We Study Billionaires - The Investor’s Podcast Network - TIP502: How to Run Your Own Private Equity Portfolio w/ Darin Soat

Starting point is 00:00:00 You're listening to TIP. My guest today is Darren Sote. Darren is the director of content at Link 2, which is a platform that lets accredited investors purchase equity in private companies like Ripple, Cracken, Whoop, Just, and others. Darren puts out a lot of amazing content on news relating to private companies, and he's the creator of another popular outlet of financial content, which we reveal at the end of this episode, so stick around for that. In this episode, we discuss an overview of investment banking and private equity.

Starting point is 00:00:30 how the democratization of private equity is changing, how Darren got involved with Link 2 and why it's an important resource for investors, the mechanics of investing in private equity through Link 2, the current environment for private equity, and how billionaires like Howard Marks are navigating it and much, much more. I learned a lot from this episode with Darren, and I highly recommend the content he produces. I hope you enjoy it as well, so without further ado, here's my conversation with Darren Sote. You are listening to The Investors Podcast.

Starting point is 00:01:03 where we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. Welcome to the Investors podcast. I'm your host, Trey Lockerbie. And like I said at the top, we've got our friend Darren Sode here on the show with us. Darren, welcome. Thanks for having you, Trey. I'm really excited about this conversation because you're doing a lot of really cool stuff and a lot of it's really interesting to me in particular. So I thought the audience would get a real kick out of it. And I'm been really looking forward to this conversation. So really excited to have you on. I wanted to kick it off here by chatting a little bit about your background because you were in investment banking. And while everyone knows what that is on paper or, you know, they've heard it tossed around, it is such a general kind of blanket statement for an entire industry. And I know that there's a lot of complexity actually underneath that. And it's a bit of a black box. Right. So I wanted to kind of get a feel for what you were doing previously to what you're doing now because I think it might help color the conversation. a little bit.

Starting point is 00:02:10 Yeah. And, you know, what I was doing previously kind of segues into what I'm doing now. Investment banking is a pretty broad term. The way that I like to describe it or at least compare it is like to a blood bank, right? In the same way that a blood bank matches a donor to a recipient, an investment bank matches an investor to an investment. You know, that could take many forms. It could take the form of debt capital markets where you're essentially advising companies

Starting point is 00:02:36 on how to structure their debt capital. It could take the form of equity capital raising, or it could take the form of mergers and acquisitions, which in a way is a form of equity capital raising and debt equity combined. Or it could take the form of mergers and acquisitions, which is kind of both, right? So in a way that you're raising equity, but in the kind of arena I played in, a lot of these deals happened using leverage, which is a fancy term for debt. Basically, what I was doing was I was advising companies that were seeking a sort of exit, be that to a private equity fund or a strategic buyer.

Starting point is 00:03:11 You could think about this like in the case where Facebook required Instagram. But, you know, the whole idea generally is in companies, seeking some sort of liquidity event. And ultimately, in some cases, advising buyers, maybe it be it a private equity fund or perhaps that took the form of a strategic buyer, essentially a company that was looking to add to their product offerings or, you know, maybe it's for a financial purpose, right? Maybe they want to acquire a company because it has good margins and they can get at a good value.

Starting point is 00:03:40 And they could use any sort of existing synergies they can to increase profitability. I think you're seeing that right now with One Medical and their acquisition by Amazon. And it's true purpose. Amazon was never intended to be a or never intended to be a healthcare company. But they went out and they acquired One Medical. In many ways, they have kind of some offerings that they can add to One Medical to maybe bring some of the costs down in the supply chain, such as pill pack, which is essentially a virtual pharmacy in a way where you're getting your medicine delivered directly to your door. And maybe there could be

Starting point is 00:04:17 some sort of overlap with one medical, but in some cases, these acquisitions happen just for sort of cash flow play. I question that in the case of one medical, but because one medical was not profitable, but they could make it profitable and they could make it make sense given any sort of existing infrastructure that they have. So the whole motif of what investment banking is it's providing liquidity to people who have investments in current companies, whether that's an IPO, whether that's a sale to another company or a private equity fund. Now, someone we study a lot on the show, Warren Buffett, is vehemently against investment banking it would seem. He talks about it sometimes. And in fact, he recently put in a lot of money to Allegheny and he actually

Starting point is 00:04:57 subtracted $27 million from the fee of his purchase price because they were paying that to Goldman Sachs for the diligence. So I'm kind of curious if you have any opinion on why that might be. Is it because he likes to do his own diligence and isn't really reliant on the investment bankers? Or what exactly is driving that, do you think? I think it comes down to how he views the fees in terms of what the banks do, right? What are investment bankers doing? I mean, for the most part, it's a high energy environment, you know, you'll hear the horror stories about junior bankers having to spend 80 to 100 hours a week working on probably four or five, six deals at once. And so in a perfect world, you know, you could look at that as these investment banks could hire more people.

Starting point is 00:05:41 But the problem is right now as it stands, it's a relatively good margin business where their big cost is just however much they're paying their people. So when Warren Buffett looks at something like that, he's probably looking at the fees and actually trying to consider what investment bankers are doing in terms of providing value. So you have junior bankers who are going out, they're creating these sorts of pitch decks, they're advertising them to private equity funds and strategic buyers. And after that, they're kind of just sitting along for the ride during the due diligence process. Sometimes their junior bankers are collecting files and providing that information. And on a billion dollar deal, when you're taking three percent of that transaction,

Starting point is 00:06:19 it's a lot of money. That's $30 million in a fee that is a lot of money for. for arguably not that much value provided. So I think his criticism comes down to the work that's actually contributed. I mean, you're paying $30 million to an investment bank on a billion dollar transaction where these guys created a pitch deck. I mean, for a billion dollar company and a billion dollar transaction, the company most likely had well-projected financials. So the chances that the bankers actually had to go in there and recreate that, probably not.

