This Week in Startups - Unlocking the Power of Data with VenCap’s David Clark | E1906

Starting point is 00:00:00 Look at the best managers and they're the ones who are able to recognize when they do have one of those top 1% companies, when they've captured that magic and they have the confidence to let that run. And I think it's something that really distinguishes the very best managers from, again, the rest of the pack that they understand when to take money off the table. They also understand when to let things run. And ultimately, if you are going to get those fund returning outcomes, you know, you might only have one of those in a portfolio of 50 companies. If you sell it too early, then you've missed your opportunity there. And almost I would look at that as a bigger sin than perhaps not investing in it in the first place.

Starting point is 00:00:44 This week in startups is brought to you by Gusto is easy online payroll, benefits, and HR built for modern small businesses. Get three months free when you run your first payroll at gusto.com slash twist. Northwest Registered Agent will form your company fast, give you the documents you need to open a business bank account, and more. Visit Northwest Registeredagent.com slash twist to get a 60% discount on your next LLC. And Wizard. Struggling to transform innovative ideas into concrete product designs? Wizard can help you turn your visions into polished UI designs and affirmation.

Starting point is 00:01:23 fraction of the time while enhancing collaboration across your entire team. Get 25% off Wizard Pro for an entire year at wizard.io slash twist. That's U-I-Z-A-R-D.I-O slash Twist. All right, everybody, welcome back to the podcast. We've got a great episode for you today. Because we have with us today, somebody who's been investing in venture funds for three decades, his name is David Clark. He is the chief investment officer at VenCab.

Starting point is 00:01:52 They're a UK-based fund of funds and investment advisor. If you're deep in the industry, you probably remember David went viral on Twitter, now X, when he broke down returns from 32 years of investments at Vencap. This was obviously to somebody like myself, who is a student of the game of capital allocation and trying to get better at what I do every day, just absolutely the content I'm here for. And so, David, welcome to the show. Thanks a lot, Jason. I've been listening a lot to the podcast that you put out and super excited to finally be on one.

Starting point is 00:02:27 Thank you. Well, as you can tell for my voice, I do a lot of podcasts. And today I've got my raspy voice. So I'm kind of like Bob Dylan in the later decades here. I just want to get started recapping the tweet Storm. And your firm, Vencap, just so I make sure I level set with the audience, founded in 1987, you've made around 500 fund investments. So you have a certain number of managers and you obviously invested in them across many funds.

Starting point is 00:02:55 Yep. Yep, correct. And just to be clear, we probably started with a very generalist approach to venture. So over time, we've backed something like 110 different managers. Over the last 10 to 15 years, we've really concentrated those down into sort of 12 to 15 groups. And it's those 12 to 15 groups that we've been active with for the last decade or so. Yeah. And concentrating in on those managers, you do that. Why? Because I've heard some people say, hey, you need to have a certain number. of managers in order to, you know, hit certain goals. Are you, is the goal here to hit the beta plus chance of alpha or just really go for that alpha across venture capital? Yeah, I think the whole conversation around alpha versus beta and venture is an interesting one because I think the beta in venture is if you look at that as the median return, you know, the average median return using the Cambridge data is about 10% IRA. And so nobody is in venture for the beta. You're only in it

Starting point is 00:03:53 for the alpha. And for me, the alpha actually means the upper quartile return. But it's because of the power loan nature of venture, what we found is that actually the upper quartile is very similar to the actual pooled return for venture overall. So again, if you look at the average upper quartile boundary from the Cambridge data since 2000 or so, it's about 18%. And so what we try and do is to hit that upper quartile as often as we can and get as many funds that we invest in, really over that upper quartile boundary. The challenge in venture is that it's really hard, and you know this, Jason, you've been doing this for a long time.

Starting point is 00:04:33 And I think people who have come into the industry more recently have been perhaps a little less aware of that because the market's been going up and there's been a strong tailwind and everybody's been doing really well. But I think the next couple of years are going to be really challenging in the venture industry. And so the reason we concentrated down is when we looked across, all the 110 managers we backed, we found the majority of those managers were only generating a median return. And there was only a handful of managers that were actually able to consistently produce up a quartile funds. And we can go into how they do that and why they do that

Starting point is 00:05:10 and what the power load dynamic looks like, but happy to take that wherever it makes sense. Yeah, I mean, let's go right to that. What distinguishes people who have not just longevity, because my perception now going into my second decade is if you build a good enough brand, there's enough people who want access to this category that if they do get the 10% with the optionality of maybe doing a little better, let's face it, there are some LPs who would be comfortable with that as part of a blended portfolio. It's kind of like I'm going to get above average returns with some optionality.

Starting point is 00:05:44 Now, if you're really trying to sharpen the knife and get into that upper quartile and hit that 18% constantly, oof, it's really hard. So let's talk about what those funds or those managers or those brands do that makes it notable or in your estimation worthy of being in your, I think you said your top 12. Yeah. Yeah. Yeah. Yeah. Yeah.

Starting point is 00:06:04 Let me tell you what they don't do first of all. Oh, I like it. What they don't do is really have any lower loss ratio than the rest of the market. So this is not about minimizing your losses. So when we look across all our portfolios for an early stage fund, somewhere between 50 to 60% of deals don't return capital. And obviously it varies a little bit by vintage air in the most challenging vintage years. That can be up at 70. In the best vintage years, it can be just below 50, but it's average in that sort of 50 to 60 mark.

Starting point is 00:06:40 And even the best managers are kind of consistently around there. So venture is not about minimizing risk. This is not private equity. If we were having a conversation about private equity, we'd be having a very different conversation. Venture, as we know, as a power law industry. And so the power law really applies to what percent of companies ultimately generate the bulk of the value for the industry.

Starting point is 00:07:04 And when we look at the exit data, what we found is that it's about 30 exits a year that ultimately account for more than half of the total exit value produced by all venture-backed companies globally. So we're talking the top 1% of exits. And as a percentage of the total number of companies backed, it's probably going to be smaller than that because obviously we know a lot of companies ultimately don't exit.

Starting point is 00:07:32 So we're talking about how do you consistently get access to those top 30 companies each year that drive the bulk of the performance that comes through to the venture industry. And what we found when we look at who are the, investors in there is that there's a relatively concentrated group of managers who can consistently do that. And it's no surprise who they are. It's Sapsel, it's Sequoia, it's Andresen Horowitz, it's Klein at Perkins. It's the managers that most people would be able to name if you ask them, you know, who would you say are the best performing managers, the franchise names out there.

