E331 | Sion Evans, VenCap: Big vs. small funds, manager selection, performance & portfolio concentration

0:00Welcome back to another episode of the European VC podcast. Today I'm joined by Sean Evans, Senior Investment Manager at Vencap. Vencap is investing out a$340 million fund and have an AUM of$2 billion. They're headquartered in the UK, focused on VC funds from C to the stage globally, and their underlying funds have backed the likes of Google, Facebook, Airbnb, Coinbase, ByteDance, and Stripe. So these are the household names that we all know, but we can't mention because that's not something that Vencap is making public. Today, we're talking about manager selection, big versus small funds, a topic that we're all constantly debating on LinkedIn.

0:33and of course also fund sizing in Europe specifically. And then a big deep dive is also the causes and remedies of performance dispersion in Europe and how Vencap approaches that. And then finally, I just want to say, I do hope that you enjoy meeting Sean for this episode because Sean is not too public about how he thinks, but he is going to be at 0100 Milan from the 28th to 30th of October, where I am also going to be. So if you're looking to meet Sean or I myself, I really do hope that we're going to meet you there. Here's a few words from our beloved sponsor. This episode is brought to you in partnership with Zero 100 Conferences, which organizes networking events connecting LPs and GPs in private equity and venture capital firms across Europe.

1:20This will be the fourth and final chance in 2024 to connect with investors from the largest firms worldwide following successful events in Vienna, Amsterdam and Prague. Their upcoming event, 0100 Conference Mediterranean, will take place in Milan from October 28th to the 30th at Palazzo Mezzanotte. Attendees will include major LPs and GPs like the European Investment Fund, Taikao Capital, Vencap, Arcano Partners, Amandi Alpha Associates, P101, United Ventures, Merseyside Pension Fund and many more. Yeah baby! Save the date, October 28th to the 30th at Palazzo Mezzanotte in Milan. This is what they're finding now.

2:04Tear down this wall. It's more than just an alliance. This is a union of values. United and determined we can serve as a model for other regions of the world. The nature of a problem requires a European response. Europe is a story of new beginnings. New beginnings. Let's start acting, acting, acting, acting, acting. This show is not investment advice and the hosts of this episode may be invested in the funds and companies featured. Sean, welcome to the European Easy Podcast. Hi, Andreas. Great to be here. So, during this conversation, it's a part of an initiative on our side, which is we want to bring up the number of LP conversations that we have on the podcast.

2:53So, I'm really thankful that you accepted the invitation to join. I'm looking forward to what we're going to dive into. Obviously, David and I are investing as angel LPs on a very different scale than yours, but I think it's going to be a very cool conversation. Yeah, I think so. I've always loved talking about the industry and giving the LP perspective. And to everyone listening in, I can tell you you're in for a feisty one, potentially, because we're going to talk a lot about big funds versus small funds. Everyone knows, of course, that Vencap plays the game of finding diamonds instead of diamonds in the rough.

3:28And I think that's a great way of putting it, Sean, that you didn't ahead of this conversation, because that's exactly what you're about. Whereas everyone, of course, listening in knows that David and I were investing directly into smaller funds in Europe, also some of the large ones, but definitely we have a love for emerging managers. And we're also venture partners with Isomer Capital. So we're obviously very much known for doing the small funds and also communicated quite a bit on that. Yeah, it's always great to sort of talk to people with other approaches because, again, as we sort of get into it, we're not dogmatic about we found the one way to play venture.

4:06And speaking to smart people that approach the asset class in other ways, I always sort of find I learned something, which is great. Yeah. And what I've also said, maybe a bit more behind closed doors than I have publicly, is I have found it a bit draining, the level of conversation around how much better it is to invest in small funds versus big funds. Because I think that you have different motivations. That's the one thing. You have different capacity. You have different capabilities. You have different styles. And for that reason, like, as you just said, the playbook for venture, even on the LP level, is so different that you can't just say single handedly, you want to do small funds.