Starting point is 00:06:49 There's also, too, the fact that these strategic companies probably also, or these companies also probably had a list of buyers lined up and an idea of who they wanted to sell to anyway. So if you're paying a banker $30 million to get on the phone and make that transaction happen, yeah, I can see why Warren Buffett would have some reservations wanting that or wanting to pay that money. Especially maybe because he's just so well known and people could, they know how to get a hold of him if they really need to maybe or something like that. Yeah. Part of the diligence process is the investment bankers aren't really doing that. They're bringing in other professionals anyway. So if Warren Buffett can do those diligence things himself or hire an accounting firm or hire somebody to do the quality of earnings, he doesn't need to hire an investment bank

Starting point is 00:07:33 to do a lot of what he wants to do. So you mentioned providing liquidity. And I know that you were doing a lot of work on the M&A side with going to private equity. So talk a little bit more about the private equity side of this and what your experience was like, it may be just, again, another very broad term. So maybe he painted a picture for what exactly you were doing there. Yeah. You know, as you mentioned, private equity is a pretty broad term. And to its truest definition, it's really just equity that's private. So ownership in a company that is not publicly listed, right? So that could take the form of anything from,

Starting point is 00:08:05 you know, early stage seed to a privately held company at a late stage series round. You can think of SpaceX for kind of the broad audience. It's a company that you won't find on a publicly listed exchange, but it's still a big company. But, you know, kind of on the alternative side of that, you have very early stage companies, maybe seeking a couple hundred thousand, maybe to a million dollars just to get up and running. So private equity in terms of its broad definition is really just ownership, private ownership in a company. Where that was for me in an investment banking was generally speaking, private companies that had EBITDA. And, you know, I like to use EBIT as a proxy for cash flow. Warren Buffett's actually against the idea of using EBITDA.

Starting point is 00:08:46 Well, let's talk about that because I'm curious as to why you are on that side of the table, because look, the point is to kind of standardized earnings across multiple industries, right? That's why EBITDA sort of exists. I think Warren's opinion is that the depreciation and the amortization, these are real costs that should be factored in. So why are they, what's the argument against Warren to keep it at EBITA, in your opinion? Well, the argument is that in any stable state company, the depreciation and amortization of a comparable company. So, you know, when you're using EBITDA and comparing like an auto manufacturer, the amount of machinery that they have should be comparable across the board between other auto manufacturers. So that's why you can kind of use the profitability profile to kind of do an Apple's comparison. But at the same time, it's hard to argue against Warren Buffett in that case, because I would say that depreciation and amortization for companies that do require any sort of capital expenditures, you cannot ignore it.

Starting point is 00:09:43 So at least when you're comparing similar companies in those industries, I would argue that you do need to include a sort of depreciation and amortization. You can't really take that out to really kind of get a meaningful measure of cash flow. So I don't disagree with his understanding with that. And to be honest, I think it really depends on the type of company that you're looking at. But for capital intensive companies where you have big machinery, I would argue that he's probably right there. So now let's talk about what you're doing at Link 2 because that is what I'm. I'm super interested in. And I'm kind of curious what you saw there when you were working in private equity. Was there something that made you say, okay, everyone needs this. And here's why I'm

Starting point is 00:10:22 going to jump ship, kind of pivot my career. So Link 2 is a platform that allows accredited investors to get exposure to this investment class of typically billion dollar companies or more, usually later stage funding backed by venture capital. And it allows people to get exposure to this investment class, accredited investors, that is, through a check size of around $10,000. So a lot of the competitors in our space will require an entry point of $100,000. We want to give accredited retail investors exposure to any of these venture-backed companies that, you know, they find desirable. And we want to do it for a low entry fee of $10,000, right?

Starting point is 00:11:01 Typically, these are, again, late stage venture funds, usually a couple of years out from a of liquidity event, be it, you know, ideally an IPO. But what we're doing is essentially we're taking this former game where it was venture capital funds who were the investors into, who essentially had exclusive access to these unicorns, these high returning companies. And we're saying, you know, hey, why not let the regular person participate in this investment as well? Joining link to was kind of based on this observation that I made working in investment banking. And that was these private equity funds, right? They're modeling, many of them are modeling from, you know, typically on average you'll see 15 to 20 percent return modeling, but in some cases you'll see the model

Starting point is 00:11:47 for, you know, 20 to 25 percent returns, right? And that's in the buyout space. So you could argue that maybe buyouts might not be the highest returning, but at least on a risk adjusted basis, they actually might be pretty well reliably returning, right? Now, what really stood out to me was that in order to really have access to this investment vehicle, you had to be an accredited investor. So what really stood out to me about the industry was that you have these investment professionals and albeit these guys are really smart guys working for these private equity funds. A lot of guys that have gone to some of the top business schools in the country and, you know, are probably the brightest when it comes to understanding not only the industry, but where

Starting point is 00:12:25 the industries are going and kind of what makes for a good company in these particular industries. I guess what really brought me to link to was why is it that these investment classes are typically used only by private equity. So somebody is getting or modeling for 15 to 20% returns. Why is it that, you know, not more people can invest into something like this? And the truth is they can invest into something like this if they have enough capital, right? And so that's why you'll see a family office, you know, very often take the form of a buyout fund, right? But, you know, the reason, I guess the most compelling thing for me of why, you know, Link 2 made a lot of sense was that if you're allowing more people retail access to this investment class, I only think that

Starting point is 00:13:10 makes things more fair for everybody, rather than just kind of limiting it exclusively to these essentially big funds, right? And to be an investor in one of these big funds, right, you typically have to write a check size of around a million dollars or more just to be a limited partner in one of these funds. And additionally, you're also paying these really high fees. You're paying carried interest. And so one of the compelling things that stuck out to me about Link 2 was you're not paying a carried interest and you're not paying these really high management fees, right? You know, Link 2's whole mission is allowing access to private equity in the form of typically billion dollar or more companies and making it so that any accredited investor can invest in one of

Starting point is 00:13:55 these companies and pick where they invest. Right. So, you know, you'll see other offerings out there where the investor will have the option to invest into a fund, again, you're more likely going to be paying a sort of fee for investing in one of these funds. But at Link 2, there are no fees for investing in any of these companies. And our model allows that because essentially what we're doing is we're buying these shares secondaries from VC funds, former employees, and then we're essentially reselling them, right? So that's how our model works.