Starting point is 00:08:07 And so, you know, when we look at the data, it's very clear to us, if we want to consistently capture that upper quartile return, the best way for us to do it. And I'm not saying this works for everyone. Other people will have different strengths and different approaches to the market. But certainly for us, the best way to do it is to try and optimize for those managers that are consistently able to back the top 1% companies. And we've been doing it for 15 years, and it works. Okay. So for your terrific 12, I'm going to call your fund managers who are made into that at least. The terrific 12. The terrific 12. I'm going to call your fund managers who were made into that The terrific 12 is yours.

Starting point is 00:08:43 Yeah, it's one of my things, branding. Or just concisiness. In that terrific 12, what you've learned is they have the same amount of losses. They strike out, they miss their shots just like anybody else. Six of 10 startups return zero. Big donut, they flame out. Not zero. Don't return capital.

Starting point is 00:09:02 Don't return capital. About half of those probably end up at a zero. Okay. So they don't return capital, but it's really about. the very small number of outlier exits. So when you look back, you've had how many companies across the history of the fund and then how many companies, I think you actually did a chart here, which we could pull up, how many companies would fall into that power law designation?

Starting point is 00:09:27 Yeah, so the data that we used has just under 12,000 companies. Wow. And 113 of them are fund returners, so just over 1%. So again, let's define a fund returner for the audience. Yeah. So a fund returner is a single company investment in a fund that returns the entire committed capital of that particular fund. So if you were typically an early stage fund might invest in 30, 40, 50 companies, so it's one company that returns the entire capital of that fund. And very often that company will do it multiple times over. So it doesn't just return one extra fund. It can return five, ten, fifteen extra fund.

Starting point is 00:10:11 And so it's optimizing for those types of companies. And there's a few things that also kind of play into that relationship. It's what's the size of the exit? It's what's the size of the fund that's backed it? And it's how much does that fund own of that company at the time of exit? And those three things have to be in balance in order to get the fund returning outcomes we're looking for. Listen, I know myself as a founder. There are things that I love doing. I love building products. I love hiring people.

Starting point is 00:10:41 And there are things I hate. Payroll, HR. So I use Gusto. Gusto is the best. Gusto's payroll in HR services make running a small business much easier because it was specifically designed for you, the small business owner. And payroll is something you definitely do not want to mess up. Oh, and I know it.

Starting point is 00:10:57 Gusto will automatically calculate your paychecks, do your payroll taxes, set up open enrollment, and that's not all. Gusto also handles onboarding, health insurance, the 401k, time tracking, commuter benefits, hey, people going back to work, offer letters, you want to get those right, and they even give you access to their HR experts. Gusto will let you focus on the most important stuff in your business, like getting product market fit or bear-hugging your customers and making sure they're happy. It's super easy to set up and get started, and if you're moving from another provider, or Gusto can transfer all your data for you easy, peasy, lemon, squeezy folks.

Starting point is 00:11:31 So here's the best part, because you're a twist listener, you get three months free. Yes, that's right, not one, not two. Three, free months. All you have to do is go to gusto.com slash twist, g-ushto.com slash twist. You must go to Gusto. Again, that's gusto.com slash twist. And so when we look at this chart, we see the 53% return under what was invested in them, get 27% that will return the money invested in them, or maybe up to 3x.

Starting point is 00:11:55 but as you said, a fund might have 30 companies in it, which means each company represents 3% of the capital or so if you're just doing back of the envelope math. And so these are truly meaningless in terms of venture capital. So you have a full 80% here, almost, yeah, exactly, 80.3% that are just not moving the needle for that fund. Yeah, exactly. And then everything, 3x, you know, 5x, 10x, 10x plus or fund returners, and that's where you start to see the returns and why venture is so special, which then leads me to believe that there are

Starting point is 00:12:32 factors that determine these outcomes. And I just want to run them by you. These would be theories because you do need to make a decision as an LP when you bet on GPs and as a GP when you're betting on companies to have what we would call a portfolio strategy. Yeah. Each fund has to have a portfolio strategy. So if only 1% are fund returners and you do 30 names, how hard? is it to get a fund returner? And does that not argue for maybe more names in a fund than we've seen historically? So maybe you could argue on one extreme spray and prey, on the other concentration, and how you think about in a portfolio construction, what's the right number of names? And when people hear me say, the number of names in a portfolio, you might hear other

Starting point is 00:13:15 people say logos. It means the names are the logos of the startups. Yeah, I think it very much depends on the stage at which you're investing. So if you're a proceed fund, then because the loss ratio looks different and the attrition rate is different, you need more names. And it also means you can afford to have more names because the delta between your entry value and the exit value is so much larger that it's easier in a way to get that fund return if you do have one company that ultimately takes off and is incredibly successful. As you start to get later as an investing fund, then you do need to be more concentrated your portfolio because ultimately the multiple you will get on any individual deal will begin to

Starting point is 00:14:01 come down. And so what we've tended to find for early stage funds, and we would classify early stage funds as kind of series A and maybe sort of early Bs, for those early stage funds, a portfolio of around 30-ish names is about the right size. And you're looking at maybe sort of ideally probably 10 to 15% ownership at the time of exit, which means that most of those early stage funds that we would be backing would today be somewhere in the region of 400 to, let's call it, 800 million dollars. And so this is where the fund size versus exit size versus ownership relationship is really important. Because if you have a manager that's only ever been able to return $500 million in a single deal and is raising a billion dollar fund,

Starting point is 00:14:56 then the confidence level that they're going to be able to produce a fund returning outcome is very different to a manager that's raising a $500 million fund and has had multiple billion dollar single company returners. So I think it's being able to sort of handicap the ability of the manager to deliver those fund returning outcomes. And what is it that you have to believe in order to get comfortable that they can continue to do that going forward. Yeah. And so when you are investing in that series A to series B, 50 million to $200 million evaluations in 2024 terms, I think we would both agree, in order to get that 10% ownership, which is kind of a goal, right, maybe even 15% if you're able to do it, to get that

Starting point is 00:15:41 10 to 15 in a company that has a 50 million dollar post or 100 or 200 million dollar post, you're going to have to write, you know, somewhere between a five and a $20 million check. If you're doing 30 of those, you can just times, you know, 30 times 10 or 30, yeah, 10 million or 30 times 15 million might be even a more reasonable number. You get to for a little bit of follow-ons as well. So you want to reserve capital for, you know, for your best companies to do the next round, maybe. Yeah. And I don't know if you saw the Brian Singerman episode we just had recently from Founders Fund. Or are you an LPN Founders Fund by chance?