4:47It depends on your setup. And that's exactly what we're going to get into here. So maybe I would just invite you to start us off by telling me what's your take on the debate of small funds versus big funds? Yeah, it's sort of always quite fraught. And there's lots of discussions going on in places like LinkedIn, which you see a lot. and I think lots of the discourse that I see and especially stuff that's been posted publicly but also conversations I have with other friends in the industry I don't love it to be honest and a lot of it sort of comes down to when you're sort of looking at you know things that are posted online and there's so many questions and so many caveats there's you know what's the data quality how have you prepared and looked at the data how have you phrased the question what are you actually trying to measure and how does all this sort of stuff map to your portfolio level performance as an LP because at the end of the day it's that risk adjusted performance that really matters nothing else a bigger question if you sort of take a step back is saying does big funds versus small funds matter um you know at a very sort of simple level and you know we sort of looked because you know we're pitch book subscribers uh we sort of downloaded the data to sort of take our own look at it and what we did we looked at the performance of funds raised from 2000 to 2016 and we split it by a quartile of size.

5:59So again, talking about the details, you can argue with all of those approaches in terms of what vintage years we looked at, how we sort of split it up and whatnot. But then what we sort of saw was there's only a very small difference between the performance deltas there, like 0.2, 0.3x on that sample. So whether it's the biggest funds of the year or the smallest funds, very sort of tightly correlated. And then we sort of overlaid that with our core managers, which is the 12 active relationships we have in our portfolio. And also, you know, the context where we've invested 90 % of our capital over the last decade.

6:32And the delta there between these was over 1.5x. So what you've got is a very small difference in performance between small fund versus large funds, but a very big performance when you sort of come to backing a small group of managers. And what that tells me is that manager selection, it just dominates the conversation. It's not that small funds outperform or large funds outperform. It's that good funds outperform. So when we sort of think about it, we're not looking at it saying we need to be invested in large funds. We need to be invested in small funds. We need to be backing the right managers.

7:05And manager selection is just by far and away the most important thing for LPs. We're going to dive further into this data, not the public data or the pitch book data, but some of the number crunching you've done on your own portfolio. So I'll refrain from asking more about that delta of 1.5x, but I think that there's definitely interesting things to unpack there. You also mentioned beforehand the importance of the footnotes that go with data. And maybe you want to add a few caveats to the things you normally see when you look at the data that we're seeing published. Yeah, so I know my colleague David Clark, he sort of posted a little bit about this on Twitter.

7:46He's our resident influencer at Vencap. um it's uh yeah it's really really important and this isn't aimed at any specific uh individual or reports or anything like that um but we sort of see it with performance where people are referring to benchmarks and if you read the underlying benchmarks the sample sizes are incredibly incredibly small and not really useful i've seen people you know with early stage venture funds pitch ah well we're a specialist so we'll outperform here's a report which confirms it and if you follow through to the report it's talking about buyout managers that's just not applicable and you know recently there's lots of stuff going around with a data set on venture fund sizes going back to the 70s with you know absolute dollar sizes in terms of how you're splitting it up but you know a 50 million dollar fund in the 70s that was pretty big it's not the case now but these sort of things are dynamic and they change over time so again like everything situations are situational sort of a great philosopher in the US once said but you've got to look at these sort of things carefully And then again, if I'm thinking about how this information is going to make my performance better in my portfolio level, is it applicable?

8:53Because again, if the caveats and the data sources, if they're not as robust as they should be, it might not be helpful overall. So it's really important things to consider without getting too far into the weeds. Yeah. So some notes there for everyone when they see this data, either if you're an LP seeing this data or if you're a VC using it, maybe make sure that you follow through to the original source and underlying data set because it might actually not show the story that you want. That's the price we're paying for social media and short attention spans and confirmatory biases, I think. It's a very pedantic point, but it's, again, very simple things can have massive impacts in this industry.

9:38There is one thing, though, that I think we should just double click on, which is now we're talking just fund sizing in general. I would venture to say that there's maybe a topic of Europe that might make it a bit more relevant to talk about. And I want to start by framing this question open and then I'll say something else afterwards. What I wanted to say is that I've seen that you've published before that you have 45 investments in your underlying portfolio that have returned more than a billion dollars to the fund in question. And then what I thought when I saw that data set was I'm also 100 % sure that a good vast majority of that were U.S.

10:19companies and also U.S. funds, which of course is important in the context of fund sizing because if you don't have that size of exits, then it's not going to be the same numbers that make up your fund size mathematics. So I'd ask you, how do you think about fund sizing in Europe? Yeah, it's an interesting debate and we often have it a lot internally as well as in the broader ecosystem. And for us, we sort of think about fund size through the lens of fund returners. So that's a single investment returning the entire committed capital of your fund. So if you've raised a billion dollar fund, that's returning a billion dollars from one investment.

