Bruce Ou – Private Market Investing at GroveStreet (EP.347)

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2:32Hello, I'm Ted Seides, and this is Capital Allocators. This show is an open exploration of the people and process behind capital allocation. Through conversations with leaders in the money game, we learn how these holders of the keys to the kingdom allocate their time and their capital. You can join our mailing list and access premium content at CapitalAllocators .com. All opinions expressed by TED and podcast guests are solely their own opinions and do not reflect the opinion of capital allocators or their firms. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions.

3:11Clients of capital allocators or podcast guests may maintain positions and securities discussed on this podcast. My guest on today's show is Bruce Oh, the managing partner of Grove Street, a boutique firm that's invested $10 billion in the private markets on behalf of 14 institutional clients. Grove Street specializes in managers that transform companies in venture capital, growth equity, and middle market buyouts. Our conversation canvases Bruce's emigration from China, thoughts on middle market buyouts, venture capital, and growth equity investing, opportunities in China, and co -investments.

3:50Before we get going, on Wednesday, we'll release the fifth episode of season three of Private Equity Deals. It's Corsair's purchase of Trevipay, a global business -to -business payments company that Corsair spun out of World Fuel Services. The deal is a tricky carve -out, a rebuild of a management team alongside a CEO, and another example of unlocking value in the middle market. Thanks so much for spreading the word about capital allocators and private equity deals. Please enjoy my conversation with Bruce Oh. Bruce, thanks so much for joining me. Thank you for having me. Well, why don't we start with your path to investing?

4:32The official beginning was 2006. I had worked several years in strategy consulting and M &A advisory and monitor group when I met the folks at GGV Capital. It was an eye -opening encounter to the world of venture capital. Although I didn't join GGV several months after that encounter, Glenn Solomon, partner at GGV, introduced me to Catherine Crockett, my now partner at Grove Street. So a typical one connection leads to another connection story, but the more unusual, perhaps, and personal one dates back earlier. This was when I was about seven or eight years old. My mom and dad had started a dairy business in Sichuan, China, raising cows on the farm and selling milk in the city where we lived.

5:22Every morning, my dad would ride a motorcycle, carry in the gallons of milk from the farm into the city near the apartment where we lived. I would greet him, help unload the milk and start shouting the neighborhoods, fresh milk for sale. And then as people walked out of their homes, lining up to buy our milk, I would help my dad or mom sell people the milk and collect money. It was in the 1980s in China. I think our milk might have been one of the first farm -to -table products. We had put in almost all of our family savings in this venture and almost lost it all. As it turned out, the milk business was very difficult.

6:03Before efficient cold storage, everything we couldn't sell the day off, we had to dump. And most Chinese consumers at the time, and even perhaps today, don't eat a lot of cheese. We only saved our investment because the cows gave birth to five calves, which my dad delivered by himself with me standing next to him, holding the medical book, reading aloud the instructions on how to do it. So we didn't spend money on the vet and the calves were worth quite a bit of money. And we ended up making a small profit after about three years of running this business. And the next few family ventures turn out to have better business models, better timing and all that, but always the same hustle and hard work.

6:50So looking back, I think growing up with those experiences has had a very profound impact on me as an investor. It has instilled in me a very deep respect and appreciation for entrepreneurs, for business owner operators who devote their time, energy, their intellect, their courage to start a business, grow a business, turn around a business. Accessing those kinds of entrepreneurs and business owner operators with whom I think I share a almost spiritual connection dating back to the memories of selling milk is what we do at Grove Street. And it's been a great privilege to be able to generate returns for our clients by partnering with these people.

7:36What was your path from China to the US? So I came here as a first -generation immigrant. And it's actually a funny story. I applied to a school in New York. And when I went to purchase a ticket, they said, well, you're going to Syracuse. And I said, no, no, no, I'm going to New York, meaning New York City. They said, no, no, you're going to Syracuse. Turned out that I went to a place named Oswego. And so I went to SUNY Oswego, unexpected, thinking I was going to New York City. And that's like five, actually six hours away. So when I got there, I realized that was not the place that I wanted to stay.

8:18So after a year, I got myself to Williams College. And that was the beginning. So you joined Grove Street. What was the history of the firm? The company was started in 1998 by my current partner, Catherine Crockett, and one of our retired partners, Clint Harris. They shared a common mentor in Peter Brook, a legendary investor, leader, great gentleman, TA Associates, right, Advent International. Peter put them in touch, and the unique insight that Catherine and Clint had at the very beginning was by aligning themselves on the one hand with long -term, sophisticated, blue -chip investors as clients, and on the other, exceptional opportunities in market segments that have higher inefficiency, therefore higher alpha potential, but hard to do.

