There is some data that suggests persistence disappears over time. But what we've seen with

Starting point is 00:12:55 our core managers is that they tend to be able to consistently produce those top volatile firms. And they do that because they're able to reinvent themselves. They're able to bring through new blood into the partnership. One of the key things that we've seen that pushes a top-tier manager down is the fact they don't handle succession well. There are plenty of instances of firms where the senior partners who've been very successful in their own right are creating the space for the newer partners to come through. And if you think about the average age of founders, founders want to relate to VCs that are of a similar generation. And so I think for us, it's really important to see that consistent flow at the GP level that new partners are coming

Starting point is 00:13:39 through and old partners are creating space for them, but aren't disappearing out of the firm itself. I think having experience of corrections, having that DNA within an organization is incredibly important because I think it means you hopefully don't make the mistakes that a lot of newer managers will make. A big turning point is when GPs get their first large carry check

Starting point is 00:14:01 and then you have to, from first principles, decide whether you still want to work with your same partners. And a lot of people are waiting for that large carry check to kind of move on to their life and work with people that they like to work with. In terms of founders, there's a different dynamic because you only really have one liquidity absent of any large secondaries. I think one of the other things on persistence is you have to look at it from first principles basis. Venture capital is not a passive activity. You're not investing in assets that you're not touching. You're not dealing with the founders. I think it ultimately comes down from the founder side, who the top founders want to work with. Hey, we'll continue our interview in a moment

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Starting point is 00:15:24 I've been a happy investor in angelus for many years and i'm so excited to have them as a presenting sponsor so if you're ready to level up your startup or fund with angelist visit www.angelist.com slash tlp that's angelist slash tlp to get started back to the show i've been walking around berkeley last year with a with a gp for one of the funds that we back, and I was wanting to test a thesis with it. And so I was saying, it seems to us there's three or four critical components of being a successful VC.

Starting point is 00:15:52 You have to see the best deals. You have to recognize the best deals when you see them. You have to be able to win them. You have to be able to then work them to make sure that you're creating an outcome that's as large as it possibly can. And then you have to exit and you have to understand how to manage that exit process because a lot of value can be destroyed if you hold on to companies for too long. And I was keen to get his view as to which of those was most important.

Starting point is 00:16:19 And he said, any good VC will see a high proportion of the best deals, and they'll recognize which are the best deals and which are the best founders. The key for him is winning. And what makes the difference is if you can then introduce that particular founder to one of their successful portfolio companies and allow that successful entrepreneur be the reference. And that's the critical thing where he felt that that was what really flipped it. And that's what gave them an unfair advantage.

Starting point is 00:16:52 So it goes back to what we were saying earlier, that in our view, the best way of figuring out which managers are likely to have fund returns in the future or back those top 1% companies in the future is who are the ones that have done it historically because they have that co-op of founders they've backed who are now household names that they can then go to to provide the references when they're looking to get into these hot deals. Let me unpack this from the other side. So if 45% or roughly 45% persist, 55% do not persist. I have a couple of theories on that, being both a founder and then a VC and LP as well. And one of those is people are corrupted by management fees. They stop focusing on alpha and start focusing on asset management. Two is, as I mentioned,

Starting point is 00:17:37 the carry checks. They get a large carry check and they don't have a true north. That's when you learn. I used to think, why do people care about founder passion? Founder passion is what takes a $100 million company and takes it to $10 billion. If every venture returner is looking for the fund returners, and you mentioned 90% of funds that return a 3x have at least one fund returner. Another way of saying, if you want to have a 3x fund, you need to have a fund returner in 90% of cases. And I think same thing with VCs. You need to back VCs that actually are in it for the love of the game, that aren't just there to make money. We're all here to make money.