Starting point is 00:16:16 Are they in the terrific 12 yet? We don't publicly disclose. Oh, okay, great. That's, yeah. Totally fine. So the terrific 12 remain anonymous, as is Dave's want. So Brian Singer was on, you know, reserving 15%, 20% of the fund to put into one name. They did it with Palantir, Airbnb, SpaceX, the rest of history.

Starting point is 00:16:40 So what do you think the right number is? And what do you, before fall for the reserves, if you had to put a percentage range on it. And then what do you think of this really agro strategy of the one? Yeah, let's take that one first because I think that's it's a it's a super ballsy strategy to do that. Oh, yes, it is. And I think, you know, credit to the guys at founders funders that they've proven that they can do it successfully. As an LP, I'm happy with some of my funds doing that, but I also feel I need to sleep at night. And if I had an entire portfolio that consisted of founders fund type bets, then I think that would be incredibly aggressive. So, you know, I look at it from, at my level, from a portfolio construction point of view, to say, we want to have people in that portfolio that are willing to take really aggressive bets and are willing to back their conviction and to double down on their very best companies.

Starting point is 00:17:36 But at the same time, we also need to have an eye on overall risk management. And from a funder fund's perspective, I can't afford to deliver a 0.5x portfolio to my investors. That puts me out of business. What we need to be able to do is to, yes, capture the upside, but also be cognizant of the amount of risk that we're taking in order to do that. And I also think it's different between, are you writing that 30% of the fund as a single check, is your first check into a company? Or are you layering it in over time as that company is derisking, as it's scaling, as you're getting more comfortable about the ability to execute, the size of the market, how the competition is playing out, how the economics of the business

Starting point is 00:18:20 are working? I can see getting to that sort of ownership or that sort of exposure over a period of time and multiple rounds makes sense. Single investment, as I say, perhaps one or two of the funds, but I wouldn't be comfortable if everyone was doing that. I think you've made a great point here that I just want to highlight, which is being able to invest in the company over time gives you a decision-making process at each of those waypoints to re-underrate the company, you know, meet with management, and really get a tight worldview on what's changed. And I've really started to take that to heart as I deploy more reserves. And I've really changed my fundstress. I had a G. When I came into the business 10 years ago, when I did my first fund,

Starting point is 00:19:06 you had finished up being a Sequoia Scout. You know, everybody was like, yeah, you just do, you know, a $10 million fund. You do 50 or 100 names, 200K, 100K, whatever. And you're done and you just hope for the best. And unfortunately, I hit four unicorns in that first fund. So I thought I was a genius again. What I didn't realize was even though that fund, you know, is 5X on paper and has returned to all the capital already and I feel great about it, we looked back.

Starting point is 00:19:32 If only I had saved a third of the fund, $3 million and taken the three, you know, of the four that were breaking out, I just went back and looked at my notes and I looked at my decision making. We knew three of them were definitive winners. It was super clear, superhuman, calm, and Robin Hood were just exceptional companies bringing out.

Starting point is 00:19:54 Density, we weren't sure because it was hardware plus software. And so, you know, we were kind of monitoring it. So I'm not certain I would have made the second bet on that. And then if I just made one or two of those bets, you know, 15 X fund, 20 X funds. So I guess my question from all of that is when you look at the seed space, do you, or any of the terrific 12s in seed? And then how do you view seed manager specifically, people who've chosen to be at the well, you know, I always use the analogy that we were on the orchard. We picked the apples. We put them in bushels and then we bring the bushels to the market. And then that's the series A.

Starting point is 00:20:30 So, you know, we run an orchard and we bring 100 every year, 100 of those apples to the market and we see who picks up on them. So talk to me about how you perceive seed. We went over the classic series A fund. Now let's do the classic seed fund. Is there one in the terrific 12? If so, how do you evaluate them? Yeah. So we don't have any standalone seed managers in that call manager group. However, some of those core managers will run multiple strategies, one of which will be a seed strategy. So there are. are seed-specific funds within our... So those 12 managers probably give us 40 or so funds across the cycle. So they're doing seed, early growth, there may be some sector-specific funds. There'll be some non-U.S. funds. So there'll be India. There'll be China.

Starting point is 00:21:17 They'll be Europe. So there are a small number of seed fund in there. Starting a business used to be a pain. You needed a lawyer. There were in fees. It was a mess. Now with Northwest's registered agent, it only takes 10 clicks and 10 minutes. Northwest provides everything you need to start and maintain your business.

Starting point is 00:21:39 Every LLC, corporation, or nonprofit at Northwest Forms comes equipped with registered agent service, a business address, a website, and hosting, email, a phone number, and this is all covered by Northwest's privacy by default. Again, your full business identity will be live in 10 minutes and in 10 clicks. So here's your call to action for $39 plus state fees. They'll form your LLC, corporation or nonprofit, and launch your business in just minutes. Visit Northwest Registeredagent.com slash twist today. That's Northwest Registeredagent.com slash twist today.

Starting point is 00:22:17 The challenge we have when we are looking at seed managers in particular is that we just feel our level, our ability to pick those managers is essentially zero. We can't separate the signal from the noise. And I'd be interested to see how successful other LPs are over the course of the entire cycle in doing that. And that's not because we haven't tried. So I mentioned we backed something like 110 different managers. You know, a number of those would be classed as seed managers if they were operating in

Starting point is 00:22:56 that space today. And it just hasn't been successful for us. And so rather than trying to do something we're not good at and hope we get lucky, what we have decided to do is really concentrate on where we think we have a competitive advantage and where we know that we are playing in a market where if you are able to access those very best managers, then you're going to get that consistency of performance and consistency of hitting that upper quartile performance vintage after vintage after vintage. So it's interesting. So I've had quite a few conversations with LPs

Starting point is 00:23:31 who are much more active in the seed space than we are. And I know you had Michael came on on one of your podcasts, the guys at Send Down who have done a great job in pulling those portfolios together. The question I would want to ask someone like Michael is what does that look like over the entire cycle?

