Creating a $140B market: The secondary market masterclass - Larry Aschebrook [G Squared]

26:22Try to underwrite like a primary investor. So we can't use the excuse of we didn't have enough information or we didn't have the interaction with management. It's truly our mistake. And it's the price we paid. Because in one example, QuickCommerce, we had a lot of success in Instacart and Postmates, Meituan, Daping, Alibaba. We had great success. Pandemic happens. We deploy over the course of 18 months a lot of money into QuickCommerce. And we all know how that story ended. And we were not immune to it. and so as I look at the process were there points in time that we could have exited our positions and the reality of the answer is yes and we didn't do the work that we should have done for our LPs on on that particular space and those are the things that we have to make sure that we improved upon and put guardrails in place to not have happen again.

27:33Larry Aschebrook:So now do you have like, yeah, sorry, go ahead. No, go ahead. Now I was wondering, now do you have like very specific rules? So for example, let's say you mentioned like companies like Anthropic, OpenAI. I mean, we've seen like the scale and how fast this valuation, I think now we're entering, you know like an era where valuations are going through the roof uh you know like to to access entropic like the last round i'm guessing they were not looking at investors below like 1 billion you know in term of check size so how do you if you have a position you know in these companies when do you decide to sell what amount do you sell do you like reinvest like how do you map out like the strategy yeah i well so leaving well first of all in those two businesses fantastic value creation for lps every day um and for their shareholders and their employees um you know congratulations to both of those businesses and we're fortunate enough to to have exposure to both um i would say you know that the rules of the game are are really changing but you know as we're playing the board game in valuation and growth and underwriting and cash needs of the, you know, AI native businesses.

28:55It's something as a LP or excuse me, as GPs, we've really not seen before. And it's very difficult to underwrite. What I would say about those two assets is they're probably, you know, still in their infancy. So the majority of the people that got in at the right time are going to have a fantastic outcome. Just generally speaking for G squared, what we're after is a North star of this two and a half to three X DPI in a five to seven year period. And as we start to achieve that per fund, um, you see us starting to, to, to de-risk. Um, now in the high flying assets, they typically have an outcome that, that happens on their own quickly.

29:38Um, you know, there's, there's no gravity holding some of them back. Um, uh, you know, Wiz showed it with their Google acquisition. That was a fantastic position for us. It closed recently and really got to know the founders through trips to Tel Aviv. And they trusted our process. And we built a very large position there. And we're fortunate to have an outcome that was generated for us by the company. But for the most part, we have to focus on selling at the right time in conjunction with the company's needs. And so I think one of the struggles of running a concentrated equity portfolio, primary or secondary, is when it comes time for you to meet the needs of your LPs, you have to do it in a way that's beneficial to the businesses.

30:24Making sure that if you are transacting, you do it with very high quality third parties that can provide value to the companies differently than you. and Coursera

30:34Larry Aschebrook:basically you you go with you go to the board saying like hey I've got let's say a very well known like a family office who has great connection in that specific region would like to acquire like let's say a hundred million of my position I think it can be like a helpful partner like can we make this happen or is it family offices to large global financial institutions Um, you know, Coursera is a great example. We were, uh, uh, I think we're the largest shareholder of Coursera at the time it went public. Um, and we worked with the company and a very large, um, sovereign wealth fund to come in and, and transition our position to them.

31:20So we didn't, you know, sell it and drive the stock down over, you know, 180 days, because I think that's one of the issues in the public markets today is there's just ultimately no liquidity for large-scale positions. So, you know, you think about, and we're small, right? And still small. We're bigger than we were, but in reality, G squared, you know, we're approaching 7 billion today in assets. It's still relatively small compared to some of the other players, but we do build very large positions, several hundred million dollars of cost basis. And in the case of some of them, it gets to be north of a billion in net asset value in one position.

31:58When you go to sell that in the public market, it's almost impossible without moving the stock price. It takes forever. And if you are unlucky and have one of those great businesses go public in Frankfurt or the LSE, there is not enough liquidity.