Starting point is 00:14:27 And it allows for people to invest in some of these companies. Like, you know, historically we've had Robin Hood. We had SOFI and it allows people to get exposure to this investment class without having to pay these excruciating fees. Is that because these companies don't necessarily have plans or interest to go public or maybe they will at some point? Because it sounds like you're giving liquidity to these VCs like ahead of their maybe otherwise prospective exit through a public offering or something like that.

Starting point is 00:14:54 And then in the meantime, you're giving it to the public who wouldn't have had the opportunity to begin with. And they might see the upside from where this company is now to a potential exit. I'm assuming publicly or otherwise. Yeah. So part of the reason why you're seeing a lot of companies stay private for longer is there's a lot of scaling that can happen that, you know, once you become public, the nature of your investor kind of changes the pressure of you as a company, right?

Starting point is 00:15:23 And so what I mean by that is the incentives of venture capital, VC firms want you to continue to scale your company, right? Whereas once you're on Wall Street, the question then becomes is, okay, you know, are you going to be profitable? And that's not to say that venture capital doesn't care about, you know, what future profitability profile of your company is. They absolutely do that. Otherwise, they wouldn't invest into your company. But, you know, while it's private, that's their big incentive is making sure that they increase the equity value of the company and they provide you enough capital to make sure that's the case. But when you are public, there's a lot more pressure to push for profitability. So when you see companies go quarter on quarter, you know, burning cash as a public company, you'd

Starting point is 00:15:59 tend to have, you know, compressed stock prices. And, you know, that tends to be actually pretty bad for the company. And so what they want to see instead is, you know, if for a company that wants to grow, they don't want that sort of pressure from Wall Street, right? If you still have market to capture, then for them, they think that they should be capturing that market. As a result, you're seeing more companies decide to stay private for much longer. In the past, you saw Google and Apple go public and most of their value was realized after they've gone public, you know, but for a lot of the companies that have gone public recently, like Uber, a lot of that value was created while it was still a private. So again, there's a lot of incentives to stay private for longer.

Starting point is 00:16:36 A lot of it really has to do with the pressure from Wall Street investors and kind of the different incentives that they have compared to Metro Capital. I think it's a trend that we've been seeing and I think it's a trend that, you know, we're going to see for much longer. Now, another trend we might see for much longer is the decline in value, right? Because we've got interest rates going up. We've got a lot of macro headwinds. So something I was kind of particular interested on the link to site was a company that is in the food and beverage space. It's actually food tech. It's called Just. So I had a particular interest in that. And what stood out to me actually is that their raise was back in 2017 and the valuation was around $1.3 billion. Now, the

Starting point is 00:17:14 link to implied valuation, it says, is only $1 billion. So what was kind of curious to me is because I would suspect, you know, at some point, okay, what's the transparency like through a platform like this, especially if the company is declining in value, is the retailer seeing that decline, you know, materialize in their offering? And it looks like maybe that's the case here where there might be a slight decrease in valuation. So I'm kind of curious how a link to tracks that, you know, be given maybe there hasn't been a fundraise as of late or is there some other metric to 409 or something to kind of monitor that value. So monitoring the value in real time is actually kind of difficult. But what we are able to do is, what we do is before we even

Starting point is 00:17:55 make an investment in a company, we look at a few factors, right? We look at who are the names behind it, right? We want to make sure that the names backing these companies are well-trusted names in Silicon Valley and have done their due diligence. We look at the valuation. We want to make sure that, you know, there were no down rounds because that's typically a negative sign to us because we want to make sure that, you know, they're going to continue to increase their equity value. And then the last thing we look for is one of the other things that I think that's really important that we look for is we look to see that, you know, there's a short runway to actually going public. And we want to make sure that, you know, users, even though they can invest

Starting point is 00:18:32 there, even though we're seeing these companies stay private for longer, the sweet spot for link to is finding these companies that are still just a short way out through an IPO. Now, the reason why we sell shares on the platform at a discount to its prior round valuation is typically because we're able to acquire those shares at a discount. And that happens with the mechanics of VC funds. Typically, you'll see some VCs is they like to shuffle around, you know, some of their capital and, you know, rebalance their own portfolios and put maybe more company or more capital in another company and, you know, try and decrease their position in one company from one way or another. It's not the case that it's a bad company. It's that, you know, they want to

Starting point is 00:19:11 focus on, you know, supporting another company. Like, for example, they, they might have been, you know, in very early, right? Like on a seed stage round and they've already seen a return on this thing. That seems almost like an advantage where you guys are negotiating, right? Probably the best price you can get. We are. That's one of the advantages is, you know, for these companies that have already seen a return and they want to realize that return, you know, we're helping them realize that return,

Starting point is 00:19:35 right? And for them, that's additional capital that they can put into another company, right? If they are a lead investor in one deal, but they're just a part of a syndicate, and another, then, you know, they're going to maybe want to put more capital into that deal that they're focused on and they're probably more invested in, right? So they're going to want to decrease the position of a deal where they're not a lead investor and get that additional capital to help support this other company, right? Because the responsibility as a lead investor is going to be much different, you know, whereas if they kind of took a passive rule behind

Starting point is 00:20:10 a syndication between, you know, let's say Sequoia and Andreessen Horowitz, right? So I think the, you know, to your point, that is a big advantage that we offer, but, you know, not only is an advantage to us, it's an advantage to these VCs. We pass those savings on to the customer, you know, ultimately we're selling these equities to. Let's take a quick break and hear from today's sponsors. All right. I want you guys to imagine spending three days in Oslo at the height of the summer. You've got long days of daylight, incredible food, floating saunas on the Oslo Fjord and every conversation you have is with people who are actually shaping the future. That's what the Oslo Freedom Forum is. From June 1st through the 3rd, 2026, the Oslo Freedom

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Starting point is 00:24:32 dot com slash WSB. All right, back to the show. I'm really curious about the mechanics we're talking about here. So just to kind of dig in a little bit further on this, if I were to buy some equity in, let's say just through link to, do I get on the cap table somehow? It's kind of a secondary market in a way, but it's not a very liquid one.