Starting point is 00:23:53 Because I think we would certainly expect seed managers to outperform at the, as the market, in the last years of a bear market, of a bull market rather. So if you were looking at that sort of 17 to 21 period, there's no question in our minds that seed managers would outperform during that period. And the reason they would outperform is because the series B and C was so competitive and people were overpaying. Yeah, exactly, exactly. So they were getting markups on their seed deals very quickly. The markups were very aggressive. and in some instances, if they were able to sell some into those later stage rounds, then they're putting real points on the board and getting DPI back to their investors,

Starting point is 00:24:34 which is incredibly important. It does feel like things have changed, probably since the end of 21, beginning of 2022, where I think it's getting a lot harder to make that transition from a series C to series A. Pricing has come down. terms are becoming much more onerous. And going back to your earlier point, if you haven't reserved, then you could be in a difficult position, particularly if one of your companies stumbles a little bit and has to raise capital where the terms are a little bit more onerous.

Starting point is 00:25:11 And we've been in this long enough to remember pay-to-play rounds, remembering recaps. It feels as if more of those are likely to be coming through over the next 12 to 18 months. And so I think one of the things I'd be interested to see is how does the performance of those seed managers that look really good back in the end of 21? How does that look in two or three years time when they're having to revalue a lot of their markups? And particularly for those ones that haven't reserved and weren't able to get liquidity onto some of their positions when the market was, was much more positive. Yeah, this seems to be a leak in a lot of the early stage managers games that they don't take advantage of the secondary opportunities as they're presented.

Starting point is 00:25:55 And, man, looking back on it, we took advantage of a number of them very strategically. My only regret is that we didn't have a proactive unit doing it. And it's a little bit dicey because, you know, being out there trying to sell your position in your startups can create a natural amount of tension between a founder and an angel. investor or seed investor. So I think that's why many of them are reticent to say, I'm going to sell my shares or just even 10% of them, or 20% of them because they haven't communicated that to the founders upfront, their strategy. Yeah. I even think it's a harder decision when to sell in some instances than whether to invest in the first place. Because the other thing is you go back to the power law

Starting point is 00:26:38 nature of venture. And Sakaya didn't become Sakaya by selling its best companies early. They did it Apple and Don Valentine said, we're not doing that again. You know, you look at the best managers and they're the ones who are able to recognize when they do have one of those top 1% companies, you know, when they've captured that magic and they have the confidence to let that run. And I think it's something that that really distinguishes the very best managers from, again, the rest of the pack, that they understand when to take money off the table, but they also understand when to let things run. And ultimately, if you are going to get those fund returning outcomes, you know, you might only have one of those in a portfolio of 50 companies.

Starting point is 00:27:31 If you sell it too early, then you've missed your opportunity there. And almost that's a, I would look at that as a bigger sin than perhaps not investing in it in the first place. And we've seen a number of managers, I think, that have done that. And I think that's one of the, again, one of the things we sort of look at is to, are they really able to identify who were the key value drivers in their portfolio? Can they double down in them? And do they recognize, you know, how to play the long game in terms of letting that value compound over multiple years? Have you seen a manager sell their position and then subsequently the company go to zero or crash and burn? In other words, they made like the great trade.

Starting point is 00:28:14 You know, this thing became FTX and they sold FTX, not to pick on Sam Bankman-Fried, now serving in a correctional facility. But if you were in FTX and it went to $20 billion, $10 billion, whatever it was at, and you were a seed investor at $25 million or $10 million and you sold your entire position, my Lord, you might look like a genius right now. Have you seen that happen where somebody sold and it went to zero or something similar to zero? Not in private companies. What we have seen, though, is companies.

Starting point is 00:28:41 that have gone public, either via traditional IPO route or more recently via a SPAC deal, where the VCs have been able to get liquidity shortly after lockups had expired. And 24 months later, that company is in a very different place. You look at the market caps of some of those companies that went public in the 19, 20, 2021, vintage, and they are, they're pretty low. And so that tends to be more of what we've seen rather than taking early liquidity in a private company and then that company going to zero.

Starting point is 00:29:18 Right now, startups have to do more with less. We all know that. And that means increasing your product velocity while maintaining or even lowering your costs. Now, don't forget, product velocity is how startups beat incumbents. So here's the great news. AI is going to help you do that. So let me tell you about Wizard.

Starting point is 00:29:37 It's spelled U-I-Z-A-R-D. It's an AI-powered suite of U-I and U-X design tools. With Wizard, you can generate your app or web designs from simple text prompts. You can then iterate on these designs with an AI assistant, and then you hand off your completed designs as React or CSS code. Wizard's text-to-U-I mock-up tool is called Auto Designer, and it's really cool. If you're watching, you can see it on the screen right now.

Starting point is 00:30:02 Here's the brass hacks. Wizard is going to help you go from idea to mock-up in minutes. So if you're creating a product from scratch, this is going to save you so much time. Start building products today faster with 25% off Wizard Pro at wizard.io slash twist. That's U-I-Z-A-R-D. dot I-O-slash-Twist for 25% off. Stop wasting time and start shipping faster. Yeah, the one I can remember was we were, my understanding,

Starting point is 00:30:29 was that benchmark cleared their position or a very large portion of it and we work before it went public, you know, maybe in the, you know, many billions of dollar range. And they might have been the only winners in that. Aside from Adam Newman getting a buyout, miraculously, which is crazy. It's interesting as we're having this conversation. I've come to the conclusion balancing all these factors that if you're a seed fund and you sell 10% once or twice or three times, you'll never be in a position to explain to LPs or yourself and sleep at night that you sold too much in a winner. and you will have locked up enough of the win

Starting point is 00:31:03 after you've sold 10 to 30%, 10% 2 or 3 times, that you'll feel pretty great if the thing does become like, I don't know, I don't pick on any companies, but BuzzFeed, I still always trading for nothing, like less than their cash. I don't know, you remember those days

Starting point is 00:31:18 from the dot-com era when companies were worth less than the cash they had in their bank account? Absolutely. Crazy moment of time. I'm kind of accustomed to that, but this time around in the cycle, I'm going to, I'm already started this discipline inside my firm, which is we're tracking all the secondary offers that are coming into us.

