Meghan Reynolds – Art of Capital Formation (EP.438)

30:29So make sure that we've level set of all the key messages that we're sharing with each constituent is consistent and clear and timely. The second piece of it is just do people really understand what really matters? Are you communicating to your existing investors what really matters? Your plans for the organization over the long term. In the existing portfolio, where are the problem children and where is the promise in the future? Where is the return going to come from going forward? If people have a good handle on that, then they will continue to support you with more clarity and more conviction.

31:07If there's any gray area around that, the plans for the organization, are you going to try to expand into new businesses? Are you going to fire your team? Are you going to make changes? Are you going to hire? Or if they're not clear on what's going on in the portfolio, you're going to have a lot of trouble raising new capital from them. You have different conversations with different LPs at different times. How do you calibrate to make sure that those messages you want to deliver are consistent and heard by everyone? You have to use a lot of different channels of communication because we're a very small team and we can't get to everyone in a timely way.

31:45And so you have to be flexible in the way that you communicate. We moved from an annual report that was not particularly powerful and maybe was hiding some good news and maybe some of the bad news if you deep into the reporting. One of my pieces of advice to GPs and people in my role is always don't assume your investors are reading the annual report. They're most likely not. And you have your key investors that you're going to get to first, but how are you going to reach everybody else? So I'd say have your list of decision makers, have your bullet points that you get out to people, the most critical people at every organization, have a concise communication that you share broadly with your team, leverage the investors on your team to help communicate some of those messages.

32:34For Brad, sometimes he talks about what's going on in his worldview publicly. He might do it on CNBC. He might do it on other platforms. But connecting all those dots and not being rigid on we have to wait for a quarterly or annual report to get that out or wait for me to call everyone is what's critical. Use the different channels to get things out more timely, more consistently, more actively. How do you think about communicating bad news? I think about this a lot. I reflected a few months back on all of the great things that have happened, the wins that I've been able to celebrate with LPs and the bad things that I've had to communicate.

33:18And the bad things outweigh the good by five times. And I've worked for amazing investment organizations. It's just that shit happens. Markets turn. There's fraud in a portfolio company. Someone leaves. You're going to mark down a business just because it's the right thing to do. It's just the nature of the business. Great exits come around not that often. And when they do, you celebrate the heck out of it. Bad news, different thing. I have a very specific framework for bad news. You get out quickly And you address very clearly what I call PIE or PI, which is what is the problem that you're dealing with?

34:03Person, company, market change, interest rates, you name it. That's the P. What's the problem? What is the impact of that change? There's fraud in a portfolio company. The impact is that company is going to zero. Or there is litigation or you name it. That's the I. What's the impact? And then E, what is the investor's exposure? What can I expect to happen to my fund as a result of this problem? And that is simply putting into people's hands an answer to the question that they are inevitably going to get to the constituents that they report to. You mentioned celebrating wins. What's an appropriate way to go about celebrating wins in the portfolio or in the business?

34:51I'm a big fan of celebrating with abandon. I actually see people under -celebrate all the time because for some reason, and this is a sweeping generalization that investment management isn't awash with humility, but all of a sudden people have a big win and they say, yeah, this was a really good one for us in a way that feels super humble. And I say, if it was amazing, say it was amazing. If this was a historic win, make sure that is clear to your investors. If this is an unprecedented outcome for an industry, say it. Your investors, don't expect them to read through the tea leaves of your humility.

35:41Shout it from the rooftops. Those investors have their own underlying constituents. Nothing feels better than looking good to your boss. And you want to arm your investors with the data points that make them look great to their boss. And so you should be able to say to a state pension, we just had an incredible victory in our fund by a company getting acquired for a 25x and this is going to return our entire fund in distributions back to you over the course of the next year. and we feel very proud about that and we're proud that you're our partner. That is something they can take and deliver with pride, which feels really good.

36:24I'm curious how you think about adding value to your partners beyond just the knowledge and the performance you're delivering. Quite different, I would imagine, sitting at Altimeter doing one strategy than at a TPG or Goldman where there's just lots of different inputs and strategies that people may be interested in. I actually think the framework of adding value is not different between organizations. We make a point at Altimeter of asking investors when we're meeting them for the first time, what does a great partnership mean to you? If you think of the most important partners to you in your book of investors or your line items of investments, what are the qualities of those partners?