32:19Larry Aschebrook:It's impossible. There is no liquidity. So this idea that the public markets create massive amounts of liquidity for GPs at large scale is really false. It's a false narrative. And so what we've decided to do in our business focused on this DPI metric is when it's time, we work with the companies. We find shareholders that they want to get involved with, and we help transition it to them in a win-win. Similarly to what they did for us building the positions. Now it takes time and energy and patience. But ultimately, we are stewards of trust from the issuers. And do you negotiate that from the start with the company?

33:07Larry Aschebrook:Because I'm assuming, you know, that obviously, you know, when a company gets to a stage where it's like super sexy, everyone wants in and they just want to raise and they don't want like existing shareholders to get liquidity. It's much easier on the way out than it is on the way in. Our business model, we refer to it as the land and expand. You kind of fire the rifle to calibrate the cannonball, so to speak. Okay. We're dollar cost averaging in, very small positions up front. It's when we get to the top 10 or so per fund where we have, you know, two, 300 million of cost basis in a position, and we need to then start to trim it as it gets to massive and scale because we have to have risk controls.

33:53Companies understand that at that point. In the beginning, if I were to show up and say, hey, I'm like, I love your business. I want to buy today. And 18 months from now, I'm going to sell the position to somebody you don't know. It's going to be much more difficult.

34:10Larry Aschebrook:And you just can't. You can't operate that way in our industry today. It is back to a club mentality. but it's more new line growth managers than I would say the old line traditional VC firms with a few exceptions. And when you reach that 2x or 3x in DPI, is it per fund or is it per position that you look at it from a liquidity perspective? Yeah. I mean, our fund models will kind of tease that out, but it's a holistic perspective on the pool of capital. Now, each individual line item you need to meet a certain return, but they balance each other out. And still within concentration, we try to democratize the return a bit, but it's difficult across our four megatrends.

35:08trends. They have different themes within the mega trends that are more, um, uh, you know, are more prevalent during a certain time period. Um, you know, it was heavy consumer in 2015 through 18. Then it was, um, a lot of SAS in 2020, 2022 vintage has, you know, everything is amazing because we bought everything when the house was on fire.

35:34Larry Aschebrook:You know, there's a, You look at all the businesses, you're like, we're so smart. Well, no, I mean, we were. Everyone was scared. Everyone was scared. And that's, you know, as a secondary market player, that's when opportunity takes place is when you have really high tenure yields and federal fund rates, and you have everybody running to cash and commodities for safety. It creates real buying opportunity. And then today it's in the AI native businesses, which are unbelievable. But along the way, there's things from SpaceX to Anthropic to Spotify. And of course, all of these businesses are unbelievable to be around.

36:18And the energy that the management teams bring and the value they create for their shareholders and their employees is unprecedented. We're just a steward of that during the process.

36:31Larry Aschebrook:And, you know, like earlier you mentioned the fact that public markets didn't have like or don't really have now much sense, even when you look at liquidity and how liquidity is managed. We're seeing like some companies like, I don't know, if you look at Stripe, Revolut, etc, etc. Like sometimes I'm wondering, like, why would they go public? You know, like they do tender offer every single year. like they can get liquidity for existing shareholder employees etc they don't have like the pressure of reporting of public market they can keep you know like long-term vision yeah so from your perspective because you've seen like that uh that market evolve what does make one company go public and do you think that's going to change over time i think when companies access the public market, it's for their own reasons, and all of them have probably unique ones.

37:29Companies today that are accessing it for raising their capital likely have some CapEx intensive business model they need to support. And you start to see some of the conversations today that are happening in the public media around some of the big private assets. It's really the ones that require an enormous amount of cash still to continue to grow and to service their customer bases. And I think for the most part, segments of the new revolution in the AI industry have that. And those businesses are probably going to be better served as public companies. Companies like Stripe and Revolut, although they have an enormous amount of AI embedded in their DNA.