Starting point is 00:31:35 They were like, hey, we have a name. We have a buyer. I'm like, tell me the number. And then why can you get on the phone? I'm like, I'm too busy to get on the phone. Just tell me the number if you want to have a relationship with our firm. You know, all these like, you must get some of this, right? Like some of these like, I don't know if they're shady, but there's just like weird underbelly of private company sales going on and the hustlers, you know, try to buy a position, sell a position, whatever. We see the same on LP stakes. We get, yeah, yeah, we do get people contacting us saying, what would be your pricing on an LP stick in this particular fund? And sometimes they have a deal there that they actually are able to talk to people about.

Starting point is 00:32:14 And sometimes they're perhaps looking for a bid in order to then go back to potential sellers and say, I've got a buyer who'll do this at X pennies on the dollar. Oh, that's gnarly. Yeah. So they're working both sides of the marketplace. I hear Jason mentioned his first fund is 4.9.5X. We do have an interest in taking a strip. Then they come to me. Oh, we might have somebody.

Starting point is 00:32:38 Oh, that's a really interesting approach. Yeah, I started during this last two years as things were, you know, how do I say it? I did have a lot of folks pitching me on these strips or getting me liquidity. I said, well, I personally don't need liquidity. I'm a worker. You know, I've done okay for myself. So I'm heads down, but for shits and giggles, yeah, tell me what this is. And they're like, well, we can get you the GP a little bit of money.

Starting point is 00:33:04 So I want to ask you a question might be uncomfortable or on, you know, maybe uncouth in some ways. When you look at GPs and they start to make money and money changes everything, especially for humans, how does that affect their psychology and how do you parse that? You know, somebody hits a home run and they had another home run and they're a GP. How do you know they're going to stay in the game and be aggressive? And how do you assess that? Is that an actual issue with fund managers over the 30 years you've been watching it?

Starting point is 00:33:33 In other words, retirement, work ethic, you know, desire, hunger, etc. Yeah, I don't know if you remember a firm called CrossPoint. Yeah, sure. So they invested in, again, we're going back to the sort of late 90s here. They invested in Bracade. They invested in Areba. These guys were up there with the sequoias and the Kleiners in terms of the performance. they were able to generate. And in 2001, 2002, they just said, look, we're done. We've made

Starting point is 00:34:04 enough money. We're not interested in doing this anymore. And I think one of the partners went and bought a motor racing team. And actually having that honesty to say to their LPs, you know, we're done, we're not, you know, we've made enough money where that's, that's finished. I think is, is quite refreshing. And it is a challenge when you're looking at GPs that have been successful individually. There are certain GPs that you know are going to do this until the day that they die. It doesn't matter how much money Vinod Kozler makes on his investments. They're going to drag him out of the building.

Starting point is 00:34:39 He will be investing in companies and working with founders until the day he can't. And I think there are a number of people within the venture industry that are like that. And I think they're doing it more because it's a passion. and the money is just a way of keeping school. They're super competitive. They want to win. They want their companies to win. They want to beat the guy down the street.

Starting point is 00:35:03 And they'll keep doing this until they're not able to. And so I do think it's important that you do have a relationship with your GPs. So you get a better sense of what they're doing it for. But I also think as organizations, it's really important to continue to bring new blood into the partner group. And one of the things we've seen with good firms that have fallen away, it's happened because they haven't handled the succession properly, because you get senior people who are still taking the bulk of the economics, their name might be on the door, but they're no longer doing the work. And they're not getting out of the way to allow that next generation to come through

Starting point is 00:35:48 and to put their footprint on something. So if you look at the very best multi-generational firms, they've done a really good job in handling that succession. And keeping the senior partners involved, but doing it in a way there where it's much more in a mentoring capacity rather than still being the dealmaker in that organization. So I think that's something that's really important for us to see. We want to see that new blood continuing to churn. And if we don't, it's a red flag. Yeah. Clina Perkins comes to mind as taking a couple of, I'm going to be generous, but taking a couple of sorts of,

Starting point is 00:36:24 swings at bat to do their transition. And it seems like they got it right with Mamun, Ilya. They got some great folks over there now running some pretty good investments. But that one comes to mind. And then Sequo getting it right, Rulov and Alfred after Doug and Maritz after Don Valentine. They seem to have, having watched that one happen before my eyes, because Ruloff was my friend who, you know, I remember his first year there when he wrote the deal member for YouTube and just watching Maritz and Doug, you know, sort of mentoring him and Alfred Lynn, you know,

Starting point is 00:36:58 and they just learned the craft of it. But, you know, I was there recently and Doug was there, you know, and I was there. I was there in San Francisco, obviously, a year ago, and Maritz was there. So, you know, this idea that people have transitioned, they seem to take a decade to transition at Sequoia, whereas in other firms, maybe they're just collecting these ginormous fees. So, you know, I guess is another interesting topic for us. The allure of, more fees. And how do you think about that? One of the challenges I have is people don't give me straight feedback. You know, when you're talking to an LP, they don't tell you what they don't like about your strategy or fund. So you and I have, luckily, I, you know, I get to have you,

Starting point is 00:37:42 you know, in my circle here. And I ask you, hey, candidly, tell me what, you know, really bang on this here. I want to be better at my game. Tell me where I suck. And you know, people were like, hey, you know, in this market, should you get 25% carry it with a ratchet up to 30? You know, that's a blocker for some people. And I was like, oh, yeah, I never considered that. And then I asked five people, and like two of them out of the five were like, yeah, that's our blocker. I'm like, why didn't you tell me?

Starting point is 00:38:04 Like, nobody's telling me the truth here. Tell me the truth, you know? And so how do you think about fees? How do you think about carry structure? Because now I had, I also had another person who said, don't lower your fees. Don't lower your carry because it's a sign of how good you are that you can actually close funds with 25% carry and then ratcheting it up to 30. So, which I'm not disclosed, probably was my carry structure, which I thought was fair,

Starting point is 00:38:29 you know, given the seed round on my performance, but it is a blocker for some people. So you just basically, it's a non-starter that they would participate with you. How do you think about fees? How do you think about carry? Two arguments I've heard. Keep your carry structure high. It's a signal that you're a quality hotel, that you have a thousand dollar a night room and you don't discount it or listening to the market.