Starting point is 00:24:54 So, you know, what does it look like on the side where if I were to invest my money, how would that materialize into actual equity in the company? The way that we're investing into these companies is we're buying the shares essentially through an SPV, special purpose vehicle, essentially a holding company that allows us to acquire these shares. And then what we're doing is we're selling ownership in the SPV. You know, let's say that Link 2 creates an SPV in particular to go on to Robin Hood, go on their cap table, which was one of the companies that we had before it went public.

Starting point is 00:25:22 We would buy those shares through an SPV so that you only see Link 2, if you're looking at the Robin Hood cap table, you're only seeing Link 2 on the cap table, or at least the name of that SPV. And it would be like, you know, Link 2, Robin Hood. SPV or something like that, right? The whole idea there is, typically speaking, these VZ-backed companies, the more names that you have on the cap table, the uglier looks for them, right? So, they want to keep their cap tables as clean as possible and have them make a lot of sense. So if we allowed every single one of our retail investors to get a spot on the cap table, not only would that be a logistical nightmare, but it would be pretty darn hard for us to actually

Starting point is 00:25:58 make that happen. And it wouldn't be favorable to the company. With these SPVs, when you invest into the SPV, we essentially give you an allocation that's directly proportional to the amount of shares that you're purchasing or the shares that we purchased, the amount of shares that we actually purchase in the company that are sitting in the SPV. Let's say that we acquire, you know, to keep things simple, 100 shares. If you invest essentially 10% worth into the SPV, then you would be allocated 10 of those shares. That's how the mechanics work. The math works out, it's directly, you know, the math works out directly so that, you know, you are technically owning those shares. And then when there is a liquidity event, we make sure to settle those shares into your brokerage account.

Starting point is 00:26:36 So on the liquidity side, I'm really interested in this as well. So is there like a closing date for the SPV, for example? So if I'm investing, does that round or that fund simply just close up at some point that my money's locked in and I'm in there until there's some company-wide exit? Or is there a way to trade my shares to somebody else, like trading out of the SPV to somebody else? Maybe it's a year later through link to. As I stands now, that's how it works. You essentially invest in the SPV and you're locked up until there's some sort of liquidity event, right?

Starting point is 00:27:09 Now, I will say we are working on a feature that does allow you to sell your shares, right? So in the same way that, you know, you can go on to a brokerage for public equities, we are implementing a feature like that for private equity, where if you invested, let's say, early on into, or at least, you know, you had equity in Robin Hood, and say you got in at $18 a share, which is what we offered it on our platform at, then you could theoretically sell those for $30 a share before it goes public at what it did at $38 a share. So you could seek some sort of liquidity even at a capital gain before it goes public.

Starting point is 00:27:49 But we're working on that feature, and we hope to have more information on that later this year, if not into the beginning of next. Now, earlier you also mentioned that this was only available to accredited investors, but I know that there's this huge movement in democratizing VC, right? There's Start Engine and all. I mean, tons of other companies that are doing this. And you guys are doing this more of the private equity space. And it's a little bit different than the VC side of things. I'm curious, are you going more that route where you can reach people who are unaccredited at some point in the near future? Yeah. Ultimately, you know, we would like to get to that point, definitely. And to the point of

Starting point is 00:28:26 fairness, right? The bigger that the private markets continue to get, you know, the more scrutinized they become. And what I mean by that is the more the public is saying, you know, why in the world am I not able to invest into this, right? If these private markets continue to get larger and larger, it increases the argument that mom and pop investors should have exposure to this investment class, right? And it ushers in the question of fairness. You know, just to mention a little bit about the numbers in terms of performance. So there's this group out there called Cambridge Associates, and they looked at the returns of the public market benchmarks.

Starting point is 00:29:01 They looked at venture capital, and they kind of compared the two. So over the past five years, and this is looking back from 2020, the S&P 500 returned about 12% per year. For the top quartile of VCs that they had, it was about 22.5%. In 19.1% for the entire BC index. Those numbers were relatively the same for 10 years before. that, so the window between 2010 and 2020. But if you look at the past 25 years, again, the S&P around the 10% mark and the top quartile VCs had 25.1% average IRAs where the VC

Starting point is 00:29:39 index had, so broad VC index had 24.9%. And I find it interesting that the delta between the top quartile VCs and the broad VC index was literally 20 basis points. It was tiny. So that goes to show that this investment class altogether is just outperforming public markets. So that then brings into the question of, okay, so you're telling me that these large, that accredited investors, people who already have a lot of wealth, can continue to increase the size of that wealth at a much quicker rate than I can. And of course, you know, it goes without saying that these are riskier investments. But generally speaking, I think that I don't know what the, you know, the future regulation looks like for something like this. Obviously, you don't want anybody to be able to put money

Starting point is 00:30:24 into a company that their friend starts, right? Or I guess the regulation, an A plus offering does offer something like that. But you don't want somebody online to start a company and just be able to solicit a sort of investment. That's kind of what you're seeing in crypto right now. And it's not good because, you know, anybody can go out there, register an LLC, you know, market it very well and advertise that it's something that it's not. And then, you know, they've just lost a bunch of people with some money.

Starting point is 00:30:53 I mean, sure, there's the repercussions of probably spending some time in jail, but you still lost investors a lot of money. So you do want to protect against that. But at the same time, if you could make it so that you could tag on to some of the investments or ride the wave of some of these really smart VCs out there like Andreessen Holowitz and Lightspeed, who've typically outperformed a lot of these VCs even in the VC index, then I think that sort of might be able to level the playing field. Now, I will say there's also the drawback here of if you just open the doors to every. everybody investing into these venture-backed companies, then you're essentially going to see this mechanic where everybody, every retail investor, let's say that, you know, you open the doors to retail investors putting money into SpaceX. Everybody would be, you know, every guy on Reddit would be investing into SpaceX. And essentially what you would be doing is you'd be driving up the price of

Starting point is 00:31:44 equity far beyond its fundamental value. So there's an amount of capital that these funds tend to raise whenever they're doing their fundraising as a VC back company anyway. And you don't want that to be too much capital, right? You know, if I'm creating a software company and I don't need any more than $10 million, but I raise $300 million, then not only do I have way too much cash, but the amount that people paid for that equity, they probably way overpaid for that equity is super expensive equity. And that's not going to yield them a good return. So you want to avoid that problem. Now, I guess that question then comes into, okay, well, is there not enough capital in the private equity space or is there too much capital in the private equity space?

