I Learn Best by Having Skin in the Game
Over the last few years, I’ve had the opportunity to invest directly in start-ups as an angel investor, invest in venture capital funds as a limited partner, invest directly into start-ups as a Partner at a venture capital firm, and help organizations do their due diligence on direct investments into start-ups with strategic value.
I’ve learned a ton from all of it—but I’ve learned the most from investments when my personal capital has been on the line. This includes investments in funds and start-ups.
I learn best by doing, and in investing, “doing” means investing my own capital.
More GP Stakes in VC?
A venture capital investor shared this article with me. I won’t go into all the specifics of it, but it says that private equity fund managers are selling pieces of their firms to raise cash. Instead of investing by becoming a limited partner in the firm’s latest fund, some investors are seeking to buy part of the firm to gain exposure to the firm’s current and future investments.
This isn’t new in private equity. Neuberger Berman started a division in 2010 to focus exclusively on this strategy. That division, Dyal Capital Partners, merged with Owl Rock Capital Group in 2021 to form publicly traded Blue Owl Capital Inc. Blue Owl just announced the closing of Dyal Capital Partners V, a $12.9 billion fund focused on taking ownership stakes in approximately 20 private equity firms.
I’ve been closely watching the world of buying stakes in private equity firms for a few years, and I have some thoughts:
- It was only a matter of time before this trend reached larger venture capital firms. It’s starting to happen more now, as evidenced by Thrive Capital’s recent news.
- This approach could provide emerging venture capital fund managers with the runway needed to continually execute on their strategies.
- Venture capital fund managers early in their firm’s life cycle see selling part of their firm as having a negative connotation. This leads to many VC firm founders having a bootstrap entrepreneur mentality and the industry being a cottage industry (there are other reasons for this too).
- As more established VC firm founders realize liquidity by selling parts of their firms, more founders of smaller firms will be open to taking capital in exchange for equity so they can grow their firms.
Decade-long Commitment a Turnoff?
It’s often seven or more years before a start-up has a material liquidity event such as an IPO or acquisition. Founders should be comfortable with a journey of that length if they want to pursue entrepreneurship.
I recently had a chat with a venture investor who considered starting his own venture capital firm. One of the main reasons he hasn’t is the realization that it will commit him long-term. It will likely take twelve to twenty-four months to raise the fund. Funds usually have a ten-year life cycle, so once he begins investing that capital into start-ups, he’s committed to managing the fund for a minimum of ten years. That’s an eleven-year-plus commitment he’s not willing to make. Instead of writing larger checks from a VC fund, he plans to write small angel checks. He’s putting more of his own capital at risk, but he wants to preserve flexibility over the next decade.
This investor has deep domain experience and a strong network in a particular sector. Any early-stage founder he works with will get a tremendous amount of help and is more likely to achieve product–market fit.
Listening to this got me thinking. I wonder how many seed-stage venture investors (current or aspiring) who could help companies find product-market fit avoid starting a venture capital fund because of the decade-long commitment.
CalPERS Commits $1B to Emerging Managers
The California Public Employees’ Retirement System (CalPERS) recently announced a $1 billion commitment to back emerging private equity managers. The goal is to foster more innovation and entrepreneurship in the investment industry by backing the next generation of managers. CalPERS, with around $440 billion of assets as of June 2022, is a juggernaut in the investment industry and can drive change.
The announcement references private equity, but this is a big deal for the venture capital industry. Venture capital is a subset of private equity and should receive some of these dollars.
Many studies have shown that emerging managers generate alpha, and the CIO of CalPERS recognizes this. This quote from her stood out to me:
It’s not about a diversity play. . . . It’s about generating alpha in a more thoughtful way, and leveraging partners we will work hand in glove with.
Can’t wait to see the impact that CalPERS’s commitment has on early-stage venture capital.
Predictions for 2023 from a Seasoned VC
Last week, Fred Wilson shared his predictions for 2023. Fred’s a well-known VC and general partner at Union Square Ventures. His thoughts on start-ups in 2023 were of interest to me. A few points that founders should take note of:
- 2023 will be a tough year for start-ups. As money-losing companies, many avoided raising in last year’s difficult environment. They’ll be forced to raise this year as their cash dwindles.
- VCs have ample capital to invest but will be more selective. Companies with product–market fit, strong teams, and good unit economics will be able to raise. Start-ups that don’t have these things will struggle to raise, regardless of valuation, and many will fail.
- Valuations will return to the levels of 2015 or so. Seed rounds will be around $10m, Series A rounds around $15–$25m, Series B rounds around $25–$50m, and growth rounds capped at 10x revenue.
- Lower valuations will lead to flat rounds, down rounds, inside rounds, and lots of structure in the rounds. CEOs and boards should accept the pain of lower valuations over a lot of structure.
Fred’s predictions come from someone who’s seen a few VC cycles. Things won’t necessarily play out just as he’s said, but his predictions are something for founders to be aware of.
I’ve had chats with a few founders in the last week about their next funding round. Many have accepted the current valuation environment but haven’t processed what impact a down round or one with lots of structure will have on the cap table and start-ups overall.
I’m of the opinion that Q1 will set the tone for 2023. If the rate of decline in public markets we saw in 2022 persists, Fred’s predictions are more likely to be accurate. If public markets are flat to slightly up, I think conditions for start-ups could be slightly better than Fred predicts.
Vista Takes Duck Private . . . More Deals to Come?
Today it was announced that Vista Equity Partners will take Duck Creek Technologies private. The transaction values Duck at about $2.6 billion. Duck is a publicly traded company that IPO’d in August 2022. Its market capitalization (i.e., valuation) peaked around $7 billion in 2021. The company’s valuation was below $2 billion last week before this deal with Vista was announced.