Starting point is 00:38:48 Yeah, so I would say pretty much all of the managers we back are at that premium carry level. And they deserve it because of their performance. The way that we look at it ultimately is what are the net returns back to us? And if the net returns back to us stack up, then we're happy to pay the fees and the carry that you need to pay in order to access that performance. So I think you can get very fixated on paying premium. carry for the wrong reasons. The challenge with premium carry is when it doesn't come with strong performance. So my preference would be to see a manager that said, you know, we're starting

Starting point is 00:39:30 at a 20% carry. It goes to 25% at, you know, when we return this, it goes to 30% when we return that. Have your full catch up. But that means that interests are then aligned. You know, if you do well, I do well. If I do well, you do well. I'm happy with that. The reality is, you know, for the very best managers out there, they don't need to offer those terms to investors. So they're not going to do it. Of the terrific 12, how many are premium carry ballpark? I would say all of them. There you go. So you like to stay in luxury hotels. The price is the price. And you get the experience to pay for it. The bigger thing for me, though, is less around the fees and carry. It's more about fund size. And I think one of the challenges we've seen

Starting point is 00:40:13 with the cohort of managers that we do back is like everybody else in the in the industry, they have scaled their fund sizes over the last two or three cycles. And now you start to, the challenge for us, it goes back to the equation we were talking about earlier, you know, exit size versus ownership percentage versus fund size in order to get those fund returners. And so one of the things I'm hopeful for, and we are starting to see it a little bit, we've got one or two managers that are coming back with new funds in the market today, and they are right sizing their fund sizes to some extent.

Starting point is 00:40:47 And so I would be, for me, it's less capital is better than more capital. You know, we've seen that with companies, the whole issue around what South Bank was doing. You know, I grew up in the venture industry in the late 90s where a lot of funds increased their assets under management pretty drastically and it didn't work out. And so my default position is in venture, less capital is better than more capital. You need to have enough. You need to be able to do the math we were talking about, you know, 30 shots on goal. be able to lead those A rounds. So there is a minimum size that works. But I also think there is a concern that if you get too big, you just become a capital allocator rather than a venture

Starting point is 00:41:33 investor. And it goes back to what are the sort of returns your LPs are looking for. If you're then getting the big checks from the sovereign wealth funds, then they're probably happy with that median venture return. need to do better than that. Not all LPs are looking for the same thing. Some would like to get the average because the average is better than other averages and they want access to this. And average, like as we started our conversation, average with the chance of alpha is a great concept for them. And you did see that with Andreessen Horowitz going to 10 billion plus under management, 20 billion assets under management. At least that was the perception here in the

Starting point is 00:42:10 valley. You know, how that's turned out. I don't have their fund returns and except maybe for the press, you know, dunking on fund managers. They don't understand the J-curve, which I don't know why, but you're not going to believe this, Dave, but somebody didn't understand, somebody on the internet made a mistake, and I felt oblig to go fix that and correct it, but these journalists were all looking at like, Andreessen Horowitz leaked data or something, and it was like misinformation about, this is year three or four of that fund. And I'm like, the fact that that fund has any IRO, do you know what the J-Cerve is?

Starting point is 00:42:44 Just started asking these folks, you know, if you're a journalist, you don't know what the J-C curve is. Listen, what we do is unique in the world. And so, and the J-C curve, did the J-Cerve go away for a decade? Is that the problem in our industry? Yeah, it did. And it was interesting. Every three months, we do a review of all of our funds. We just did it yesterday.

Starting point is 00:43:03 And what was really interesting was that when we were looking at the investments we've made in our current fund, which is Fund 16, 90% of those investments were below 1X. They were in the J-Cerve. And that's the first time we've seen it for probably six or seven years. The J-C curve prior to that had been compressed and in some instances had disappeared altogether, whereas this time round, it's back. And while that might seem counterintuitively, for me, that's a positive. Absolutely. Less money's coming into the industry.

Starting point is 00:43:40 It's harder to raise capital. only the best companies are going to be able to do that. So the level of competition for the best companies is going to go down. Their ability to be more capital efficient because they're being forced to do more with less is increasing. Their ability to recruit the best talent is increasing because that talent isn't as thinly spread. So the fact that we're seeing a J-Kirb in years, one, two, three of the investments we've made recently, I take as a positive.

Starting point is 00:44:08 Yeah, constraint makes for a great art, you know, and definitely, headlines make for great art. This is something I've learned in my career. I was listening to an interview with Bob Dylan and arguably blood on the tracks. I'll go back to Bob Dylan today. I don't know why. But yeah, blood on the tracks, I mean, a seminal album and they were, you know, asking him, like, how did, you know, he hit this magical album, you know, tangled up in blue, shelled from the storm. This is really great, great tracks on there. And he said, yeah, you know, Columbia Records, I owed them a record. And they were going to sue me and I had gotten a big advance. And so I had to give him a record. And so my manager said, Bob, you're going to have to pay a big settlement

Starting point is 00:44:45 if you don't get that record out. So I went to the studio and I recorded. It's like, all of the starboard is absolutely crestfallen at the inspiration. What on the tracks is, you know, had to return the advance or had to get this thing out the door. Yeah, no, it's, it's, I was going to say it's crazy. It's, it is, it's crazy. You know, what, what it takes to, for that inspiration to happen, you just never know. And then I remember at the turn of the century, the digital camera came out. The Sony VX-1000. I had met this kid, Bennett Miller.

Starting point is 00:45:18 He did a documentary called The Cruise at Sundance. And there was this big debate. Well, now, because you weren't using film sock, you didn't have to get it developed, that we would see this incredible renaissance where anybody could take this VX-1000, shoot on digital, and you could do 100 takes. So no longer did you have to worry, you would get better art because. And it turned out the control. of having to ask your investors for more money to develop more film to get an extra day of shooting, the constraint of only being able to shoot for 10 days on an indie film or, you know, 45 days on a

Starting point is 00:45:53 medium-sized film or whatever it is, constraint made all of those artists, directors, set designers, actors, focus. And that's my perception of what's happening right now is the constraint of LPs, constraint with the founders having only a certain amount of money deploy. Everybody gets a smaller budget, everybody gets really focused. Make better art. Make better startups. It's just clear as day to me, you know? Yeah.

Starting point is 00:46:18 Yeah. No, it's really interesting. Just one comment on the sort of fund sizes and what you were saying about a firm like Andreessen. Again, there seems to be a bit of a narrative growing around sort of VC Twitter that it's impossible to get fund returners on a billion dollar fund. So we just had a look at our data to see how. many times we've had one company return a billion dollars back to a fund.