9:12There was an opportunity to build a company that could compound in its success and reputation over a very long runway. Alignment was a foundational element in their original vision. So from day one, it was structured that the senior members of Grove Street are required to commit personal capital alongside our clients. And for the partners, a significant portion of long -term compensation comes only in the form of performance -based carried interest. And finally, there was a strong belief that talent drives performance. And so from early on, there has been a very strong, consistent emphasis on attracting and growing the right kind of talent that are both capable, but also aligned in terms of values.

9:59What does the business look like today? A lot of the core of the business is very similar. I'll maybe start with a few numbers. 25, 14, 10, and 43. Start with 25. 25. Company was started in 1998, so 25 years old as a company. 14 is the number of clients that we have had since inception. 14 great elite clients. For them, we have built 43 separately managed accounts. So you can do the math, lots of repeat customers. And in total, the clients have committed about $10 billion to us. So what are the types or the profile of the clients that you have of these 14? While we have a concentrated base of clients, we serve a quite diverse group.

10:51So we work with very sophisticated family offices, large insurers, pensions, sovereign wealth funds, and they span the globe from the US and Canada to Europe, the Gulf, Asia. Underneath that variety, however, are some important common characteristics. The first thing I would say is that our clients are very sophisticated investors. So as either some of the largest institutional pools of capital in the world or hyper -connected families, they have great market access, great intelligent internal teams, and exceptional investment track records. As opposed to what your former colleague, David Swenson, would call the casual investors, our clients, I would say, are really serious investors.

11:41So they understand deeply the potential, but also the challenge in certain segments of the market, whether it's venture capital or low -mid market buyouts, and approach them really thoughtfully. So the final common thread across them is I think our clients tend to have a unique combination of self -awareness and self -confidence. They are deeply aware, because they're great investors themselves, the benefits and the trade -offs of what to do in -house and when to leverage an external partner, and they're confident to operate from the first principle. In picking a manager, for example, they can focus on what should matter the most, the expertise, the alignment, the transparency, how dedicated this partner will be to me, how important am I to them.

12:30Should I say they're bold enough to not always hire the IBM? What do you think the core use case for what you're doing is for your clients? There are several areas I would just maybe mention too. Number one is returns. Take one of our target investment areas, low -mid -market buyouts in US and Europe. For example, the medium return of funds, let's say sub $1 billion, is quite similar to the medium returns of funds $5 billion above, observable from the industry data, but the top 10, 20 % performers in the sub 1 billion category generates meaningfully higher returns than the same corresponding top 10, 20 % in the larger funds.

13:17And as a result, a dedicated investor with the right resource, the right experience and process have a chance to systematically capture that upper layer of the opportunities and form portfolios that add both absolute returns and risk -adjusted returns over cycles. So after looking to us for returns, the clients look to us for deal flow and knowledge sharing. So for some clients, we act as a farm team. For example, we first invested in a fund here in New York called American Industrial Partners when they were owning $400 million. As the team continued to deliver results and became a consensus fund among LPs, we handed that relationship over to our clients and they became large direct investors in AIP's subsequent oversubscribed funds.

14:14So in effect, the talent that we try to identify early in the life cycle can be caught up, just like in baseball, into the direct portfolios of our clients. So let's dive into how you do this. And maybe to start with, what are the groups of investments that you're putting into portfolios? So our targets have remained quite consistent over the 25 years. And those are venture capital, growth equity, and lower mid -market buyouts, which we typically define as funds sub $1 .5 billion. And we do them through commitments to funds and co -invests. These are areas where, generally speaking, we observe higher degrees of inefficiency.

14:56We observe higher dispersion return. Those are places where astute investors go for return, although people tend to forget the caution label. The obstacles to getting them are very significant and something people often unfortunately ignored. But those are the areas where we tend to focus. How do you take in all of these areas of fairly large universe and start to think about how you get to that top 10 % in each? I'd say the guiding principle relates to sourcing is that to pick well, we believe that we need to map the universe of opportunities, triage quickly to filter out those that do not meet your criteria, then seek to meet with as many options that meet your criteria as possible and proactively approach the best teams.