11:00And for us, that's what drives performance in venture. Again, it's a very straightforward thing to say that it's all about the outliers in a power law industry, but it really is the truth. And we looked at all our early stage funds that were doing over 3x net, and about 90 % of them had at least one fund returner. So it's incredibly important. And then this sort of lens applies to any fund, no matter what size it is. So again, if we're underwriting a fund that's maybe an early stage fund, it's a billion dollars. And if you think you're going to have 10 % at exit in terms of ownership, you need to underwrite a$10 billion exit.

11:31Now, that's very, very hard to do. But what you'll find is some firms have got a very consistent track record of delivering that. So that's the thing that's really important as opposed to just the sort of standalone fund size. You know, I'd much rather underwrite a firm which has got a consistent record of delivering those sort of outcomes versus someone with a much smaller fund, say 100 million, without the track record of doing that, or even worse, track record of failing to do that. So again, it's a little bit more nuanced, but looking at it through that lens is really helpful. I mean, that also sort of backs into what's your portfolio construction, where in the market are you playing, what's the concentration, like, you know, all these sort of things.

12:10It all sort of feeds back quite nicely into fund returners. Why is it that you choose to go for the funds that have a track record of investing in the very, very large outcomes that then justify the very, very large tickets and very, very large fund sizes versus the ones that have, because they exist, right, that have a similar track record, but with 100 million euro exits and 200 million euro exits? I honestly think this is a taste question more than it's the only way that works. But it's the discussion of exactly power law. Yes, that's what drives returns. But you can have power law in a 1 billion euro fund versus a 50 million euro fund is very different when you're looking at the exit size of the final company.

13:05Yeah, I think you're right. It is a taste thing to a large degree. But one of the things we like about the people that can consistently access the top 1 % companies is that it's remarkably consistent. So, you know, this is sort of backed up by some of the academic data. Again, you know, make sure you check me on this. Go back and read the report. Tim Jenkinson from the University of Oxford, which is in no way affiliated with us, has sort of written quite a bit about this. But that persistence in venture capital has persisted, to quote Tim's work. So what you've got is when you've got that track record of getting into the top companies, it becomes a real sort of flywheel effect and it becomes sort of accumulating advantage for you.

13:44So, you know, entrepreneurs, you could hypothesize, would want to work with the managers that back the very best companies. And because of that, it's, again, a great virtuous circle. So what we're sort of finding is that with the group of managers we back, it's not just that they've got that, you know, great performance and that they've consistently been able to do fund returners. But we can see over a very long period of time, you know, measured in decades, that performance is remarkably consistent. And, you know, when we sort of come on to talk about the distribution of returns within our portfolio, that is really, really important.

14:15Because we're very open that we're not going to back the very best Venture Castle fund of any given vintage. If you want to back a fund that's doing 20, 30, 50 times, that's likely not going to be in our portfolio. But what we sort of find is having that more consistent level of returns. To be clear, you're still getting real venture outcomes here, where it's 5 to 10x maybe higher if things go really right. But our portfolio level return has really benefited from that approach. And we could dive much more deep here. But let's go to another topic or a similar topic, which is when you then think about Europe, is it Europe is done with one or two tickets?

14:51Or is it not? It's one or two core tickets and then it's a couple of smaller ones that we add to it? or like Arsene Macavro covers Europe with 50 funds. Yeah, I think we're the opposite end of the spectrum there. So, you know, historically for us, we've had two core relationships that have covered Europe for us and they've done a phenomenal job. But again, to take a step back, we don't allocate on a top-down basis in terms of geography. To be honest with you, we don't have a really strong in-house view on Europe versus China versus the US versus anywhere else in the world. And that might sound like a bit of a strange thing for an LP to say.

15:32But for us, again, going back to manager selection, it's all about the quality of the manager. So for us, we're looking to back the best managers globally, full stop. If they happen to be in Europe, great. That's a lot more convenient for us being based in Oxford in the UK. If they're based in India, that's exactly who we want to add. And we sort of say this because we've made those mistakes in the past. You know, we used to have artificial constraints saying, here's a bucket for a particular geography. Let's fill it up with the best managers we can find under these artificial constraints. And then what you end up doing is having, you know, a manager roster which isn't as high quality as it could be because you're adding a manager in one geography when that's not the best talent you can access on a global basis.