37:09Returns are never the first thing that they list. communication, trust, sharing of insights, sometimes deal flow, are almost always the consistent answers that we receive from the largest to the smallest organizations. There's something to learn by that, which is if you're in the business returns our table stakes, and this is all about what else you deliver to people. And a lot of that comes down to just great communication. So when I think about what that means at a Goldman Sachs, when you have tons of resources to Altimeter, which is a very small organization, to me it's bringing what are the most unique insights that are available to me that I can bring to the investors that I work with.

38:01That might be Brad's view on large language models, or it might be a soundbite from a Goldman Sachs economist. But the characteristic is the same, which is it is unique and it can be communicated back in a timely way to add value to our investors' portfolio or to help them understand what we do and the value that we bring in a more cohesive way. I'd love to turn to prospecting for new clients and how you think about that process. The land war that we fight going around the globe and building new relationships, especially in a world where capital doesn't necessarily flow free these days. It's not always easy.

38:45What I have learned is the most important way to build your brand is the great existing relationships that you have. I've asked many LPs how they source new relationships. The number one answer that I get is from other LPs. So to me, that says your existing relationships are the key to building new relationships. Having a warm referral, having a great institutional investor when asked, say, who are some of the best partners in your book? Or who's doing something really unique? Or who's your best partner in tech? say your name is a great way to build relationships. I think that's number one. Two, having an understood brand in the market, telling your story when you're not marketing.

39:39That could be by being present at industry events. It could be being on CNBC. It could be simply having a presence in places where LPs exist, but it's always wonderful to sell yourself when you're not actually fundraising. The capital should be raised before you're even in the market is something that I like to say. So I think many people think about prospecting that I'm going to go raise a fund and now I'm gonna build these relationships so that they commit to my fund now. That's not the right way. Building relationships is a longer process that comes over brand building and building presence and relationships in a different timeframe.

40:26How have you gone about establishing the relationships over time with people that aren't investors, recognizing they have their own set of relationships and they're very, very busy? One of the things that I do is think about that same value add that you are providing to your existing investors. How do you illustrate that to someone before they're an investor? So that unique subject matter expertise that you may have as an organization start to prove the relevance to an LP before they're an investor so that they know what the investor experience may look like. Some LPs will say, we'd love to do a co -investment with you before we invest so we can see how your organization works.

41:15That's really hard because you have a lot of mouths to feed from your existing investor base that want your co -investment. So I actually would say that's a very hard ask to deliver on in practice. But what they're really trying to say is I want to understand what you can uniquely bring to me that I'm not getting from other places. And I want to understand how your organization works. For me, that is reaching out to people that I've met that are important that I want to build a relationship when something happens in the market like DeepSeek and we have a view and I share our view with them. Sometimes it's inviting them to a webinar we're having with our existing investors where we're going to talk about something topical that may be of interest.

41:59They can see what types of content we deliver to our investors. Unfortunately, it's rarely a deal because we have plenty of people that want the deals. But it is that is around that transparency and unique insights piece. When it comes to communicating what it is you do, what have you found most effective in telling the story? First of all, people love deal stories. They love storytelling. If I reflect on the most impactful fundraisers and marketers that I have worked with, they are incredible storytellers. They bring you inside what's happening in a deal. Hearing David Bonderman tell the story of how they bought MEMC for a dollar in 1999 is so incredible and unique and insightful, but also just fascinating.

43:05So it's not just about talking about I'm doing this deal or we are involved in this market. It is about bringing that to life and getting the people on the other side of the table engaged and excited about what you're working on. I think Brad is uniquely talented. He knows how to tell a story. And when he talks about the future of AI, you feel something. You have to have the investors on the other side of the table feel something. That is what makes someone inclined to action. They also need to connect with you personally. I think that we're beyond transactional at this point, especially institutional investors.