15:51And we do that through cultivating a reputation in the marketplace, building informed networks, as you would expect, and a lot of just daily hustle. One example that comes to mind, although I cannot disclose the name of it, a venture fund, for example, came to us from one of the most respected venture investors in the Valley, who we asked who he most respects. It had a pretty high bar, so it didn't have a lot of ideas. And then we ended up backing this incredible team along with owning four other LPs, including several prominent university endowments. So that's an example of marrying a carefully cultivated reputation, the right relationships with proactive work.

16:40What are some of the criteria that you use that fits that type of fund you're looking for other than someone great recommended them? So in both buyouts and venture, I would say there's a set of clear criteria that define the attributes of something we look for. In buyout, for example, we look for operationally intensive teams with a well -defined strategy, a set of expertise, low loss rates, a demonstrated ability to generate upside and strong alignment. And in venture, we're looking for teams led by partners who have invested in a meaningful way, not just a casual join in the club way, the most important technology companies, including those that are becoming tomorrows.

17:27This is part of the judgment we have to exercise to call which ones are that execute a thoughtful strategy in terms of portfolio construction, stage focus, and raising funds that are appropriately sized for the team and opportunity. I'd love to dive into the diligence process maybe on each of them. And so let's start with a mid -market buyout. You mentioned teams with operational intensivity and helping their companies. How do you tease that out? Because it's something that oftentimes you would expect many of the managers would say, oh, we do all these things to help our companies. Again, astute observation, because nobody, at least now, comes to market without saying they are operationally focused, even though that was maybe less the case dating back 10, 15 years.

18:17There was a period of time investor focus on where the source of return may not have been front and center about operational. There's a lot of things we look for, as you said, to really tease that out. One would be looking deeply into the core members of the team's prior records. So we like, for example, teams that have members that have been not only investors, but also true operators. And there are many examples of that. we look for demonstrated evidence where they have truly changed the trajectory of companies, including sometimes near failures that were able to be saved. And quantitatively, there are things you can look for too.

19:03For example, it is usually the case that an operational intensive team tends to use also less leverage at the beginning. So if we see a team that tends to use a higher leverage at the beginning, that is a bit of a warning signal to us. Because if you are trying to really impact the trajectory of a company operationally, you don't want to compound that with high financial risk, certainly not at the beginning. What are some of the other metrics you might look at when you're thinking about the operational expertise of the team? Maybe I'll mention an example. So a fund that's based here in New York called In Tandem, it's a healthcare specialist in buy and build healthcare services businesses.

19:46The team came out of another well -known private equity firm where they were acting as a contracted management team running deals. And they did that for close to a 10 -year period with an exclusivity during certain periods with this one fund and other times bringing other investors. So they were literally acting as the CEO, the chief marketing officer, the chief legal officer, the M &A officer for each of those buy and build platforms. They did it sequentially. So in that particular case, when we talked about their experience, we spoke to the CEOs they worked with, the level of engagement when you force rank that to what a typically advertised operational team, it just stands out.

20:39You mentioned wanting low loss rates. I'd love to pull that thread because on the one hand, the way to get no loss rates is have a new fund that's never done a deal before. So they have no loss rates, which probably isn't optimal under that lens. But there's also a degree of assessment of risk reward that goes into loss rates. How have you thought about the importance of having low loss rates? This was added, I would say, after the financial crisis period. So we went back and looked at our buyout portfolio. In that sample, there were funds that generated very strong total fund level returns while having a higher degree of portfolio variability.

21:22But countering that is that there were a lot of funds that generated equal, if not better, total fund returns while having less variability in the outcome. So our conclusion from that was, if we have teams that can control the trajectory of their companies, there's exogenous factors that could always hit a company and a portfolio that we can't control for. But if they are truly experts in the sectors or the strategies that execute, they are really careful investors that don't use a lot of leverage, then the odds should be that a real wipeout, a bad deal should be lower. And that is not necessarily a trade -off for lack of upside.

22:10What does that imply about what stage fund do you like to dive in? So they can be fund one or they can be fund four. Now, even for fund ones, we would never invest in first -time investors. As we say, we'd invest in first -time funds, but not first -time investors. There need to be teams that have demonstrated track records in their prior pre -fund careers, whether spin -out situations or bootstrapped deal by deal. So what we're really trying to look for, I would say, is that really exceptional high -quality field choices that we can find every year out of literally thousands in this market, as you know.

22:54If you turn over to the venture side, how is your diligence process different than what it is in buyout? I think underlining the process of diligence is quite consistent. The process itself has to be bottoms up, detailed. We always, for example, spend a lot of time with the manager. We always do deep references, including lots of offsheet references. We always do independent modeling work on the important unrealized investments. So we have our own low, medium, high views of the trajectory of unrealized investments and always have multiple internal discussions where everybody shares their views and votes.