Starting point is 00:18:09 There's no judgment there. But we need people that care about more than just making money. I think those are the ones that persist. And the other things that I note is aging out of networks. You have a lot of founders. David Sachs famously had an incredible portfolio early on from just backing his friends, and now he continues to do really well with Kraft. But in the early stages, he was just backing his friends, which is a really good way to de-risk investments. And I think other people that are not like David Sachs and do not scale up end up aging out of their networks, especially if they're not consciously aware of it. So that's my thesis. What do you think about that? I think it's an interesting one. I think, again, we've seen some academic research

Starting point is 00:18:48 that suggests the first time you back that top 1% company is actually pretty random. It's very difficult to predict who's going to be able to do that in advance. And so from an LP's perspective, it makes our job pretty challenging. But once you back that, the likelihood of you then being able to leverage that skillset becomes a lot higher. But I think the points you make are absolutely right, that you need to do it within a fund structure that allows that next company to have a disproportionate impact on the overall return. And so if you're suddenly going from a $50 million fund to a $250 million fund to a $500 million fund to a billion dollar funds, then it's a totally different game. What worked for you at $50 million isn't going to work

Starting point is 00:19:30 for you at a billion dollars. And so I think from a GP perspective, I think you have to find the part of the market in which you continue to be comfortable. You look at the likes of First Round and Union Square that have kept their fund sizes relatively modest despite huge success. And I think there's huge credit to the GPs at those organizations who are willing to do that. Having said that, I do think that venture capital as an industry can scale to some extent. When I started in this business, it was funding a few companies coming out of Silicon Valley, maybe some healthcare companies at Boston, and the outcomes were a couple of hundred million dollars. That was a good outcome back in the mid-90s. Today, I think you'll see companies

Starting point is 00:20:17 that are capable of scaling to tens, if not hundreds, of billions of dollars. I think one of the things that power law does tell us is that we tend to underestimate the impact of the best companies and how large they can get. Part of that is dependent on the market environment that they're reaching out into. But again, I was having a conversation with a fellow LP yesterday. And his point was that these bull markets are not a book, they're a feature adventure, just as corrections aren't a book, they're a feature adventure. So I think, you know, you do have to expect the outcomes, the very best outcomes will surpass most people's expectations.

Starting point is 00:20:57 And so, you know, optimizing for those managers that are able to back that just becomes so important. There's been several studies that show that if you miss the last three years of a bull market, in many ways, you could miss the entire returns of the bull market. So even when things are getting overheated, there's a rational decision to stay in the market or at least not to liquidate. One thing that I think we should double click on is you mentioned fund returner. People get that confused with unicorn. Unicorn is not a metric and investing at $75 million and getting diluted 3x and getting a unicorn is not what you're looking for. You're looking for fund returner, which is a combination of exit value times

Starting point is 00:21:36 ownership. What are your views on ownership? It very much depends on where you're investing and the size of your funds and how many companies you want to have in your portfolio. I think the earlier you go, the more sense it makes to have a more diversified portfolio as you start to get more towards the later stage of growth there, then I think the more concentrated portfolios work. I don't think there's a magic number for what that ownership percentage has to look like. The way that we look at it is to kind of work back from fund size, exit size, and ownership. And what do we have to believe for those three things to come into alignment in order to generate fund returns? And essentially, we'll go back and look at what are the historic exits from that particular manager. If we have

Starting point is 00:22:24 to assume that they need a $10 billion exit in order to be a generative fund returner, if their most successful exit ever has only been $100 million or a billion dollars, then it's a real leap of faith. But if we see multiple exits from them at that range, then we get greater conviction that they could do that again. Similarly, when we look at ownership percentages, we want to find how much of those businesses they're owning at exit and look to see, okay, if we apply a similar metric going forward, what does that then mean for the fund size that they need to be investing out of? And what does that mean for the exit size of the individual companies? One of the consistent things that every smart investor that I've ever talked to