43:52They're going to put capital behind you. They're going to use their very slim allocation to make a new investment that involves 10 years of relationship and trust and a ride through markets and illiquidity. They really have to have a sense of who you are as a person. And your personality is going to help reveal differentiation. There's also another framework that I think that is important in building new relationships around what every manager. You need differentiation at every turn. And I think of it as literally a circle with five components, which is sourcing. How do you source your ideas, picking, winning, adding value, and then how do you think about exiting?

44:42If you've left the room and you haven't covered those five things, you've left them wondering about your strategy or how you really are managing your portfolio. When you think about that personal relationship side, how do you think about the impact of someone in your seat and your relationship with the LP as adjacent to Brad's seat and his relationship with the LP as the person who's managing the capital? I think of myself as a really important liaison. I never think of myself as a substitute for Brad in the room. I never will be, but I'm a really important conduit that plays a critical role. One, they need to trust that I'm going to deliver important, relevant information and all the things they need to know.

45:37I'm going to make sure they get it. Two, I am transparent and trustworthy, a sounding board for when there's issues going on within our fund or in our portfolio, they have concerns that they can come to me and that I will accept all feedback in a safe place. Sometimes it's hard for people to tell Brad that they're upset with something that we've done or they don't like an investment or they're concerned about changes that we're making on a team. I know I'm winning when an LP is telling me what they're not happy with. If they're just telling me they're happy, I actually keep digging. Because to me, the way that I can add value is the feedback loop from our customers, our key partners, to Brad.

46:28And not so that he changes the way that he may act or changes the deals that he's doing, but that he's conscious of how the market is perceiving that. because ultimately it will impact how we're able to raise capital going forward. When those feedback loops are broken, it's problematic for an organization. I love it when people turn it back to me and say, you're most valued partners, what do they do for you? And I say, they tell us the truth. They tell us what they're thinking. What are some of the most common mistakes that you see GPs make when they're in the market to try to raise capital? The biggest mistake that I see GPs make is they say too much and they don't listen.

47:14If a GP meets with a new investor or even an existing investor and they're raising capital and they have talked through the whole meeting, it's a missed opportunity. It's a problem. You have an opportunity to interact with your customer, partner, and understand how they think, understand what's important to them, understand how the organization works, understand their process. You should take advantage of that and know your customer deeply. You should be making decisions about who the right capital is for you. It's not about just them deciding that you're the right partner. What is the right capital base for your firm, for your strategy, for the next 20 years of your organization?

48:03It doesn't all look the same. Not all investors are created equal. You want to make sure that you're getting partners and customers that are aligned with the goals of the organization that they're going to invest with you over the long term. So that's the number one mistake that I see people make. I'm curious about the difference that you've seen in the hedge fund side of Altimeter, that private fund cadence. Say you're giving advice to someone who's managing a hedge fund or a public equity fund where effectively they're always in the market. Public fundraising is so hard. I am so lucky that I built my career for basically 20 years with only having to raise capital.

48:49And then it basically sits there and you don't have to fight the redemption and you get a break between fundraisers and their cycles. I have deep appreciation for people that are doing an open -ended fund construct and the constantly in the market construct. At the heart of it, I don't think it's different. I think it's about building relationships before you make the ask. Though you may be in the market, it's about taking time and understanding that there's a sales cycle before you just march in and ask for the check. So though you may be open, don't treat it as such when you're building a new relationship.

49:31Now, Megan, I know that you've had a very fun Twitter X account summarizing some of the conversations that you have with LPs over time. And I'd love to just get your opinion on some of the things in the market now. Sure. So let's start with fund flows. Been a tough time. What are you hearing from LPs about what their plans are in the private markets? It has been a tough time. My reflection is that For the last three years, it's been the hardest time to raise capital in the 25 years that I've been doing this. And that includes 2008 and 2009. It's actually been harder. Why? Because in 2008 and 2009, you had people that were still in building mode that didn't have big allocations to alternative investments.

50:24They were blank slates. And they knew that this was a good time to invest. So though very little actually closed during that time, a lot of new relationships were still building, a lot of planning was still going on, and there was capital raising going on behind the scenes and capital raising for recovery capital and tactical funds. The last few years, there's very few blank slates. There's very few people that are taking their allocation from five to 10 to alternative investments or from 10 to 20. If anything, they are grossly over allocated because of the lack of exits. And that is consistent across almost every channel of investors from endowments and foundations to family offices.