38:15It makes them great. We were fortunate enough to be early in Revolut and were in Stripe as well. Those businesses accelerating at scale is probably the most impressive that are profitable. And there's many of them like that. So I'd throw Databricks in that group too where you can stay private, not live your day in 90-day increments, invest in R &D, have great profitability, have programs for your employees that are similar to open periods of selling their stock as a public company and not have to deal with the majority of the cost or the pain of being public. And I like to think that we're a small part of helping those companies do that from the beginning, helping kind of write the rules and the processes within the tender space and the secondary space and seeing it flourish the way that it is today in these fantastic businesses and the reward that the employees are getting and shareholders for creating the value is very rewarding for us.

39:26Larry Aschebrook:and maybe it's a very european thing to say but do you think like at some point there's going to be like a regulation coming into play because if you look at uh so i invest also like in secondary through like friends connection or whatever but what i'm seeing it's like the moment you know like entropic was at 380 billion dollar valuation the the price of people selling on secondary market starting climbing you know at first it was like 400 then 450 then you see blocks of 500 550 so the markets like on private market there are like definitely like no rules things can be kind of like manipulating and changing so what do you yeah i think part of that is i call it chasing ghosts internally um because a lot of what you're saying is is is noise and it's not real it's um kind of the retail movement trying to get access to a very tightly controlled um business and cap table and so you see that in many of the businesses that become mainstream is is is logo recognition I would say Elon backed businesses have taken it to a new level of this and others have seen that business model and are replicating it so I think from a regulatory standpoint yes Europe loves their regulations we have a business in Europe we've had an office in Zurich since 2017 we've backed many of the terrific businesses in Europe and the founders And I think what you'll continue to see is a significant number of those founders continuing to come to the U.S.

41:16to set up their businesses and operate because the shareholder agreements are more flexible, raising capital is easier. The regulatory environment to operate in is less controlled. And I don't see a very heavily regulated secondary market. their private transactions, it would be like controlling you selling your home to someone else and then having regulations of somebody, just the government deciding how you can sell it and when you can sell it. That doesn't seem like a democracy or free trade to me. So I don't think that that happens. What I do think will happen and continue to evolve is the idea of some type of exchange that works.

41:59Today, there's a lot of ideas and a lot of capital flowing into it. Outside of kind of the tokenization, there's issues with exchanges to trade private securities, mostly because of the settlement. We don't have a T3 settlement period. The best you can get probably is a T14. And that's what - What does that mean? What does that mean? Like that's a transaction plus settlement. Like in the public companies, if you buy a share of meta, it settles within three days that stock trains hands for you. Right. So in the private markets, that doesn't exist. It's all paper still. Yeah. Right. Robinhood has figured out how to tokenize it and, and others.

42:42And that's super interesting. But at the end of the day, you're not owning actually any paper of the companies. And until specifically in Europe, until the early stage managers in Europe changed the way they deploy capital into companies, you're not going to see a very robust secondary market and you're not going to see the ability for companies to have an opportunity to get to the place that would be the holy grail is a trading platform. In the US, we're probably closer, but I still don't think by the, you know, I'm 48, 15 years in managing G squared. By the time I decide to walk away, hopefully 20 years from now, I don't think you'll still see it Because it's very difficult to settle private transactions.

43:27And the way the shareholder agreements are constructed, it's nearly impossible to do it outside of approvals that are needed.

43:36Larry Aschebrook:And what I've seen, you know, in private markets is a lot of different layers. So with G-squared, I'm assuming that you're always like direct captable. So you have like the proof of shares. everything is super clean but what we're seeing is layer 1, sometimes layer 2 sometimes layer 3 and people exchanging the shares just because it's easier and it doesn't it's not under the company's right to choose who's selling, who's not selling how do you see that kind of secondary market but that's a lot more on the layers of SPV the shadow market, the SPV market Look, I think that that's going to be very difficult to control.