Starting point is 00:23:05 in the space talks about ownership targets, how it's so important to be able to have significant ownership targets. The math is a little bit confusing to that. Could you explain why ownership is so important? In other words, why is it so important to have 20 companies that have 5% versus 40 that have 2.5%? Why does it not add up in that way? Yeah, again, it comes back down to the power law nature of venture capital and the fact that power law returns aren't equally distributed. If you have exposure to 10% of the market, it doesn't necessarily follow that you're going to have exposure to 10% of the fund returners or the 1% companies there. What you have to do is to make sure that when you get one of those companies in your portfolio, you own enough of it to ensure that it moves the needle at the fund

Starting point is 00:23:50 level. Now, that number might be very different depending on whether you're a seed investor, whether you're an A round investor or B round investor, also the size of your fund. As a general rule, we tend to invest in managers who are most active at the A and B level. We have a few seed funds there and some growth funds. But typically, when we're talking about early stage investments, we're talking about A's and B rounds. And what we would typically tend to see is ownerships that are in the low to mid teens on that first check.

Starting point is 00:24:23 And then they may get slightly diluted over time to perhaps high single digits. Having 8% to 10% of one of these companies as they do exit is incredibly powerful. Obviously, it depends on the individual company, because if you own 8% to 10% of ByteDance, then you're in a really good position. But owning 1% of ByteDance could be a good returner for most funds. We talked off-camera about adverse selection. You say, if people are getting the full market, I think that's an enormous assumption. I think the vast majority of venture capital firms are highly adversely selected, and the vast majority of LPs are highly adversely selected, to the degree that I think would shock people. Let's talk about adverse

Starting point is 00:25:05 selection. How do you as an LP avoid adverse selection? And how do other LPs that may not have the same access as you do, how can they avoid adverse selection? It's a really challenging topic. One of the difficult things I think, going back to what have I learned from Duke's 30 years adventure, the diligence that we do as LPs is great for helping to identify who are likely to be the bottom 25% of phone managers. Because there's lots of rookie mistakes that people make. There's lots of pretty straightforward things that allow you to rule managers out relatively quickly. What I don't think LP diligence is great at is predicting who's going to be in that top 25%, because I think a lot of the things that LPs will traditionally look at

Starting point is 00:25:53 tend to be necessary conditions of success, but not sufficient. And we've seen multiple managers who've been able to tick the box on all of the things that LPs typically talk about wanting to see. But then when it came to, am I going to choose company A or company B, they chose company B. And company B ended up being the second or third best company in that particular segment. And company A was the very best one. And the outcomes for the particular fund are just so dramatically different. And so I think with venture, there is such a high level of randomness in choosing that one individual company that actually the level of diligence or the predictability from an LP perspective of doing diligence on managers is really tough. I'd be really interested to see if anybody has a data set out there that shows that they can

Starting point is 00:26:43 consistently predict which are going to be the successful managers at funds one and fund two. Because we've tried to do that and we can't. I think on the emerging managers, it is very random as a former emerging manager, as a VC. You mentioned something really interesting, which is all the data comes until you have the first fund returner. And let me try to shine a light on that. One of the reasons fund returners are predictive of other fund returners is because you start to see the level of quality. To use a crude analogy, once you have a really great girlfriend, you're not going to go below that quality. You understand what is greatness. Once

Starting point is 00:27:18 you have a really great friend, you're not going to come up with a second tier. So yes, there's randomness. One thing that I remember from Naval Ravikant, he said, I had a bunch of really talented friends, and all of them became successful over 15 years. You know, one company might have failed, one might have succeeded, it was hard to predict the individual company, but it was very easy to predict the individual. And I found that in my career, I started in 2008, I found that to be very true as well. Incredibly predictive way that you know, all the data in the world would not be able to predict. So that's my personal, that's my highly unscientific opinion.