Starting point is 00:32:25 Or if we started a lot more retail investors into this space, I guess what would the effect be? And McKinsey actually looked at this. And right now, asset managers are, they essentially have mandates, right, where they can only allocate a particular amount towards alternative investments. And so what they're doing once they max out those mandates is they're turning to their wealth managers to help find retail investors to invest into these alternative investments, right? Alternative investments is a broad term, but private equity can be included in there. So when you think about is there an over allocation or under allocation of funds in the space, the data right now tends to suggest there's a demand for capital in the private equity space,

Starting point is 00:33:03 and that could be an opportunity for retail to get in there. So McKinsey estimates that this is going to, it could double within the next three years. Given the current market circumstances, I don't know if that's going to be the case, but you know, you could actually argue, and we can talk about this later, that these alternative investments tend to be more resilient even during economic downturns. So something you said earlier stood out to me. You mentioned that you kind of lean on institutions like Andreessen Horowitz, Lightspeed ventures, et cetera, for doing their own due diligence for these companies. But, you know, Lightspeed and Sequoia and BlackRock

Starting point is 00:33:36 and Lux Capital and Third Point. I mean, the top of the top, the creme of the crumb is we're all just kind of, you know, caught in the tide here with FTX. And of course, you know, fraud at FTCS could have manifested post their investment, right? Not saying they didn't do diligence here. But I'm curious because, like, these guys miss or maybe they just alluding to the possibility that they could miss. And I'm just kind of curious what you think about that. So look, I think the FTX situation wasn't necessarily something of a, you know, lack of due diligence. I think you could do as much due diligence as you want, but mismanagement of whenever they were doing their fundraising, their books were probably in order and made sense, right? But for they, it was Sam McMahon-Fried, you know, I would argue that

Starting point is 00:34:20 you can't trust the guy whatsoever. But if what he is saying is true, then everything, then all the crumbling really happened and the cascading happened within the last few weeks, right? Now, I will say that comes down to the fact that one, yes, there is an inherent level of risk with private companies and public companies too. Like, you know, you saw that with Enron. But, you know, There's an inherent level of risk, but fraud should not be accepted as kind of the operating standard. And there are some very smart people at Saskahana that I personally known and Sequoia that, you know, maybe they were frauded out and, you know, maybe they were defrauded of their investment. And it's hard to actually try and qualify that as kind of the norm for the industry, right?

Starting point is 00:35:03 So yes, it happened and yes, it's not good. And yes, it makes Sequoia look bad. But I would argue that there's a good chance that Sequoia actually did a good level of due diligence in that there was nefarious actors managing the company of FTX that ultimately kind of painted their investment or lost all the value in their investment. What other changes might you be looking for or from in the private equity space now that we're kind of in this new world, right? Higher rates and the cost of capital for all these funds is now much higher. Does that mean lower prices for private companies for a long time to come? Is it just a general slowdown in deals? What kind of are you expecting from the offerings, especially through maybe link two?

Starting point is 00:35:46 So there's an interesting trend that you'll see in venture capital, though. So, you know, with the increasing rate environment, right, I think you have to do a little bit of bifurcation of venture capital and kind of the buyout private equity side, right? And that's because buyout private equity tends to be very debt. reliant, a good amount of what they're using to acquire these companies is leverage, essentially debt. And when you see the increase in interest rates, well, that tends to drive enterprise values down. There's a different trend, though, amongst venture backed companies. And one of the things that a group called the Kane Angel network looked at was performance of venture capital

Starting point is 00:36:26 during the 2008 global financial crisis. In the year 2008, the S&P 500 returned negative 38%. Right. the NASDA composite negative 41%. Just take a guess where VC performs during that year. It was 14%. Well, there's then the question about why this is. And one of the interesting things that you'll see venture capital funds do during recessions is they tend to be a lot more conscious about where they're deploying their capital. Not to say that they're not conscious at all.

Starting point is 00:36:54 But what I mean by that is, you know, if they have a good company that they know was growing and can still continue to grow, but might have a little bit of capital constraints, What I mean by that is, you know, let's say that they raised three, four years ago or even a couple years ago and they're running out of cash. And at the same time, it's still a good business model that can very much survive beyond, you know, beyond a recession. What they'll do is instead of deploying capital, a new company, they'll instead allocate some of their capital to making sure that those companies may like stay afloat, right? So you kind of have this, in a way, this nursing of your portfolio companies during times of recession. And I think that could be one explanation for why this is, right? Is that, you know, thank goodness for the lead investor out there who's really focused on making sure that they can go and raise a larger fund in the future, that they have this capital that they can continue to deploy into their good companies instead of maybe making new venture investment.

Starting point is 00:37:50 And that's not to say that they aren't making new investments. They are. But, you know, a good practice that they'll see is just making sure that their current investments stay afloat. Now, another billionaire we study a lot on the show is Howard Marks, and Bloomberg was recently reporting that private equity in general is moving to net asset value loans. And Howard's firm, Oak Tree Capital, has raised $2.7 billion for its dedicated NAV loan fund this year. And it's made about $5 billion of NAV loans and preferred equity investments over the last 12 months. So I'm kind of curious, is this a fairly new product in a way, or just a strategy? And do you see this becoming maybe a new norm and maybe just start off by explaining what a net asset value loan is for those who don't know? Yeah. You know, that's interesting. It's something that I've just to become familiarized with, you know, but the concept is actually really interesting, right?