23:36So those core elements of the process don't change. The specific questions related to each investment can change. So in venture versus buyout, for example, while you can analyze the emerging driver companies that are unrealized and build models and projections and gather different facts around it, there's a lot more qualitative, pooling different sources of insight and facts and context when it comes to venture. To understand, for example, who is on the rise in terms of reputation, who is maybe dying on the vine, may I say, that's oftentimes not obvious to the broad investor base, but we're trying to get to that.

24:24What does a fully baked due diligence process look like and result in for you? A fully baked diligence process includes the elements that we talked about a little bit earlier, lots of cycles together, lots of references, lots of modeling work, and lots of internal discussions and debates. The result is a strong set of views emerging within our own team, not always consensus, but a strong set of pros and cons that have emerged that each key members of the investment team of Grove Street are fully aware of. Because we have a quite concentrated approach to investing, picking not that many things to do every year.

25:14One of the things we try to do is to have, for the high priority opportunities, is to have an all -hands -on -deck approach, where while everybody is encouraged to source their best ideas, when we come down to a subset of those to do, it's not just one or two or three deal team members. It can be the full team that spend time. So the result is, I would say, a very strong set of clarity around the key questions for each investment. Once you've done the work, found someone that you think is great, it's rare that you're the only one who's done that. and in a market where everyone is trying to find the next great manager, how do you think about this concept of your reputation so that you can win over a GP in the event that there's scarce capacity?

26:07It is true, as you say, oftentimes really compelling opportunities tend to attract more capital than needed. It is, of course, however, worth remembering that sometimes the contrarian views can be correct. And even the consensus views, even when they're right, can still be diluted. If an amazing fund that should be raising $1 billion ends up raising $2 billion because investors pile in, the risk return profile may have changed, that they're not as compelling anymore. But yes, in those situations where the opportunity is truly amazing and competition for it intense, part of our special power is to sell ourselves as preferred investors.

26:51So a recent example that comes to mind is a European lower mid -market buyout team. They had been backed by a number of prominent European families exclusively. And over a dozen year period, generated exceptional returns and demonstrated that this was a team that could have a lot of potential ahead of them for many years. So we caught wind of them before they decided to raise their next fund, reached out directly, and they included us in their outreach. But on the day of the scheduled call, they emailed and said, sorry, we have to cancel it because we've decided that we're not going to take any non -family investor.

27:34We're not going to take no for an answer. So wrote a letter from one entrepreneur to another, had one of our GPs call them directly and had a CEO of a co -invest portfolio company call directly after that. We got the call back. And then through interactions, they started to realize and appreciate that institutionalizing with Grove Street does not have to come with the ugly parts of bureaucracy, painful circular processes, inefficient decision -making, or heightened turnover. However, as the funding partner said to me towards the end of this process, he said, you know, I like the fact that you guys are also business owners, just like us, you get us.

28:20And I like your record of stability so that I know the chances that I'm going to deal with the same people, you as the LPAC member, 10, 15 years from now is high, just not something you can say about a lot of institutions. In situations like that, how do you balance trying to get them to understand that you can be a good partner with wanting to do your full breadth of diligence to make a decision on the other side? The latter will not compromise. If the situation is such that we are not allowed the full ability to really get to know each other's partners, then we probably are not meant to be together.

29:02And one of the lessons I have learned by observing broadly is that there are always amazing opportunities and we don't need to get too attached to any opportunity. Just wait for the fat pitch. And ironically, the ones where we had to sell ourselves are the ones that I think want you to do real deep work because they want us to fully understand what we're buying into and so that we have a chance of having a long -term relationship. When you have a mandate that canvases each of, say, middle market buyout's growth and venture, how do you think about putting that portfolio together? It's a Makase Sush menu we're trying to build for each client where every dish has to delight and then they have to come together as a smartly diversifying way.

29:53So a buyout portfolio, for example, will, as you would expect, target both vintage diversification. We typically target a three -year commitment period. We then seek to diversify strategies within buyouts from turnaround to buy and build. and target the core segment's GDP. So the portfolio is diversity across industries. And in venture, we're typically targeting, I'd say, 80 % in information tech and the rest in healthcare and biotech. And then 60, 70 % in the US and the rest in proven parts of venture centers around the world. In addition to those general rules, we use a number of quantitative tools as well, including a Monte Carlo simulation tool that we developed with Josh Lerner.