Starting point is 00:46:48 And there's been nearly 50 instances, 5-0. 5-0. Wow. Yeah, 5-0. I could name them. Yeah, it's Facebook, Uber, Robin Hood, yeah. I mean, it's hard to get a billion dollars. WhatsApp.

Starting point is 00:47:03 Snowflake, Coinbase. Coinbase, sure. Airbnb. Airbnb. Agon, Roblox, Pinjodo, U-I. Slack. Some of them are still unrealized.

Starting point is 00:47:14 So, you know, data breaks, Bigma, Stripe. Stripe. Comes to mind. Yeah. It makes sense when you think about it.

Starting point is 00:47:22 It's so hard to hit a decacorn. That's the other thing. Like a $10 billion company, everybody thinks that they're, I think because of the paper corn, you know, I just had Aileen Lee on the pod three weeks ago. I mean,

Starting point is 00:47:33 it's such a bounty of knowledge on this podcast. And, you know, she was talking about the papercorns and we were trying to estimate of whatever number, of unicorns out there, she thinks it's like 40, 50% are not going to reach unicorn status again. What do you think it is? Unicorns from the last cycle that will not get a billion dollar evaluation again. Yeah, I mean, I don't have any visibility into putting it into putting

Starting point is 00:47:57 a number on it. I think broadly, I think there's a lot of companies out there that are way overvalued. And one of the things we look at is, you know, those loss ratios. And we talked about sort of somewhere between 50 to 60% of companies not returning capital back to the funds that back them. We've seen those numbers be a lot lower in recent vintages. And my sense is that they are only going to go up. So, you know, whereas for the last four or five vintage years, you know, we might be at 20 to 30 percent. Ultimately, I think they're going to hit those 50 to 60 percent.

Starting point is 00:48:31 So, you know, if you're backing that into, you know, what does that mean for companies? I don't know what percent of companies are valued at a billion dollars out of of the cohort that was funded over those years. So it's difficult to give you a percentage of how many of them are going to disappear. But I think broadly, we have to expect that things are going to get worse before they get better. In the seed stage, it was unbelievable to me how often a founder would be able to get a bridge for 18 months, 12 months.

Starting point is 00:49:04 And they didn't have product market fit. And this was just a new startup in the same shell of the past. one, you know, is basically a hard pivot or soft pivot, but generally hard pivots. And then something happened last year where the founders themselves, and my belief is one I learned from Ruloff, which was I give up when the founder gives up, or, you know, the day after the founder gives up, that's my, that's when I decide to, to give in and accept the reality that the startup's is, or whatever, we're doing an aqua, aqua, whatever it is, they shut down. Yeah, we saw them all come in the last year. And, you know, we had to like sit with the founders,

Starting point is 00:49:36 recognize the effort they put in for two, three, four, five, six, seven years and that it was going to result in a zero and I give them all a talk, you know, I said, listen, this is like the greatest success that you tried. And all I ask in this failure is two things. One, we shut down properly so that you don't have tax issues and employees, everything. So just let's do this properly because I've seen this blow up in a bad way. So let's wrap up gracefully. And then number two, I be your first phone call when you have your next idea. It's the only two things I ask. And then let's have a dinner in, you know, 30 days or 60 days and when you're licked your wounds and feel good. And let's figure out what we learned and what you want to do next. And if you want

Starting point is 00:50:21 to gig somewhere, I can help with that. If you need a vacation recommendation, I can tell you where to go skiing. And I just kind of like really focus on that moment because, man, having been to myself as an entrepreneur, it sucks. It really sucks to put the startup to bed. And, you know, I hate to say it didn't trigger anybody, but it's like putting down a dog or something, you know, like, that feeling of like, oh, it's imminent pain and suffering I'm going to have. But I find so many VCs and so many capital allocators don't own that moment. They just disappear from the board and they stop talking to the founder. And I just thought, well, if you're going to be there. Yeah, one of the things that I think will be interesting again over the next year or two is it feels like we've, there's clearly been a huge influx of new.

Starting point is 00:51:05 entrance into the BC space, whether they're solo GPs or sort of super angels. And we haven't invested in any of them, but we've talked to a number of them. And it does feel as if there is a, you know, clearly not all of them, but a significant percentage that are, you know, almost seen as a lifestyle choice. They're doing it because they can raise a little bit of money from friends and family and they can fund their friends companies and they can be everyone's favorite person. and when the music's still playing, it's great. But when you have to tell your friend that you're not going to fund their next round

Starting point is 00:51:43 and they're going to have to lay off half their company and actually they're probably going to have to shut their company down, then it suddenly becomes a very, very different business. And so I think it'll be really interesting for us to see what happens to that group of investors that came in towards the top of the market thinking venture was an easy asset class when you do start to have to have those really, really difficult conversation. Yeah, they're just not built for it. I'll be honest. I'll call it what it is. You know, like when you have to have those hard conversations, some people are built for it,

Starting point is 00:52:18 some people aren't built for it. And I just don't think most people are built for it. I'll be honest, this is an extreme pursuit on the founder level and the GP level, on the LP level. And each person, it's a little bit less extreme, but it's still an extreme pursuit. And most people are not built for the conversations we're talking about here and how hard it is. And then I can tell you, if you do happen to be lucky enough to make it to your third or fourth fund, guess what? Now you've got a track record. Now you have every bet you've ever made.

Starting point is 00:52:46 And people like yourself who love to dive into that data. And then you will face the reckoning. You gave an extra 50K to this company instead of giving it to a new company. Why? Oh, well, I want to support the founder. And this is something where I've changed my attitude 100%. I'm telling founders, the reserves are for the top 5% of performers. And then my team, because they have big hearts and they love these owners.

Starting point is 00:53:11 I really think we should put something in, hey, can we just put 50K? Can we put 100K? And I have to tell them, hey, well, that 50 or 100 could go into the top 5% who we know are going to, on average, return at 2050x. So do you want that 100K to turn into 5 million or do you want to put 100K into something that we are relatively sure will just extend its life for 12 months? And this is, you know, again, not to use graphic analogies here, but if you know this is, you know, person's going to die, we're doing triage. That's the way to say. And, you know, triage is not a pretty business.