16:14So we've sort of stuck quite rigidly to that. So if we're looking to add a manager, it's competing for that same dollar with people from all around the world. and that makes for very interesting conversations for us because you can never have an apples to apples comparison but it does really make sure you've got the best possible portfolio. And also worth saying that that same thing applies to sector within tech, it applies to stage. So really having that manager lens has been really important for us and it flows through to how we think about Europe today. What this in effect means is that And since you have these core relationships that you would rather put more money away the manager you trust and believe is the best than add a new one just because they cover a different deal.

17:06I'd love to ask you, and we're going to talk about this later as well, but just could you tell me a bit about how you think about the constraints in a model like yours? Because you have, I think you have 12 relationships today. core relationships. And what then limits the fund size of Vencap? Why are you not bigger than you are? What's the core activities within a firm like Vencap with 12 relationships? What do the whole team do? Where is the growth trajectory for you? Yeah, there's a lot to unpack there. I think very simply for us, the amount of capital we can raise is dictated by what we can put to work with our 12 relationships.

17:52You know, our head of fundraising likes to joke with us, it'd be much easier for him to raise a billion dollar fund because we can talk to people that write much bigger checks. But if we raised a billion dollars, we wouldn't be able to put it to work on our strategy. We'd have to double our number of relationships. That would inevitably dilute the quality. It would dilute the returns. And again, it just really wouldn't work. So for us, the amount we raise is really based on what we can put to work with those managers. Like, Could we add a couple? Absolutely. It might also be likely that we'll cut down a little bit.

18:23It's not going to massively increase. And I think for us, in terms of what we do all day, some people would joke, oh, do you just go to the beach, write your re-ups and have a nice life? Maybe that's some things what some Americans might think about what goes on in Europe, but that's really not the case. We're really quite paranoid about our portfolio. We spend a lot of time digging in. And again, we run full diligence processes every time these managers come back, even if we've been with them for 20, 30 years. And that's still a full process. Because we've got that quite a tight group, we sort of do something we all call continuous due diligence.

19:00So we're meeting these managers on a regular basis. We're reading the quality reports. We're going to the annual meetings. And if any issues were to come up, then the classic ones are things like generational transition. We're identifying those in real time. and we're not waiting for a formal diligence process to have those conversations with a manager. So we sort of see that as a much better way of doing things rather than saying we're going to cram all our work in terms of investment in the three months before you raise a fund. When you only have 12 relationships and you say, so maybe we could do another two or three or five, but if we went further than that, we'd inevitably lower quality.

19:40can i put you on the spot to tell me when do you think you'd lower quality because it's it's rare that you have a global lp that could actually i think with your reputation and performance you could raise significantly bigger fund if you wanted to so it's a bit of it kind of feels like when do you actually see that performance deterioration right now apparently the magic number is 12, but I would venture to think that there must be 15 or 20 on a global level that would be worth putting 10 million, 50 million. I actually don't know your ticket size, if you could say that as well. Yeah. So generally we're anything from sort of 10 to 20 million for the most part with some, you know, outliers above and below.

20:31But for us, our investable universe is probably 20 to 30 managers. You can sort of take a broad view. And then if we look at, you know, who we're not with, a lot of them are groups that we'd love to work with, but maybe we haven't had access. You know, there's firms that, as long as I've been at Venkat, where we're saying, look, we would like to invest with that group, but so would pretty much every other LP in the business. And there's other LPs that have been with them for sort of 20, 30 years. So that can be very challenging to access. And, you know, when we're thinking about our sort of deal flow, our investment process, it's less about saying we've got a funnel approach where we want to speak to a thousand managers and evaluate them all and then do diligence on the best 50 and invest in the top two or anything like that.

21:13That just doesn't exist for us. A lot of it can be saying, look, these are the three managers we think we've got a reasonable chance of getting in over the next cycle or two cycle. Let's try and build a relationship. Let's try and convince them that we're the long-term partners that they want to work with. And again, this can take years, in some cases, decades. And occasionally, we get there. But it's a really different proposition to us saying, look, here are 20 opportunities and we need to decide which one we want to do. Just deciding you want to invest is generally by far the easiest part of the process.