We can’t do an apples-to-apples comparison of the two companies. For example, Duck reported $80 million in revenue last quarter, of which $27 million was professional services revenue and likely not recurring. Salesloft is private, so we don’t know the details of its $100 million in annual recurring revenue. But the Duck transaction shows that Vista is buying a public company for around the same valuation they paid for a private company a year ago.
Last year, I thought that low valuations of great public companies would make them attractive acquisition targets. I didn’t see this play out last year, but I suspect we’ll see it this year if valuations stay depressed. Vista’s deal for Duck could get things going. If this happens, great public tech companies trading below a $2 billion market cap could see increased interest.
Emerging VC Fund Origin Story
I love hearing company origin stories. It’s always interesting to hear what led someone to start a company. I’ve started asking for the origin stories of younger VC funds too. Emerging managers are founders too, and going from zero to one with a fund can be difficult. I love hearing why they made the leap. I recently heard a VC fund origin story that was different than any I’d heard before.
Venture capital and its outsize financial rewards have been known in areas like San Francisco for decades. A founder from another country was able to take his start-up public and reap a massive windfall for himself and his investors. This hometown story caught the attention of founders and investors in his native country, who wanted to know how they could support the next local founder who’d have breakout success.
A multifamily office in that country was repeatedly getting asked by the families it managed wealth for if it could find some early-stage investment opportunities. Its leaders realized there was no venture capital in the country and decided to start the first venture fund there. They settled on a hybrid strategy of investing in other venture capital funds and making direct investments in start-ups.
Fast forward a few years, and they’ve raised a few funds and had one of their seed-stage start-up investments go public. The fund managers are happy, as are the founders they backed and the limited partners who invested in their fund.
What an interesting origin story.
Takeaways from an Interview with Vista Equity’s Robert Smith
I watched an interview Robert Smith gave recently. He’s a billionaire and founder of Vista Equity Partners, a private equity firm focused on software companies. Robert was very open, sharing details of his childhood, his journey from engineer to investor, and his perspective on a variety of topics. He did a great job of explaining private equity, venture capital, and capitalization at different growth stages in a company’s life cycle in a way that many people can understand.
I’ve spent time thinking about the impact of knowledge gaps on a founder’s velocity. Robert shared his thinking about knowledge gaps and how filling them is core to his strategy at Vista. Here are a couple of things he said that stuck with me:
“You’re accelerating the corporate maturity of that business. It might take you 10 years to figure out what we’ve done 45 times already. Now I bring that intellectual property into the company.”
“You may not have figured out or may not figure out because you may not be in an environment or circle of people who have dealt with that before. That’s why the expertise we bring is often more valuable than the capital.”
Even though he’s a private equity investor, Robert is also a founder. He founded Vista over twenty years ago and built it to almost six hundred employees and almost $100 billion in assets under management. He was speaking from the unique perspective of both a founder and investor who’s had outsize success. I think it says a lot that he’s built an organization whose success is largely based on creating value by filling the knowledge and capital gaps of people running later-stage companies.
Perspectives from a Real Estate–Focused Family Office
I chatted with someone who used to work at a family office with a real estate background that manages a large investment portfolio across different asset classes. This person shared a few things that stuck with me:
- Opportunities to create value and wealth in real estate won’t look like the past. The return profile will look different. Individuals and families who own real estate will likely keep it and pass it on for a variety of reasons (taxes is a big one). The acquisition prices seen in the last few decades likely won’t be repeated, making it harder for new entrants to create returns like those of people who started thirty or forty years ago.
- Other asset classes, such as public equities, aren’t great for multiplying wealth.
- Venture is the best asset class for value and wealth creation. It’s a great asset class for those looking to multiply wealth, not just preserve it. But it’s one of the hardest asset classes to penetrate if you don’t have a background in it or existing relationships. It’s also hard for family offices to be successful if they don’t have the appropriate risk appetite and portfolio construction strategy (i.e., in relation to check size and stage). Family offices like venture as an asset class but can struggle to have success.
Interesting thoughts. Some of them I’ve heard from people in other family offices I’ve talked with. We’ll see more capital flow toward owning private companies (i.e., private equity), with many family offices and other institutions specifically wanting access to early-stage private companies (i.e., venture capital). Overall, I think this is good for entrepreneurship and founders. I do think we’ll need to see improvements in how that capital (and other resources) are matched to founders. At the early stage (seed and pre-seed), the process is massively inefficient.
Emerging Managers and Founders: Lead with Your Story
One of the things I like to learn about a founder is their origin story. How were they raised, and what were they doing in life that illuminated the problem their start-up is solving? Sounds simple, but the origin story can be a leading indicator. Today I listened to a few fund-of-fund investors critique an emerging venture capital fund’s pitch deck and give guidance about how emerging managers can best pitch limited partners (LPs).
A consistent piece of advice for all the funds of funds was that emerging managers should lead with their story. The pitch deck shouldn’t jump right into thesis, investment track record, or how much the manager is raising. It should start with background on the manager—what their journey has been and how led them to raise their own venture fund and come up with their investment thesis.
LPs are buying a portfolio of to-be-determined portfolios of investments. Ideally, they’d look at previous fund investments to gauge what a manager’s future portfolio of investments might look like. However, many emerging managers won’t have an investment track record. When that’s the case, LPs are investing in the managers. They want to get to know who the managers are, how they think, and why they are the way they are. Understanding what makes them tick will give LPs more comfort around the person they’re backing and the nonexistent portfolio they’re buying.
This feedback makes a lot of sense, and it was a reminder that emerging VC fund managers are basically founders. Telling an authentic, compelling story—as a manager or founder—can be the key to getting early believers on board.