51:08There's very few exceptions. One of them is the retail channel. My observation from feedback from LPs is this is about haves and have -nots. This is a market of, am I backing someone that actually deserves to be here? That wasn't just a fluke fund that was able to get raised when money was free, but an investment organization that's really going to be positioned to grow for the foreseeable future. I do think that's why there's been safety in larger funds, because there's a sustainability to that capital and those organizations versus smaller organizations that don't have the track record, don't have the history of distributions, DPI, that other firms have experienced.

51:59And the result of that is all of this is going to be very scary if you are a merging manager during 2020 and 21. And I define a merging manager as someone that raised their fund one or fund two during that time. So if you bring together, you mentioned the retail channel and the strength of large funds. There's a lot of capital coming into the space and private markets into that. What do you think happens with return expectations? So I think that there's going to be a bifurcation of return expectations for megafunds versus smaller funds. And I'm specifically speaking about venture now and the private markets.

52:44That's generally the world where I'm operating. And I'm saying that because this is exactly what happened in buyout. You had buyout funds, pre -mega funds that were consistently delivering 3x plus returns before they got really large, they got really large, and then they consistently returned 2x. I just was looking at KKR's returns, which were in a Bloomberg article. And sure enough, their pre -80s, pre -billion dollar funds all returned 3x plus. And then after 1987, they raised a series of many billion dollar funds that have consistently returned somewhere around 2x. My theory is that the same bifurcation is going to happen with mega funds versus smaller funds that are able to take advantage of power law and drive bigger returns.

53:372X and participating in that part of the market with a brand that you know and love may be sufficient for certain pools of capital. You will see the institutional investors that have historically loved venture and participated in those big pools move down market just like they did in buyout. All the ENFs left the mega funds between 2008 and 2012 for the most part. I think the same thing will happen, but you saw retail move in. You saw the I Capitals of the world, like Blackstone selling massively at JP Morgan, KKR, all those mega funds started selling in the Wealth Channel. I think the same thing will happen.

54:16And I think that there's plenty of people in retail and high net worth that have no exposure to the asset class that will be very happy to get exposure to great firms like General Catalyst, these mega funds that allow them to participate in a market that they hadn't participated in before. If that leaves a very large swath of smaller funds, some of whom have brands and pedigrees and have succeeded and many of whom may not, what happens with the challenges in fundraising throughout the rest of the venture market? I should draw a distinction around big funds and large funds, by the way. I'm specifically talking about classic venture when I'm referring to that.

54:59I actually think there's this emerging understood part of the market, which is growth that is getting redefined at the moment that does scale because of the company staying private for longer, because of the scale capital raising that's being done with those companies where you can deploy at scale. And that's a different return profile. I think that's more of a two to two and a half X and an IRR strategy that's similar to what you would expect in public markets. These are quasi public scale private companies. But your question was around what happens on the venture side and to some of these smaller organizations and the constrained capital raising.

55:42A lot of the funds go away. A lot of funds cease to exist. there's thousands of zombie funds in the market that will never raise another fund because their track record does not justify it and because people will realize that venture is not a get rich quick scheme that not everyone and their mother deserves to have a venture fund that all goes away i think that it becomes the brands that deserve to be there and the differentiated products and models move forward. And I think fundraising looks a lot like what it did historically, which was a, I think there was a pretty steady pattern around venture fundraising that was going on in 2015 and 2016, 17, 18, even 19.

56:28And then it went crazy. And I think we're just back. And I think we're just going to trudge along like we were trudging along before in a healthy way. So for those smaller firms that you could look and ostensibly have a right to play, They've generated strong results, but are still struggling in that fundraising aspect of their business. What advice do you give your friends who reach out and say, how do I do this? How do I grow? I say, throw your 2021 fund size out the window. A lot of calls I get are from GPs of funds that are on fund two, trying to raise fund three or fund three, trying to raise fund four.

