E215: The Pursuit of Uncorrelated Returns in Venture Capital w/Dan Kimerling

0:00It really helps that our first two portfolios are both in the top 5 % of their respective vintages on a TVPI basis. So we now have some evidence that the approach is a theoretical approach, but it's actually a practical approach to, right? We don't want to be print for the sake of excellence. We started with a bit of a thought experiment, which is what would be in this highest greatest seed investment you could have ever made on the top of that list? would have to be if you were a seed investor in a renaissance technology. So you're the founder and managing partner at Decian's Capital, which is one of the most interesting first principle fund out there, which is backed by sovereign wealth funds, endowments.

0:44So tell me a little bit about what Decian's Capital, the type of portfolio companies that you're investing to, and give me some examples of some previous investments. Of course, David. So Decian's invests in early-stage companies in the financial services ecosystem. So that could be fintechs, and we have a long legacy of investing in B2B and B2C fintechs, including Chipper Cash and Treasury Prime. We also invest in financial services companies. So these look more like what we want to be the next generation of stock exchanges, asset managers, insurance companies, banks, like true financial institutions.

1:32And those could include names like Tint Insurance, Sidecar, Simply Wise, Generous Energy, and so on and so forth.

1:52And when we last chatted, you mentioned that Destin's was not correlated to other venture funds. What did you mean by that? How a lot of LPs think about the world is they have allocation models that say that they need X percent in equity, Y percent in debt, Z percent in alternatives and so on. And so then they come down to, well, we want a certain amount of money in venture capital, whatever that percentage may be. And what ends up happening is they add a bunch of managers to their portfolio. And those managers, they're largely highly diversified. And so that provides a set of beta that the LP can rest assured on that they will get some level of return.

2:50But what we're trying to do is provide an uncorrelated alpha stream within the venture capital asset class for our limited partners. And so what does that mean? We don't want to invest in the same kinds of companies other people invest in. We want to provide very differentiated exposure to our limited partners. So that's what we mean when we say it's uncorrelated. and we want to provide it in a way that we think is highly alpha seeking. Like we want, one of our LPs says that Desians is the get rich or die trying venture fund. And that's exactly right. We are get rich or die trying. We will have funds that perform excellently or poorly.

3:39There will be nothing milquetoast about our performance. And that's what makes us a very attractive firm for a LP that has a mature venture portfolio and is looking for alpha and not more diversification on top of diversification. I hear what you're saying there, which is basically venture funds have this beta or this predictable kind of 2 to 3x returns. And then you could put in Decians into your portfolio to get this asymmetric upside. In reality, though, a lot of LPs do not want this, you know, highly, I guess, bipolar return where sometimes you're getting 1x, sometimes you're getting 7x. It doesn't necessarily make them look great in front of their investment committee.

4:31How do you manage around that, around the realities of your LP investor base? Well, first, you have to just have an unusual level of transparency and alignment with the limited partner. right like david what i just told you about our portfolio construction and our approach we don't hide that we we talk to lps about it in the first conversation and in every conversation so that we try and maintain that alignment um and really about setting reasonable and appropriate and uh good expectations you know i've learned over the years that we are only i'm only as happy as my least happy limited partner.

5:24And what keeps my limited partners happy is that we have done what they expect us to do. And so it's about really the communication. And we talk about it in every conversation with limited partners. We talk about it in podcasts or forums like this. We talk about it on our website, in our writing. You know, we've written about what we would call betting on convexity. And we have a whole white paper called betting on convexity at decions.com. So David Teer, a question. It's about the communication and expectations management. And then it's also about finding an LP that is at the right time in their life cycle.

6:08So maybe they've built a mature program and they don't need more of the same. They need something different. So that's one thing. And then your audience is probably familiar with the idea of principal agent conflicts, but just in case they're not, institutions don't allocate to us individuals, humans, real live breathing humans ultimately make the decisions on behalf of the institutions that they represent. So it's about finding our counterparties, you know, the people that we sit across the table from that are at the right place in their maturation process within those organizations and within their own career development that can say yes to something like us.

7:00How do you think about portfolio construction? Well, we think about it in a very non-traditional way. how we started was we actually started using with a set of computational simulations and if you go on our website we actually share those simulations on our blog what our simulations showed was that you either want a highly concentrated approach or a highly diversified approach to venture capital. And I think either of those two can work. They provide different things for your limited partners, but you need one or both of them. You need one or the other. And we really believe that a highly concentrated approach is actually the most risk-managed approach to venture capital, because we can be the most active and engaged with our companies when we are not spread thin as peanut butter.