44:21I think as anybody out there is trying to buy stock from someone, know what you're buying, do as much research as you can. Uh, it reminds me today of similar to when the first kind of craze was happening with this, with the Twitters and the Facebooks and the LinkedIn's and the Spotify's and the Palantir, this early movement that took place in the 2010 to 2014 period. and when it all unraveled, there was a lot of fraud. And I think retail investors that are out there that listen to your podcast or even small firms, like be careful, partner with good partners, do your research, do your due diligence, dig in and know what you're buying.

45:09And I think that's

45:10Larry Aschebrook:the biggest issue with that. So your process, if someone is entering like a layer two or something, it's to check who's on top, like make sure they have the proof of found, et cetera, et cetera. If I were in one of your listeners' shoes, I would start from the first entity. I would dig through it. I would ask for all the documents. I would get all the way down so you can follow the tree all the way to the cap table, tie it out, get audited financials of each of the vehicles. It's onerous and most people don't do it. And there are these SPV shops that are out there that this is their business and many of them are great.

45:48And they serve a place in the ecosystem. But there are, you know, not so great ones. Bad ones. People need to pay attention and they need to do their own due diligence because there will be, in my opinion, stuff that comes out as these companies get liquid and it's inevitable that there is some bad actors out there. So as investors want to play the space, go to the reputable firms that do it and there are those out there and find an opportunity.

46:21Larry Aschebrook:So when you decide to sell a position do you actually use continuation vehicles or do you like We tried. We tried one. And I would say that that industry needs to evolve from where it's at, especially in the growth tech space. The process that's currently put in place for CVs, and I understand why they exist and it's a good business and there's good returns to be had as the investors in those vehicles. It's currently structured for a PE-like transaction. Not in the world that we live in every day. It's not meant, It's currently not set up to have success with managers that have underlying assets that three months is like five years in traditional industries.

47:20The assets move so fast. The best assets in the world are achieving greatness on a daily basis and growing at unprecedented rates that most of us haven't seen before. And when you overlay a complex M &A-like CV process, because that's what it is, it takes months to get done, it puts a lot of risk on the transaction. We did one, we had it all the way to the finish line, and we ultimately didn't close it because the underlying assets moved so much. And you also need the full support of the underlying portfolio companies, which, you know, in our space, they're very protective of who gets on that cap cable.

48:04And it becomes very difficult to get some of those transactions completed. So I do think the CVs as an investor, because I'm an investor personally, and some of the large players in the CV market and they do great work and there are great people behind it. I do think the process needs to evolve. and I think if those players want to be more and more around the hoop, so to speak, with the logos that are getting all the attention today, they have to change their process because it just fundamentally doesn't work for a GP. How would you change it? Like what would you change in the position? It needs to be handled like a traditional secondary, not an M &A.

48:44It just needs to be very simple. It can be done in a matter of weeks. it shouldn't take six months.

48:53Larry Aschebrook:Okay. So it's like selling shares, putting them into a new vehicle, and then like, I guess. It's very simple. It's no different than if you and I decide to transact on an individual name, just transact in 10 names real quick. Time kills everything. And in our space, you know, three months, you just look at some of the businesses and their performances that have been publicly announced. In three months, it's... It's insane. The movement is, the company's raised two rounds of capital in six months. Yeah, it's insane. And whenever you look at the valuation that we're seeing today, so yeah, Entropic close to like 400 billion, SpaceX more than a trillion, OpenAI close to a trillion, like how from an investor's perspective do you like value these businesses?

49:47Larry Aschebrook:So for a lot of people looking at SpaceX, they might think, you know, like, okay, it's doing 15 billion in revenue. How do you make up, you know, that huge gap between the 15 billion? The TAM is so big. Yeah. Yeah, look, I think it's a struggle, right? It's you're paying today for growth tomorrow. and you have to do your own work and decide what's the right value to enter and if you can get access at that value. I would say some of the AI-native businesses are the larger ones, the first movers, the clear leaders, consumer enterprise level, and the two LLMs you mentioned. They're probably a bit easier to underwrite at those prices.