Starting point is 00:38:44 So what essentially they'll do is they'll take the net asset value of their company and they'll take some sort of loan against the portfolio companies that they have. So if you think about that, right, for a bio fund as their portfolio companies pay down their debt, what they're essentially doing is, you know, They're increasing the equity value, right? So they buy all these companies, they use leverage, then pay down that debt, and then they sell this company again, hopefully, you know, maybe increasing the enterprise value simply due to, you know, growth. Or if you had a company that didn't even grow at all, after paying down the debt, you've still created value, right? But, you know, as you're paying that down, you could still try and maximize the return of your portfolio by continuing to give yourself access to this leverage. And so it might be a better use of capital. to take on a piece of debt, buy more equity, if you will. So like if you're a private equity fund

Starting point is 00:39:35 and you've leveraged up your company and you've already paid down the leverage in one company, you could leverage up those companies again and use the cash flows from a new company you're acquired to service that debt. Right. So it's interesting. I would say in times of high interest rates or economic crisis, I would say especially if you have investments that aren't really that liquid, It might be a little troubling to have a net asset value loan. You know, it's a new product. These funds will do, you know, just about anything to continue to maximize their returns so long that, you know, they can continue to raise another fund and they're not losing

Starting point is 00:40:12 money for their investors. Kind of like taking out a second mortgage to like buy an Airbnb or something. It's exactly right. Yeah. It's like taking out a second mortgage. Just a provider of more liquidity, right? So, yeah, actually you were spot on with that. Now, the loan to value of a second mortgage might be different because there's a little bit more liquidity maybe with a mortgage than portfolio of private equity companies.

Starting point is 00:40:35 But, you know, hey, that's kind of one of the advantages we have, you know, the liquidity profile being able to sell your equity. So, you know, at the same time, you know, I too have just heard about net asset value loans as of, you know, pretty recently. But for the most part, I would say that it will definitely enhance returns, but it could be a problem if you're kind of facing a high interest rate environment and there might be. might be a little bit of a liquidity crisis where you can't service this debt. And so if you default on it, well, what does that look like? Are you going to have to sell some of your portfolio companies? Are you going to sell them at a huge discount? Is there going to be, are you going to be then losing a lot of money for your investors? I don't know. So it's kind of one of those things that you want to just wait and see. Let's take a quick break and hear from today's sponsors.

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Starting point is 00:44:40 have been listed since 2020, which is just kind of mind-boggling. If you think about 2020, everyone had savings built up. They weren't spending it on travel or anything else. And credit went way down. All these people were pretty flush with cash. So they went and they bought these excess income properties probably as part of the great resignation. And then you have to kind of assume that there's been sort of an oversupply here that's going

Starting point is 00:45:01 to drive down. I mean, people can't even probably manage these mortgages with, you know, if you're competing at such a low base rate, right, for rentals. And so I'm kind of curious if I've seen a number of properties going for sale now because, you know, they can't just get the nightly minimum that they were. want just to cover their mortgage on it. So I'm wondering, like, in a similar fashion, could there be this cascading effect where, you know, you start to liquidate a lot of things just because you've kind of over-extended yourself? Is that kind of what you're alluding to here on the private

Starting point is 00:45:27 equity side? Yeah, that's exactly what I'm alluding to. Not only am I alluding to that, I think it's very much a real possibility. Now, granted that these private equity professionals tend to be pretty savvy just from working with them, but, you know, you never want to say that too soon. I mean, you see very smart people losing a lot of money. We're doing some things that probably weren't nefarious in nature, but ultimately had a bad effect, whether intended or not. Probably had a bad effect, even though that they really didn't intend it. Well, I know Oak Tree is pretty conservative.

Starting point is 00:45:58 We've had Howard on the show a number of times. So if they're doing this, what would you read into it as far as like a prediction on whether or not we're entering into a very deep recession or not? Is this a signal perhaps that they're thinking, hey, this isn't going to be that bad. The risk is fairly low for us to take this approach. Yeah. I mean, I think that's the saving grace for me is like, one, to your point, Tree is a very conservative group. And then the other is that we're entering high interest rate environments, right? So a nav loan for these portfolio companies may not make a lot of

Starting point is 00:46:31 sense. But at the same time, a nav loan for these portfolio companies might not be a good thing. But the thing is what I've really come to understand is I don't want to doubt those that group. I mean, for the most part, a lot of them are much smarter than I. There's probably a very good reason why they're doing this. I honestly don't think anybody has a good idea of whether or not we're going to be entering a deep recession or not. It's one of those things that, you know, it's kind of like forecasting weather. Everybody kind of has their guess. Some of the really smart fixed income guys like Mohamed Alarion said kind of there were three mistakes that the Fed made that ultimately led to this sort of environment that could push us into a deep recession. I think

Starting point is 00:47:13 nobody really knows for sure if there's going to be a deep recession or not, but at the same time, if Oak Tree is putting out these NAV loans, maybe it's an indication that they don't think that this is going to last all that long. So, you know, in two, right, maybe all this means is these portfolio companies at these private equity funds. Maybe, you know, I don't want to doubt to the due diligence that Oak Tree probably will put into these loans. Maybe the cash flows of these companies makes a lot of sense. Still, maybe the fundamentals of these companies still looks good. So a loan providing these private equity funds loans in order to maybe scale up their

Starting point is 00:47:49 portfolios, maybe there's some rhyme to this reason beyond it just being a high interest rate environment. Like maybe the fundamentals of these companies still make it make sense, even though the interest rate is higher. So I don't want to just immediately say that a high interest rate environment is going to lead to is not a good reason for them to leverage up. It tends to be the case, but if the fundamentals make sense, then why not go for it? So speaking of leveraging up against collateral, right? It seems like the only real casualties we've had in this sort of early recessionary environment has been in crypto.

Starting point is 00:48:22 And, you know, because no one's really using this crypto as collateral outside of crypto, it seems like there's not really that contagion effect happening, which is the good news. So far, I mean, I think it may be too early to be said, but, you know, I'm kind of curious if you have this idea around, given the everything bubble, right, that we've just sort of built up, is Sam Bankman-Fried going to be the Lehman moment? Because it's hard for me to imagine that given everything we've built up, that's going to be the only casualty so far. In fact, even though it's kind of isolated in crypto, do you see anything crossing over or have any further insight as to how you might see further decline happening if that's the route we're going? Yeah, well, one of the effects of the Federal Reserve kind of pushing us into a higher interest rate environment and more broadly speaking, tightening through both higher interest rates and quantitative tightening is you tend to see a lot of companies that probably shouldn't have made sense as a company start to drain out. So I don't know if it's just going to be crypto or if there's going to be contagion beyond crypto. I would imagine so. Generally speaking, there tends to be a ripple effect through not only one particular sector, but more broadly, you know, others as well. I don't know what that will be next. I think it's way too early to kind of make any