8:09And we get very involved with each and every company. My partners or I talk to every company every week.

8:21But the important thing to know, David, is this sounds radical. I know it sounds radical to a lot of venture limited partners, But I actually don't think it's that radical. If you look at the history of investing in equities, what you see is that concentrated portfolios that allow for compounding at high rates of return with a low dilution and tax-advantaged structures have been the way to create wealth for limited partners for a long time. Newton said that we all stand on the shoulders of giants Newton was obviously correct in that but there's not a lot of appreciation for the question of whose shoulders are you standing on and so the approach I just outlined is actually not at all controversial if you look at, you know, Munger said it best I think when he said put all your eggs in one basket and watch that basket like a hawk that's what we do every day we have a small basket, we're putting our eggs in it, and we're watching it like a hawk.

9:34And so I actually think what we do is very conservative, even though it sounds very avant-garde. Tell me exactly how you go about constructing your portfolio. We start with a model. And that model says to us how, right, there are like three variables that we always work with. How much do we own of a company that what the target percentage ownership at entry and at exit? So that's one variable. The number of companies in each portfolio, that's the second variable. And then the third variable is the reserve ratio. So what percentage of dollars do we put into a company in our first check? And then what do we hold back?

10:33So those are the major variables. And within a fixed fund size, you know, our third fund is$93 ,330 ,000. So we know exactly how many dollars we have to allocate. and within those three variables we try and build a theoretical portfolio that gets us to at least 5x net and so then we work somewhat we work backwards and in an iterative process where like we do our first deal we look at how that works relative to our model and then our second deal and our third deal and we're constantly updating what we're doing against our model in order to drive at least 5x net return to our limited partners. And we do this until we get to, in our typical portfolio, we're trying to do between 10 and 15 investments.

11:29And then really where the rubber meets the road is when do you stop? So like in our second fund, we stopped after 11 investments. You know, we target 10 to 15, but when do you stop? Do you the 10th, the 11th, the 12th, and so on. And there's a whole art to that, which I'm happy to talk about now or any other time as well. One thing that's hard to grasp is LPs want to sit down and they typically want a very specific strategy, check size. And one of the things that they harshly judge GPs on is, did you do what you said you were going to do in your portfolio construction because if you take a step back, what they're trying to do is build a portfolio of portfolios.

12:14The LP is not just investing to your fund. So how do you get around this constraint, especially given that you are raising from endowments, pension funds, sovereign wealth funds? How do you get past their IC with having so much flexibility in your strategy?

12:37it's interesting david that you think our strategy is flexible i use the word focused i think our strategy is very focused we want to invest in 10 to 15 next generation financial services companies as the lead investor over like a three to four year period and we want to start those relationships as early as possible in the company's life cycle. On one hand, that's clearly a very flexible mandate because the world of financial services is quite large and dynamic and we work very early and so there's a lot of malleability in what happens. But I think of it less about the malleability and I think about it more about the focus.

13:30We want to focus on financial services at the early stage as the lead investor. And that positioning has been very effective. Now, it really helps that our first two portfolios are both in the top 5 % of their respective vintages on a TVPI basis. So we now have some evidence that the approach is not just a theoretical approach, but it's actually a practical approach. We don't want to be different for the sake of difference. We want to be different for the sake of excellence. And we're starting to show that that is, in fact, the case. And you believe that financial services companies can return the same or even higher than traditional venture investments.

14:24Break down the math for me and how could financial services have kind of these same power law returns? this this whole thing actually started with a bit of a thought experiment which is what would be uh in this hypothetical what would be the single greatest seed investment you could have ever made um and clearly on the top of that list would have to be if you were a seed investor in Renaissance Technologies, a Jim Simons hedge fund. If you would, like in this like thought experiment hypothetical, if you could like go back to Stony Brook, Long Island, when he was leaving the university and like owned 10 % of the company that turned out to be Renaissance, that would have been an incredible seed investment because over the forthcoming decades, renaissance has printed immense wealth for its owners its clients and so on and you you and then you start thinking about other things like if you had helped seed firms like bridgewater two sigma shaw and these uh if you had been there when they were starting kkr tpg carlisle blackstone black rock and so on and you just start to think about what would be the multiple what would be the multiples of invested capital you could have achieved if you were bloomberg lp another one right like it is astounding because these businesses can get very large very quickly they have very real moats around them they can print cash in the form of dividends they can go public you can sell them or buy them and so they have many of the best attributes of venture capital but they're definitely overlooked within the realm of venture investing which you know is like largely a software technology driven kind of business but that kind of really comes out of the birth of the modern computing industry.