57:07Their last fund was raised in 2021 and it was $400 million or $200 million. But their previous fund was $50 or $100. And now they've raised $50 or $100 and they don't know what to do. And I say, congratulations. That's amazing. Just invest it. Keep going. Readjust. Just swallow the pill and go back to where you were before. reestablish yourself and grow from there. The market is giving you what you deserve. And it's saying that that moment in time was an anomaly and that they want to see more from you. And hopefully you run the business that you can live off of those management fees. And I think it's a very healthy gut check to say, if you can't, then you need to make changes to your organization.

57:56Or if that's not enough money for you, you should do something else. And that's okay. And by the way, in 2005, 6, 7, 8, funds contracted by 50%. when they went to raise their next fund. That happens. And it's a pride swallowing siege, as I like to say. It's a line from Jerry Maguire. But that's just what you need to do to move on. I'd love your view on LPACs. I love LPACs. They're the best. Full stop. Sometimes there's a perception that an LPAC is a administrative burden to an organization, that this is a body that you have to create an extra burden or some regulatory burden on your organization.

58:45And I think that that is short sighted. I think that generally LPACs represent the largest and most strategic investors that are a part of your partnership. consulting them on some basis on matters that are important, that are tricky, that may be consequential to the business is really healthy and important. If you have something going on in your organization, you want your largest investors on sides and fully understanding that because most likely you want them back into your capital. And so when you have a body that can give you feedback and be those truth tellers for you and feel comfortable about what's happening, whether it's a conflict of interest or whether it's because you're going to raise a new strategy and they have approval rights or whatever it is, embrace it and recognize that this is your opportunity to get your most important investors feedback and get them on sides.

59:45Because of that, and because they often do have rights that could be consequential to the business, be very careful about who you put on an Alpac. Be very thoughtful about it. Make sure that you don't just give away the rights, but that you really have a group of investors that you know will listen and tell you the truth and be rational and understand the organization and governance structure that sits behind them when you're making those decisions. Often I see people have situations where they've put people on their LPAC from an organization. That person leaves, you get someone else, and that might not be the champion that you had before.

1:00:31That's challenging. So make sure you take that into account when you're building your LPAC. What are some of your other favorite concepts and things you've heard that you've been writing about? Well, I really am interested right now in fund math around venture to understand the dynamics around venture capital as an industry because it is a power law business. How that translates to how you should size your fund and how you should construct a portfolio to optimize returns. It is very different because of the power law dynamic in venture that only a few deals drive the returns for the whole industry than buyout portfolio construction or growth portfolio construction.

1:01:24You have to weight your capital differently. You have to size your funds differently. and in the world where so many people just went out and raised venture funds and everything was working and for a minute there, it wasn't a power law industry. It was everything was delivering great returns. You could get away without having to be thoughtful about that. But if you actually look at the historical data, there's been very few funds in history that have achieved 3X plus that were over a billion dollars. And when you dig into the why, It is because you have to size and weight your capital to deals accordingly to maximize those returns.

1:02:08And it's hard to do that at early stages. So I'm very fascinated by this because I think understanding and having agreement on it across the whole ecosystem between LPs and GPs will make us all more powerful. It will help LPs understand what to do with a track record that's concentrated around one deal. Do they celebrate it? Or is that a complexity that you need to wrestle with? It will help GPs think about how to manage reserves, how to think about opportunity funds, how to size capital. So that's one little course of study that I've been undertaking. I have follow -ups to tweets that I'm keeping in my back pocket for a Saturday or Sunday when I'm ready to get more intellectual.

1:02:48Any other favorites? I definitely am unpacking this. What's the difference between growth and venture? Growth at scale versus venture. How do we define the strategy or the asset class, quasi -public businesses that for companies staying private for longer, what do we do with that as an investment that we've never really dealt with that at scale before? Although the trend has been there, the existence of companies like Databricks and Stripe and even OpenAI, those are truly quasi -public. So what does that mean from a return perspective? Where does it fit within a portfolio? Should it actually be getting allocation from the more public side of the book?