50:37um you know and spacex is now a complex business it's when we invested back in 2014 it was like we want to you know win some nasa contracts and build some spaceships you know that it's very different today um and and the scale of it by the way is unbelievably massive and congratulations talk about the ability to to to create something that nobody thought was possible it's staggering to think about

51:08Larry Aschebrook:never bet against Elon no and never bet against Elon is a good rule I'm going to add that to that we have the G squared 8 now it's G squared 9 don't bet against Elon exclamation point and my friends at Valor Equity would say Larry you know and listen to Guillaume he's absolutely right but yeah I think it's difficult fundamentally to underwrite so how we do it is we use public comps. Of course, in some of these assets, there are no public comps. You have to use a basket of comps. You have to see what you've invested previously. And the history doesn't repeat itself, but it often rhymes. The characteristics of great businesses really don't change.

51:48If they can generate a significant amount of free cash and they're still growing, they're good businesses. It's just a matter of what price you pay. And can you get involved at a price of safety? and a margin of safety embedded in it. And that's what we pride ourselves on doing. And sometimes we miss. We don't get the shiny logo because we can't underwrite it. And other times we come back around. You have terrific business. It's been all publicly reported in Stripe and it's accelerating at scale. And that's unbelievable to see a business where one out of every$60 that transacts on the internet flows through their platform.

52:32It's insane. I mean, one of the businesses that got away early on and now it's like an opportunity, but, you know, nine years ago, we could have invested in Stripe and how stupid was I for not doing it? It's like when the Spotify founders introduced me to the founders at Klarna and I could have done it for, you know,$250 million valuation and I passed.

52:55Larry Aschebrook:I mean I think we're almost running out of time so to conclude what would be one tip you could give to anyone you know like starting a business from scratch and wanted to build something ambitious I think it's all about your teammates hire grinders grinders that will do anything to win people that have had adversity, ones that will show up and have a chip on their shoulder every day to try to prove the world wrong. And founders of businesses, we often back two founders trying to solve the same problem. And it's almost always the founders and team members that have that edge that win. And they might not have the best product.

53:45I think of Turo. When we invested in the car sharing platform and rental car business and Turo, we also did get around at the same time. Turo's pitch deck was something like, um, you know, our children probably put together. It was terrible, but the founders and the leaders of that business were grinders. And today one is here and accelerating and the other business is gone. And the other business raised way more capital, had all the shiny things, all the great investors, and it didn't work. and it's just a true grind mentality. There's that. And then from a GP perspective,

54:25I steal a line from my friend Mitchell Green at Lead Edge Capital who says all the time and I believe in it too, which is investing is easy and selling is hard. You have to sell your winners in order to have a sustainable business. The idea that you can wait and hold and have paper gains and be a new fund manager and go raise a bunch of money. It is difficult as a seasoned manager that has a robust DPI that's in the top 10 % in our industry per dollar invested. It's very difficult to still raise capital. Don't chase moik. Don't chase paper gains. Don't follow the herd. That's what I would say.

55:10It served me well.

55:14Larry Aschebrook:Awesome. Thanks a lot, Larry. It was really great chatting with you. Where can people follow you? What's the best platform to follow you? Our IR team does a great job on our LinkedIn page and our website. I'm pretty off the grid. You can find me at Larry at Gsquared.com. I'm not an avid tweeter. I still call it Twitter. Still dear to my heart. In your heart. In my heart. It's Twitter. You know, but you can find me if you need me. But I really appreciate you having us on, humbling for me. And I'm really thankful for the interest you're taking and what we're building at G Squared. And we'll continue to grind.

55:56Awesome. Yeah, it was awesome. Have a great day. Thank you. Take care. Bye-bye.

56:09you