21:48And let's digest it a little bit here, because then we should divide it into two things. One is, what do you look for in a manager? What is it that you're looking for? What is it that makes people join that covered list of 20 to 30 funds that are in your realm, where you actually just want to come in whenever you could. And secondly, I want to talk a bit about sourcing because this is a special dynamic, right? Yeah, absolutely. So for us, it's really straightforward criteria. It's quite challenging criteria, but it's very sort of simple to explain. Taking a step back, the venture industry, the value creation, it's all about the top 1 % of companies.

22:28You know, when you look at the exit numbers the last decade, it's the top 1 % of exits have generated the majority of exit value. you. So are you able to consistently get into those companies? Have you consistently backed the companies that matter? And then the sort of second part of that, the follow on is the fund returner piece, because if you put a very small check into a very late round of all these companies, that's great for, you know, collecting logos, it's not great for performance. So have you consistently generated fund returners? And when the answer to both of those is yes, that generally means your performance would have been very good.

22:57And then we'll look and say, do we think the conditions for that will continue. Again, going back to fund size, if you're suddenly saying we raised, we had great success at a$500 million fund size, and now we're going to raise$5 billion, there'll be some questions. If you had a lot of generational transition, or maybe not, which can be even worse, is that going to be an issue going forward? I think the other thing to think about is for us, it's not just accessing those funds that might be very well established, multiple decades old, you know, large franchises. Historically, the earliest we've gone is Fund 3.

23:31And at that point, we're not expecting you to have a long, long track record of, you know, multi-billion dollar IPOs. But we want to see if things are on that same trajectory. So at that point, you're leaning in on a couple of points. But you're saying, look, the first fund, there's some really interesting companies. They look to be on the trajectory to be, you know, a very meaningful company. It looks like it's on the same path with the Fund 2. This could be a good place to access. So I think probably the majority of our relationships in that 12 have probably come around that fund three. So that's the other sort of side of it, where as well as looking at people who we say we would love to access, they might be on fund 13 rather than fund three.

24:08We're sort of looking and saying, all right, well, who's that fund two that's starting to look promising? That's a much harder thing to do. And again, if you look at people that will graduate from that very promising fund three, it's generally a very small list because again, that investable universe of people that are consistently getting into those companies is very, very small. Could you tell me when you're looking at this, staying with the topic of diligencing funds, when you look at Fund 3 and trying to decide, do we want to put a ticket with this team? First of all, you have your program that's called Core Managers or part of your portfolio that's Core Managers, that's the 12 relationships.

24:49And then you have, I guess, some of these small investments that are kind of like, okay, we're getting in now. And me, to everyone in the audience, I'm conjecturing. I'm just thinking here, but I imagine that that's how it works. You have the 12 core managers, and then you have the fund threes, emerging blue chips or whatever we might call them, that you're kind of pressure testing. And you've decided, OK, if we want to get into the fund four and five and six, we need to get in here at fund three. And thus, we're now putting two million or whatever to work with. So actually, Andres, that's a really interesting point you bring up.

25:28That's a debate we have a lot. So historically, up to now, we have not done that. so um you know legally in our funds we have at least 75 of capital has to go to that core group in practice it's more around 90 and what you sort of tend to find that the groups that don't fall into that 10 are groups where we're saying we're making a full check so if we think someone is going to be one of those core relationships and it's at a fund three or any other number for that matter it will generally be a full check so we don't really have that sort of seed pool if you like might be a decent term for it for those managers.

26:01Now, that is an ongoing debate. Is that something we should do? There's different opinions within our investment team. But I think for me, it's we want to have full conviction. Could it be beneficial if we're good at picking those, say if we started doing fund twos, we'd have to be confident that we'd have some sort of edge in picking those fund twos. So I think it's really important for us to sort of know what is our sort of advantage as an LP. And just saying we're going to go one fund earlier and write a smaller check, that might not be the best use of our capital. So we'd have to be very sure that we'd have a very good chance of picking those prospective outperforming fund threes if we were to do that.

26:38And historically, we actually haven't. I imagine just because of the fund discussion, right? Actually, with the fund size discussion that we just had, I think that it's perfectly fair to be super excited about a 3X huge fund. If you're fund three, still only a couple of hundred million or maybe just 100. I guess that's not what you're looking for. Yeah, and again, it's not necessarily down to fund size, but then we sort of look at it, and if you're backing Series A companies in Silicon Valley, especially if you want to back some people in the AI space, 100 million won't go very far, especially if you want to lead those rounds.