Starting point is 00:27:50 But I think there's something about seeing what is a top entrepreneur. We're an investor in Scott Painter for the autonomy. That's one of the top entrepreneurs. That guy has taken companies public, but you see it, you know it. We're an investor in Joey Levy from Better. These are entrepreneurs, are world-class entrepreneurs. And I'd love for anybody else to say anything else. So whether this company will be $10 billion, time will tell. But whether they have that in them, I think is highly predictive. There's pattern recognition there at the founder level. And I think there's also pattern recognition that develops at the GP level. You have to be a little bit careful with that pattern recognition that you're not GP level. You have to be a little bit careful with that

Starting point is 00:28:25 pattern recognition that you're not ruling out people that are coming from different backgrounds, because I think that's one of the challenges that we do have as an industry. And it can be very easy to say, all my great deals are white guys who went to Harvard, so I'm only ever going to do companies that are run by white guys who went to Harvard. I think as an industry, we need to find ways of trying to look beyond that a little bit more. But it's really difficult because, as you say, pattern recognition is a real thing. Sometimes being able to see beyond that and take a chance on some other things is going to be a challenge. Absolutely. 100%. One program that I think has done incredibly well in this pattern recognition, that's race and sex blind, has been the Teal Fellowship. The amount of success that's coming out there in terms of track records and everything, but the amount of diversity in that program and the amount of success at an early age. I think the oldest Teal Fellow is 31 years old. It just is mind-blowing to me how well that program has both been diverse and also high performing. Let's switch to a topic I don't think I've ever heard talked on a podcast,

Starting point is 00:29:31 follow on. You focus on series A, series B, there's also pre-seed and seed. First question is, what is a good amount of follow on that a fund should reserve? Let's call it at the pre-seed seed and maybe you can break it down by stage. There's no one answer that sort of fits there. You can't be doing VC by the kind of road that says, if you're a seeded manager, you need to reserve X percent for each company. I think it's part of the skills of recognizing when you have one of those top 1% companies. And it's interesting, when we look at our core managers, how does that portfolio break down by number of companies, less than 1x, 3 to 5x, 5x plus? And how does it break down by the capital that they invest? What we have seen is that they invest less capital into their less than 1x companies than

Starting point is 00:30:18 the percentage would be for the number of companies that are in that category. And they're able to funnel a higher percentage of that capital into the 10X and funnel returning companies. So I think being able to recognize when you've got one of those high potential companies and being able to lay a capital in is very important from the upside. But there's also a downside protection point to this as well, which is something that, again, I don't know how many managers have faced this issue, certainly not over the last 10 years. But when I look back to 2009, 2010, and also 2000, 2001, we were seeing pay-to-play rounds. We were seeing funds that didn't have any follow-up capital left, who weren't able to do their pro rata in the next round, getting converted to common and essentially washed out

Starting point is 00:31:11 to zero. And so from a defensive perspective, having some capital to make sure that you're able to back your best companies during the most difficult times and help them survive, but also to make sure that you're preserving your ownership there. And we've seen with some of our best managers over the last 12 months, actually leading it quite aggressively to some of their portfolio companies, because they recognize it's an opportunity to actually increase their ownership at a part of the market where people are hesitant to put capital to work. I think that's one of the reasons why we've tended to see our core managers outperform as the market

Starting point is 00:31:50 starts to recover, because they've done all those things through that downturn. They've made sure their best company, they've got the capital to make sure their best company survive, and they've been able to lean into those companies aggressively on a very selective base. Being both defensive and offensive in nature, I think the arbitrage between the headline and the reality is a persistent financial return in every sector. In terms of follow-on, I do want to give our listeners very specific and granular data on that. When you have a Series A fund that comes to you, what is the range?