Starting point is 00:49:37 sort of judgments. Now, for the crypto space, I would say that, you know, the contagion, you know, fortunately seems to be restricted to that. And I think a lot of that too just comes from some mismanagement of capital in terms of, you know, how you should be managing your company. I mean, it's why, you know, we had Basel 3 for banks after the 2008 financial crisis. It's why banks are so heavily regulated. But, you know, in this crypto space, you're seeing a lot of these companies, companies go belly up, you know, starting with FTX. And, you know, you see that too with, with Voyager and Celsius. Part of the reason why you're seeing this is really because of either business models that really, you know, don't have businesses. You're seeing this because

Starting point is 00:50:17 you have, you know, businesses that are either mismanaged, some kind of experimentation happening in this. I mean, the decentralized finance space is really a lot of experimentation that you're seeing happening right now. And so as that happens, there's obviously going to be some losers that don't make it. So broadly speaking, I think the issues with the crypto space are due to a lot of growing pains and lack of sound business models in many cases. So I don't think that in particular, that contagion will be spread broadly to other spaces. I mean, hopefully not. Now, if there was exposure, I know that there's a particular bank out there that did have exposure through offering lending vehicles to Bitcoin. Maybe that might have exposure. You know, hopefully that might just be a bank

Starting point is 00:51:00 that's not way to, maybe there's not that many depositors there. It's definitely not, you know, the size of Lehman Brothers. But it's way too early to tell if this contagion is going to spread just beyond crypto and into other spaces like software as a service. I don't think it'll expand into software as a service at all, but, you know, it could, right? It really depends how bad the recession, if it does happen, exists. Or if we are in a recession, I, you know, I don't, I don't want to get into this. I don't, I particularly, I don't care, you know, definitionally, are we in a recession or not? You know, where are we at in terms of the healthy economy?

Starting point is 00:51:35 More broadly is what I do care about. Now, what are you taking from these major tech companies, Facebook, Amazon, all announcing these massive layoffs? Is this something that is just, you know, tied to these companies that were playing with all this free money and experimenting, like you said, and going into these really radical moonshot ideas and then coming to this new environment saying, we've got, you know, some excess fat here to trim. and that kind of is unique to these kinds of companies,

Starting point is 00:52:02 or do you think these layoffs are going to trickle over into other types of companies as well? And if we do see unemployment tick up, what do you think the Fed's response would look like? I do think that you're going to see a lot of these layoffs just beyond sort of the big tech companies. I do think that you are seeing these happen, but maybe they just don't make the mainstream, like these big tech layoffs do happen.

Starting point is 00:52:24 You know, I think the function of why these companies got so big really was because of cheap capital out there. And, you know, when you tend to have typically high margin companies, software companies are, you know, in the case of Facebook, an advertising business, when these companies get to a, you know, a particular size and they have so many employees, right, they ultimately get to this point of inefficiency where, you know, there's probably employees, I wouldn't say probably, there's definitely employees that they just probably don't need, but they've hired simply because, you know, there was no repercussion for not, right?

Starting point is 00:52:58 So that was primarily due to, you know, a cheap capital environment. So even though I think we're just seeing the beginning of this, I think it's going to expand more broadly into other areas as well. I think it's going to expand more broadly to other companies that are not just, you know, like the Facebooks or the Amazon's of the world, right? Again, they probably won't hit the mainstream news for this, but they're definitely happening and they will happen if they haven't already. With the Federal Reserve, I mean, they have this dual mandate, right? mandate number one is price stability, in no particular order, at least, you know, in terms of how they lay them out, price stability, and then the other is maximum employment, right? And so when you, when the two are at odds, ultimately, what is history tell us that the Federal Reserve will do,

Starting point is 00:53:44 is that they will maintain or that they will focus on price stability, right? You know, we saw this in 1970 where, you know, the Federal Reserve had increased rates, inflation, was coming down, but they decided then to, okay, you know, inflation's coming down. The economy is not doing well. We need to do something about the economy, right? So they ended up decreasing interest rates. And what the resulting effect was that inflation shot back up, right? And the Federal Reserve, they're privy to this. And Neil Kishari had even said that, you know, he quoted this instance as something that they want to avoid happening altogether. So when price stability and maximum employment are at odds, it tends to be the case that they focus on price stability

Starting point is 00:54:29 because there will be long-term effects if inflation does stay high that they want to avoid immediately. On that note, I'm kind of curious where you stand on the side of criticism of the Fed. There's a lot of folks out there who, I mean, almost believe this is some nefarious entity that doesn't have the public's best interest. Then there's others who are like, hey, these are just, you know, normal people trying to do their best. Where do you kind of fall on this side of things? Yeah, you know, I fall into the ladder camp. I believe, you know, the Federal Reserve is not a nefarious organization and they truly are trying their best. And, you know, I think we should

Starting point is 00:55:04 acknowledge that the Federal Reserve is kind of in a difficult position right now, right? In particular, I don't think that they are completely void of any sort of fault. You know, first, I want to recognize that the Federal Reserve is in a very difficult position in that I do believe that they are genuinely trying their best to make it better. Now, I tend to it subscribed to what Muhammad Alarion believes about this and that there were three mistakes that the Federal Reserve made. The first one was seeing inflation as transitory as something that will resolve itself. But in all fairness to the Federal Reserve on this, though, the textbook response here is that whenever you have kind of these supply side issues and whenever you believe that

Starting point is 00:55:46 inflation is driven by a supply side issue, you kind of let it resolve itself, right? In very free market response to this. But some people like Jamie Diamond, you know, makes the case that when you put $6 trillion into the economy through a combination of fiscal and monetary policy, then you're going to have a sort of inflation. And so, you know, that brings me on to the second mistake, which is that when they saw inflation and they saw as persistent in high, they didn't act right then. And now we're at the point where they're kind of late to the game. They enacted 75, three consecutive 75 basis point rate heights. And now we're kind of hitting the brakes really hard just to bring us into restrictive territory, right?