1:03:39Investors are talking about this right now. So I'm excited to explore that. One more thing that I'm exploring is co -investment. I had a tweet that got a lot of spicy responses. I think I might have struck a chord and it came from a conversation I was having with an LP. Usually my heard from LPs this week always comes from a topic that I happen to be discussing that I think might be interesting to the world that we live in. The tweet basically said very few institutional investors or organizations are actively managing public equity portfolios. They're not choosing stocks directly, but almost all of them are choosing in private companies directly and co -investing in companies where they have less information, that are less liquid, where there's more risk.

1:04:31So as an organization, if you are not comfortable investing in public companies directly, what makes you sufficiently resourced to invest in private companies directly. Very fair question. Just a question. I want to make sure I get a chance to ask you a couple of closing questions. What is your favorite hobby or activity outside of work and family? I love spending time outside in nature. California is a glorious place to live, to be able to do that. I also grew up at the beach. I grew up at the Jersey Shore and love of staring out into the abyss of the ocean and recentering myself. Lately, it's been an obsession with redwood trees and getting lost in a forest with my kids.

1:05:17It's very grounding for me. What was your first paid job? Well, I grew up in a family that believed that if it wasn't something that you needed or you were getting for your birthday or for maybe a holiday like Christmas and you wanted it, you needed to get it yourself. You needed to pay for it yourself. So technically, my first paid job was scrubbing kitchen floors and bathrooms and doing chores at the age of six or seven. True story for my mom for an allowance so I could buy my own clothes. But my first paid job was working for Hoffman's Ice Cream in Point Pleasant, New Jersey, a family -owned old -fashioned ice cream parlor.

1:05:59I applied for the job the day that I turned 14, which is when you could legally work in New Jersey. And I absolutely loved the job. What'd you love about it? Oh, delivering ice cream to people and bringing them joy. What's better than that? I love making people happy. That's my Enneagram nine coming out. And it was a really great quality product. It was handmade ice cream. We're hand making these ice cream cakes. Everybody in town got their birthday cake from this store. It was just commitment to quality with so much joy and love put into it. How's your life turned out differently from how you expected it to?

1:06:39I never expected to have traveled the places that I've traveled, to have met the people that I've had the pleasure of meeting. Being able to do what I do was beyond the wildest dreams of a little girl that was a child of two elementary school teachers in a hamlet. I think you could literally call the town that I grew up in a hamlet by the beach. And I feel so incredibly blessed and lucky to be living the life I'm living. The other piece of it is you have these expectations that you're going to have children one day and they are going to be chips off the old block. And my children are nothing like me.

1:07:25And so that is not what I expected. That I think is probably an experience of most parents that you just throw your expectations out the window when the kids arrive. What's a mystery that you wonder about? I wonder about what happens when we die. I wonder about how the life that we lead, the implications of that for whatever happens next. And I live my life knowing that that is a mystery at the end of the day. All right, Megan, last one. If the next five years are a chapter in your life, what's that chapter about? That next chapter, I think, is primarily about three things. The first is being a mom to teenagers.

1:08:13My daughter just turned 13. It's the next five years. This is it. This is before they go off to college. I got to make this chapter really good. And I know having teenagers is going to be a book that I have no idea how to write. So we'll figure that out as we go. Professionally, we're about the age of AI and the impact to our business. That is investment opportunities. That's how we interact with the world. That's how we interact with people. Everything's going to change sooner than later. And we're going to figure that out on the fly, just like being a mom to teenagers. You figure that out as you go.

1:08:53And then I think the third thing would be it's a chapter where it's more about me sharing what I've learned and reflecting on my first two decades as I'm in my third and thinking more about pattern recognition and passing that on to the teams that I work with, the organization that I'm a part of. I'm more reflective in my mid -40s than certainly in my previous chapters. Well, Megan, thanks so much for sharing all of your insights from the past few decades. And good luck with the next few. Thank you for being interested in chatting through it. Thanks for listening to the show. To learn more, hop on our website at CapitalAllocators .com, where you can join our mailing list, access past shows, learn about our gatherings, and sign up for premium content, including podcast transcripts, my investment portfolio, and a lot more.

1:09:50Have a good one and see you next time.