Starting point is 00:32:22 What is the 80% range that you'd like to see reserved for follow on? Let's give a specific number. We don't want to be too prescriptive here. We're not going to say to a manager, this is what you should be doing. This is what we don't want to see you doing. I think our view of how you do venture best is to pick the manager and trust them. Trust them to play the game on the steals. Don't try and second guess. There's a reason that I'm an LP and I'm not a GP, is because I can't do that job. What I could do is I can both elite select managers at a level that's slightly better than the market. But what I wouldn't profess to be able to do is to then tell those managers how they

Starting point is 00:33:00 should be managing their fund. And so for that reason, we're pretty agnostic when it comes to sectors, when it comes to geographies. We're not going to do sector specific funds because I think by the time it becomes obvious to an LP which sectors are hot, the best companies are probably already being as well established, well funded, well on the road to success, and you're there playing catch up. So I think for us, it's really a case of trusting our managers to play that game on the field. And obviously, we hold them to account. We want to understand why they're doing things they did.

Starting point is 00:33:33 A number of our managers would have invested quite aggressively through 2020, 2021. And we like to see three-year fund cycles. So we'd have that conversation. One of the lessons we learned in 1999, 2000 is that time diversity is really important. So for our own firms, we want to make sure that we put those to work over a three-year period. And we like to see our managers do that. And we'll press them as to why, if they're running at a faster pace, why that's the case. But we're not going to say, oh, you're a manager who has a two-year investment cycle. We like a three-year one. Therefore, we're not going to invest in you. Ultimately, it comes down to, can you be successful with the strategy that you choose to implement?

Starting point is 00:34:12 You have guiding principles, but you're not dogmatic. Is your fund cycle then three-year per vintage on a typical basis? We had a fund that we raised at 99 that was invested in 18 months, and it was the worst performing fund that we've ever raised. And so I think one of the key learnings for us there is that we actually want to have three-year investment periods for our funds, which is challenging at times. Because you look at the funds, our fund that was investing through 1990, 2021, maintaining a three-year investment period there was a real stretch because our

Starting point is 00:34:46 core managers were coming back just like every other manager. They were coming back to the market in 24 months, 18 months, raising larger funds as well. And so we actually, during that time, we cut the number of active relationships that we had because we wanted to manage through that three-year investment cycle. And so in a way, it's interesting when I hear people talk about wanting to reduce the number of managers that they back today. Actually, the time we should have been doing that was two or three years ago when the market was at its height. So you were controlling the amount of capital that was going into the top

Starting point is 00:35:18 of the market. Our sense today is that actually, there's an opportunity to play offense. We've got for playing defense for the last three or four years to really now starting to lead in, looking to try and increase our allocations with our managers where we can, and even perhaps looking to see if we can add one or two new managers to our portfolio. Because it feels like these are the sort of vintage years where you do see the very best performance. We saw it back in 2009, 10, 11, after the financial crisis. We were able to add a couple of new relationships there and those relationships have done exceptionally well. So I think trying to be slightly counter cyclical, we talked about VC being a cyclical asset class, but trying to kind of support move against the

Starting point is 00:36:03 herd is something we have tried to do. And definitely something that in this sort of environment where it is a lot tougher for managers to raise capital, we think it's an opportunity for the best managers to really start to differentiate themselves. For us, it was almost impossible to figure out who's just been capturing beta over the last five years, if you'd actually be generating real output, we think the next four or five years, you know, we'll get a much better sense as to who's been doing what. We'll be able to really gauge skill and talent in more tougher environments. Everybody knows about the VC reset, a term that I've tried to coin as the LP reset. And the reason for that is there's an opportunity right now for maybe LPs that, unlike you, have been investing for 30 years in top managers, didn't have access to these managers. And now's the time to act. Now's not the time to be on the sideline. Now's the time to be bold.