Starting point is 00:56:28 And, you know, there's a reason for that. Inflation is driven by money velocity. And when you can slow the speed of spending down, you could ideally bring down inflation, which would negatively impact GDP. But look, you know, it's, again, I want to recognize that the Federal Reserve is in a very tough position. It's really hard to respond to high interest rates or it's really hard to respond to inflation. Now, are they part of the source of that inflation? Jamie Diamond would say no. To be honest, you know, I think it's a combination of supply chain issues as well, not just, you know,

Starting point is 00:56:59 excess liquidity. But I think that, you know, the criticism is a little fair and it's also a little bit unfair. Which brings me to, I've noticed that, you know, some organizations like the United Nation has written directly to the Federal Reserve saying that your aggressive monetary or your aggressive rate hikes that you're enacting is really bad. for some of these developing countries, right? I mean, you know, a strong dollar is not good for a lot of these countries, right? You know, whenever you're borrowing in a foreign currency and it's denominated in dollars, the dollar increases in strength. That's more dollars that you have to buy in order to pay back that debt capital, right? So it's understandable why that's hard for some of these

Starting point is 00:57:41 developing countries. It is really a tough position to be in. Kathy Wood also wrote to the Federal Reserve in an open letter for Mark Invest, suggesting to that, you know, there are, monetary policy is going to be really bad for the economy. I mean, maybe it will be, but what we've seen is that the Federal Reserve will do everything that they need to do to restore the strength of the dollar and bring inflation levels back into the 2% range. All right, Darren. So one other fun fact that we're going to reveal here on this show is that you are actually the voice and creator behind how money works, which is a massive channel on YouTube where you've been providing all these incredible high production value videos about not only

Starting point is 00:58:19 how money works, but the economy and a wide range of investment, et cetera. What kind of prompted this and tell us a little bit more about how this came to be? So I think you could kind of trace it back to 2019 when I was starting my first banking job. And I was working in a relatively small shop, just trying to get my foot in the door. It was one of those shops where you kind of had a banker that used to work at a relatively big shop and has since just wanted to do his own deals. and I was kind of interning for him. And I saw the opportunity to build a channel and one that, you know, I could talk about money. And so the original channel was actually called Compounded Daily.

Starting point is 00:58:59 And I was just going to just focus on really interesting like case studies around finance and companies. And, you know, through a lot of trial and error, I kind of figured out what didn't, didn't work. And then things weren't really working out for the channel and Compounded Daily. And so I started to switch my model to, I had a lot of interesting things to talk. about, but the video production was what was taking me a lot of time. And so what I transitioned to then was essentially writing these things I found interesting. So the approach of the channel I like to describe it as very much like a Malcolm Gladwell of money approach where I find an interesting case study that's not really talked about a lot.

Starting point is 00:59:33 And I make a video about her. So one of those things, David Graber, he writes about bullshit jobs in a book. David Graber is an anthropologist, some guy who I find incredibly interesting. And I figured, you know, I can make a video form of that, just basically talking about what David Graber thinks. So I basically took that approach to the whole channel, making things that are interesting. So yeah, you know, when I started the channel back in 2019, it was more so an experimentation thing, bringing some of, you know, my skills from animating that I did kind of as a freelancer in college

Starting point is 01:00:05 and then applying, you know, what I learned in finance and working for that small shop. And now, you know, I kind of continue my career with banking. and in 2020, was when I rebranded the channel to how many works and at the time it had, like, what, 3.8,000 subscribers? It really wasn't that much at all. And I basically changed my model to, let's make it a lot easier to put a video together.

Starting point is 01:00:32 I'm going to speak like it's really interesting. I'm going to put together an interesting case study and, you know, I'm going to try and streamline the video production process by using like stock footage from story blocks. And that allowed me to create a YouTube channel while I was also doing banking alongside that. I eventually got to the point where the channel got large enough that I could hire an editor. So I did that. And all I had to do was speaking to a microphone and write scripts at that time.

Starting point is 01:00:58 But originally it started out as a hobby. I believed at one point it could end up turning into a nice bit of income. But in many ways, it's kind of turned into a second job for me. But, you know, I love it. And it's really interesting. and it allows me to really kind of bring what I like doing out. And that's being creative in a way that I can talk about something, you know, be economics or finance in an authoritative way.

Starting point is 01:01:24 It's an amazing resource and it has almost 600,000 subscribers on YouTube. So you've done a massive job here and it's incredibly impressive. So congrats on that. And Darren, I really enjoyed our discussion. We talked about a lot of cool things I'm interested in and I got a lot out of it. So I hope our audience will as well. I know they will. before I let you go, can you just give a handoff to our audience where they can learn more about you,

Starting point is 01:01:46 how money works, and link to. Yeah, you can check out link to at link to.com. If you are an accredited investor, I strongly encourage you taking a look at some of the assets we have on there. You could reach out to our team. If you're interested in investing, we'll bring you through every step of the process. Or you can check us out on Twitter. Our handle is L-I-N-Q-T-O. And then me personally, you can find me on Twitter at Darren, so, D-A-R-I-N.

Starting point is 01:02:11 S-O-A-T. And then if you want to check out how money works, you can go to YouTube.com, search how money works. It's a green logo with a dollar sign and a question mark. And, you know, there's a lot of content on there. So hopefully you can find something interesting. Fantastic. Well, Darren, thank you again. Thanks, Treff. All right, everybody, that's all we had for you this week. If you're loving the show, don't forget to follow us on your favorite podcast app. And if you'd be so kind, please leave us a review. It really helps the show. If you want to reach out directly, you can find me on Twitter at Trey Lockerby.

Starting point is 01:02:42 And don't forget to check out all of the amazing resources we've built for you at the investors podcast.com. You can also simply Google TIP Finance and it should pop right up. And with that, we'll see you again next time. Thank you for listening to TIP. Make sure to subscribe to millennial investing by the Investors Podcast Network and learn how to achieve financial independence. To access our show notes, transcripts or courses, go to the Investorspodcast.com.

Starting point is 01:03:09 This show is for entertainment purposes only. Before making any decision consult a professional, this show is copyrighted by the Investors' podcast network. Written permission must be granted before syndication or rebroadcasting.

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