Starting point is 00:53:43 Yeah. And it's interesting. It's super important as well because one of the different ways we've cut our data is, you know, we've talked about what it looks like in terms of the, you know, the percent of companies that don't return capital and or do 5X. We've also looked at it by the cost basis. So how much capital actually goes into each of those. companies at those different levels. So, you know, companies that return less than 1x,

Starting point is 00:54:05 companies that return 1 to 3x. And what we find generally is that the underperforming managers tend to put more capital into their worst performing companies. So their percentage of, so let's say they had 50% of their companies fail to return capital. They could be putting 55 to 60% of their capital into those companies. Whereas the opposite is true for the best performing funds, they actually put less capital into their worst performing ones, and they put more capital into their best performing ones. So if you were looking at, say, 5% of their companies were 10x multiples, they might have been able to put 7, 8, 9, 10% of capital into those 10x companies. And it's that nuance of portfolio management and portfolio construction, which I think

Starting point is 00:54:54 you have to be a real kind of venture geek in this industry to really to really appreciate. Yeah, it's such a good point, man. I think it's like, it's the one for me as a manager that, along with doubling down, which this falls into, really the most important of my game that I have to get better at. You know, and you have, it's great about talking to you and, you know, appreciate your time and the conversations we had off the program is you can only get better at the game by studying your performance. If you're not willing to videotape yourself putting up three-point shots and have people say, listen, you know, this is what you need to change in your shot. review game tape, you're not going to get better and you're not going to win. And then if you don't win, you don't, you know, you may be able to fake it for two funds, but you can't fake it for three or four, you know, you got to bring it. And I know the reason why these managers give it to the bottom half

Starting point is 00:55:46 of the performers instead of the top half is because the bottom half are the squeaky wheels that run out of money that don't have a competition to buy their shares. So if you were to compare the bottom to the top, the top is got tons of people throwing money at them. And they may not not even come to you or they may ask you to waive your pro rata. In which case you've got to fight for your prorata, which I've become an expert at, you know, dealing with certain firms, I won't say which ones, that have tried to screw me on my prorata. But people who follow me on Twitter might be able to guess literally being in standoffs with one particular fund twice. And they know who they are. But then, you know, you're, you got the other group, which is

Starting point is 00:56:21 struggling to get capital. And so they ask you for capital. And founders are self-selecting for charisma, self-selecting for spinning a yarn, the good ones at least, but I think all of them. And so the bottom half that probably should be shutting their companies down, and they're just so good.

Starting point is 00:56:41 Hey, I need you, Jake Howl, you supported me early. I need you to support this round. I need you to lead this round. We don't lead these rounds. We've already made two bats on the company. I find having that conversation on the way in two or three times with the founder,

Starting point is 00:56:54 how we do our follow-on investing, has helped us deliver the news a little bit more crisply later on. Hey, remember when we told you, we only have reserves for the top 5% of performers? Here's what that looks like right now. It looks like 4x revenue year every year.

Starting point is 00:57:09 What was your revenue growth? It doesn't help either that there are so many examples of really successful companies that have had those near-death experiences that in the back of your mind as an investor, you're thinking, that's a good point.

Starting point is 00:57:22 Just one more round. Just one more round, we'll get them over. and because every company that you invest in, you have high conviction on, every founder you back, you believe it's going to be super successful. And so to actually flip the switch and say, you know, it's time, it's time to call it a day. Because for that founder, their most precious thing is their time. It's not the capital. It's their time because they have a finite amount of that.

Starting point is 00:57:49 And if they're spending it trying to, you know, knock their head against the wall on something that's not going to work, then. they're missing doing something that could be really impactful. Yeah, it's just such a good point. I didn't even consider that one because you also have the fund manager, the GP, is like, I just want to see one more card. Maybe my hand will improve. And you know what? Yeah.

Starting point is 00:58:09 Sometimes it does. Sometimes you hit runner, runner, and all of a sudden your flush comes in or you hit your straight or you hit your trips and, oh, yum, yum. But you do have to put a percentage on that. Listen, Dave Clark, amazing to have you on the program. I'm putting it on the schedule right now. You're going to be like one of the top guests already of 20, 24.

Starting point is 00:58:24 So we're going to do our year-end wrap up in December. Can I put you on the schedule for a December show? Yeah, no, it would be delighted. All right. Thank you, my friend. And we'll see you all next time on this weekend startups. Bye-bye. Hey, everybody.

Starting point is 00:58:37 I talk to a lot of founders here on this weekend startups and as an investor. And they tell me the same thing over and over again. They want to spend time together. So we've been working here on a new meetup program. We call it Founder Fridays. And Founder Fridays are an event by founders for founders. This is an event that is. hosted in cities by people like you.

Starting point is 00:58:56 If you're listening to This Week in startups, you're a founder. Now, why is it important for founders to get together? Shouldn't you be at home just focusing? Shouldn't you be in the office just focusing on your startup? Well, if you get together with other founders, true founders who are in the arena, building like you are, you're going to get a lot of value from that because you can trade notes about what's working at your startup and what's not working. The truth is, if you're facing a problem, there are hundreds of founders out there who have

Starting point is 00:59:21 probably solved it already. And instead of you, banging your head against the wall, when you sit there and you talk to three or four founders, somebody say, oh, you know what, I had that same human resources problem. Oh, I had that same technical problem. Oh, I had that same marketing problem. And they might tell you about a tool or a service that'll solve that problem for you. This happens over and over and again when I do Founder Fridays with our portfolio companies. Now we're going to give you that same experience, but here's what I need you to do. I need you to host this in your city. So you're going to go to this week in startups.com slash. meetups. That's it. And you'll see a landing page where you can sign up and you can say,

Starting point is 00:59:56 I want to host in my city. Now, your city may already be hosting so you can just join that person. We're using a wonderful piece of software that we've invested in called River. You can sign up for a river account just by going to this week and startups.com slash meetups. And we're going to do these on a rolling basis. You can join an existing meetup if it's already occurring in your city or you and one or two other founders can start your own. Please go to this week in startups.com slash meetups if you are a founder. This is for founders by founders. We vet everybody to make sure you're a founder. And if you host it, it's a non-commercial event. So this is your chance to connect. Go to this week and startups.com slash meetups.

This Week in Startups - Unlocking the Power of Data with VenCap’s David Clark | E1906

There aren't comments yet for this episode. Click on any sentence in the transcript to leave a comment.