Starting point is 00:36:55 A famous Warren Buffett quote, be fearful when others are greedy and greedy when others are fearful. You mentioned new managers and playing offense. In terms of the next 10 years, there's different theses out there. There's a thesis that there's going to be a disintermediation of capital or that there's going to be, in the last couple of years, there's been thousands and thousands of emerging managers. Do you see where on the pendulum of 15 funds being out there and 3,000 funds, where do you see will pan out in the next 10 years? And as a side on that, what do you think about spin-offs from traditional top quartile managers? Just in terms of the number of active VCs, it's felt to us that even though the industry is

Starting point is 00:37:37 growing and the outcomes are growing and the fact that technology is now applying to every individual sector and industry. So the market opportunity for VC-backed companies has just exploded. It still feels that the amount of capital and the amount of managers out there is unsustainably high. And so my sense is that we will see a contraction in those managers over the next, in terms of raising new funds, I guess it'll be the next kind of 12, 24, 36 months. But it takes a long time for a venture fund to wind up. You know, I think certainly for seed or early stage funds, you're looking at 20 years for

Starting point is 00:38:10 a lot of those funds to be fully done. So I think it'll take time for those managers to finally disappear. But in terms of active managers in there, I think we'll see quite a significant contraction. I think part of it will be a lifestyle challenge. You know, It's great when you're a manager and things are going well, and you talk about David Sachs, you're giving checks to your friends and you're everyone's favorite person. When you're telling your friend that you're not going to give them another check and they've got to cut 50% of their company,

Starting point is 00:38:39 it's a very different relationship. And so I think we'll see some VCs that came into the industry figure out that it's actually not what they want to do long-term because VC is really hard and it takes a lot of work. And there's a lot of periods where it looks like things are going to hell and back. And so I think that will partly be a driver. I also think LPs came into the VC industry with unrealistic expectations of performance and an unrealistic understanding of what's reasonable to expect, both in terms of ultimate returns, but how those returns are distributed and how long it takes to get there. We will probably see sub-LPs pull back because venture is delivering what they expected. I also think sub-LPs will be faced with some

Starting point is 00:39:23 liquidity issues. Nothing's gone public for the last 18 months. There's no real liquidity coming through. A lot of investors need to have that liquidity to come through in order to fund future commitments. So I think that's partly going to be a driver of it as well. And then the second bit around spinouts, it's an interesting area. We've had mixed results when we've looked at spin-outs. So we've got one that was particularly successful. We've got a couple that were not successful at all. I think you have to kind of, again, understand why are those managers leaving that firm? Are they leaving a firm that's vibrant and continues to be one of the top firms? If that's the case, then are you actually getting the full story for why they're leaving? Are they jumping or have they been pushed? If you've got younger

Starting point is 00:40:10 partners who are leaving a firm because the older partners aren't getting out of the way, creating space for them, then I think that's something that looks a little bit more interesting. We mentioned previously something like Kleiner Perkins. You look at Mahmoud leaving social and going to Kleiner Perkins and taking Ilya Fushman with him from index. Something like that looks really interesting. Mahmoud was moving from social because he felt there was a real opportunity to do something with Kleiner Perkins. So I think you have to know the individuals, you have to know the dynamics of the old firm, and you have to know the dynamics of the new firm.

Starting point is 00:40:44 Share some secret sauce. How are ways that you read between the lines and diligence that whether the spin out is a top person or not? Have they backed a fund return before? It all comes back to this. We can take references from founders they've worked with. Unless the person is terrible, you're not going to get a bad founder reference. But ultimately, one of the challenges we have is trying to handicap the quality of that founder. Is that a top 1% founder who's giving us that reference? Or where do they lie on the distribution of founders? So founder references tend to, again, allow you to weed out those people you don't want to back. Certainly in our experience, it's been very difficult to use them as a predictor for who's ultimately going to be that long-term successful manager.

Starting point is 00:41:30 Where we've tried that, it just hasn't worked for us. Again, it may be that we're based in the UK, we're not plugged in socially to the Silicon Valley VC network. It may be that our signal isn't as strong as some people who live and breathe that. I absolutely accept that. But actually the signal that is the strongest is when you look at someone like Mahmoud, who did he back at Social? He has that patent recognition because he's backed a couple of those top 1% companies. He has the founder network. And then you're backing on someone like him to be able to go and replicate that at a new firm with a new set of partners.

Starting point is 00:42:09 For us, the odds are reasonably high that once you've been in that situation once, then you can do the game. You don't want the media in a reference either. If you look at the two most difficult managers and managers that many people hate to work before, it was Steve Jobs and Elon Musk. It also happens to be the two most people that people people hate to work before. It was Steve Jobs and Elon Musk. It also happens to be the two most people that people praise as being great managers. And the takeaway there is that the top people want to be pushed. They want somebody that makes them uncomfortable. They want somebody that makes them work 100 hours a week. In society,

Starting point is 00:42:38 it's not very politically correct to talk about and people criticize hustle culture. But in venture capital, we're not trying to back the average millennium or Gen Z entrepreneur, we're trying to back the fund returners, the next Elon Musk, the next Steve Jobs. I can't let you get away from the podcast without talking on market on GP terms. We had several GPs talk about what they're seeing from management fees and what they're seeing from tiered carry structures. Are you seeing 50% to 75% of your fund managers still charging tiered carry structures? And what are your philosophical thoughts on that? We're investing in established managers that are the kind of household names, and they will all have premium terms. Some of them would

Starting point is 00:43:20 be a flat 30% carry from the outset. Some would start at two and a half X wrapping. There's a variety. For us, in a way, what it comes back to is what do we think the net net return back to us is going to be? And so if you could justify a 30% carry because your returns historically allow you to charge that, we have no issue paying that. One of the worst things you could do as an LP is to turn somebody down because of the terms of their fund. Because ultimately, the whole power industry means that if they are successful, the success is going to be worth the fees of carry that they charge. So clearly, we'd rather they took less fee, charge less carry. But we recognize that actually the demand for those managers is so high in a lot of instances that they're potentially undercharging what the market clear price might be. And that's why they're oversubscribed.

Starting point is 00:44:11 10 times oversubscribed, you could say that they're underpricing their product. One thing that makes LP's reluctance to pay premium carry even more foolish is when it's on a hurdle. You return a 3x, 4x, 5x over that, you get a premium carry. I think that's kind of a foolishness not to be willing to pay that to the top managers, managers that have earned that right over their careers. From a philosophical perspective, we have no issues paid for exceptional performance. I think we just want to see as much alignment as possible in those terms.

Starting point is 00:44:40 But clearly, with some of the very best managers, your ability to negotiate is zero. So you're price takers. And then it adds to, you know, do you think the performance that you're expecting from these managers is ultimately worth it? And it comes down to self-awareness at that point, and understanding the dynamics of the situation. David, you've been an incredible guest. You've allowed us to really dig into your incredible tweet storm. It's not a coincidence that so many people shared it. And not only so many people, but the most important people and the smartest people in the industry. So you've been really generous with your time.

Starting point is 00:45:14 What would you like our listeners to know about you and your firm? Venkat, we've been doing this for 30 years. It's all we do. We're not the most well-known funder funds out there. We're not the largest funder funds out there. We're not the largest funder funds out there because we're very focused on trying to build a portfolio that really optimizes for performance. And we've done it in a way that we think works for us. Thank you, David.

Starting point is 00:45:36 Your reputation precedes you. A lot of the really the top DeSalle GPs have told me about you and the way that you've done business. And of course, the tweet storm kind of was your coming out party in terms of the performance. But certainly that's 30 years of incredible performance. Thank you for being a supporter of the industry. And thank you for coming on the podcast. I appreciate those kind words, David. Thanks very much. I've really enjoyed it. Thanks for listening to Limited Partner Podcast. If you like this conversation,

Starting point is 00:46:01 please like, subscribe and review on YouTube, Spotify or Apple. Thank you for your support.

Investing Billions - E9: David Clark, Investment Director at VenCap | What Every LP Gets Wrong About Power Laws, Adverse Selection in VC, and What % of Startups Go to Zero?

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