16:53In venture, you obviously have fintech, financial technology companies, companies like Robinhood, Coinbase, Stripe. And we cover those, of course. And that's really where I come from, that background. And that is certainly within our remit as well. But you're also talking about these financial services companies. Are these traditional startups? Are these closely knit companies? And talk to me about this ecosystem of portfolio companies that you go after. David, I think your audience may not appreciate how large some of these companies are. I was just looking earlier today at the market capitalization of S &P Global.

17:38The market capitalization of S &P Global is$158 billion. So the scale, financial services is 20 % of global GDP. It's by some measures the second or third largest industry. And it's been, broadly speaking, the word would be dematerialized. It's been, back in the day, there were like people running stock slips around. Now it's all done electronically. And so the potential for digital innovation in financial services is just immense. Now, the kinds of businesses we talk about, the FinTech businesses and the FinServe businesses, they're definitely, some of them are based in Silicon Valley. Over half of our portfolio is based in San Francisco or the Bay Area.

18:29But a lot of them are built by entrepreneurs that come out of people adjacent to the financial services industry. As an example, we have in our portfolio a company called Sidecar. And Sidecar, the founder of Sidecar, Nick Talraja, he was an investment banker. And then he went to law school and was a securities lawyer. And he was doing securities filings for issuers of securities. And he was like, software can own this. It can eat this. and so we we've ultimately partnered with sidecar for a number of years now but what we find are the people that want to build the future of financial services some of them have traditional technology backgrounds but a lot of them have backgrounds more like nick they were uh they were in the bowels of the system sometimes you know turning the crank to get the system moving.

19:39And there's just so much opportunity to digitize that entire system that it makes me extremely excited to find the Knicks of the world, wherever they may be. In his case, he was actually in Houston. So there are these people all over the world. One of, I think, the concerns that LPs or VCs have about investing these super contrarian or otherwise not venture capital backed companies is that you sort of need the venture capital industrial complex to bring in more capital, to take it to liquidity, to force kind of an IPO and M &A. And I know that you're not supposed to say that, but that is kind of the business model.

20:27And that does lead to this pressure, does lead to this power lot outcomes. How are you able to navigate these companies to liquidity, given that sometimes you might be, you know, the ones the only ones investing in them?

20:44David, what you're partly talking about is the. Well, there are a couple of things. First, there is definitely a kind of self-referential aspect to the venture capital ecosystem where like a VC needs to raise their next fund. So they want to get another VC involved to market up. And then the second VC needs to raise their fund. So they get the third VC. And we call this the venture hamster wheel. And so there is this kind of self-referential dynamic within the venture ecosystem for sure. And I think sometimes this creates like really perverse incentives. So, for example, if you could grow a company profitably, even very quickly, if you could grow a company at, let's say, 3x year on year profitably, you would some venture capitalists would rather grow 5x year on year unprofitably so that they can go get it marked up so they can like you know get the mark to market accounting dynamics in their favor we ultimately eschew that whole approach because ultimately whenever you're running companies unprofitably you risk there not being capital for them when you most need it i I would rather, you know, own a company that can like profitably double or triple every year than kind of like play this game of Russian roulette with the livelihood of all these people and the equity and all that.

22:31The reason you're able to play it that way is because you align with your both the companies as well as your LPs from the onset. So you're selling a different product to a different market and everybody along the value chain is aligned with that strategy. Well, I don't think it's a different product in the sense that we have to compete with traditional venture returns, right? Like if you're an LP and you're picking Decians versus another fund, we have to be at least as good as the other fund, if not better. What we're talking about is an alternative way to get there. It's not different outcomes.

23:12We're not trying to lower the bar. We still want to do at least 5x net funds. What we're just talking about is that it is, in some ways, to do a 5x net fund where you're highly diversified, own very small percentages of each company, and have high mortality rates. what you are assuming is that one or more of your companies can be a mega mega mega outcome the reality is there are not that many 10 or 100 billion dollar outcomes your audience may know that the largest venture-backed m &a is whiz at 32 billion there are many venture funds out there that would need multiple whizzes in order to pay out.

23:58We call this heroic assumptions. If the model requires heroic assumptions in order to hit your return target, you shouldn't allocate to that because heroic assumptions don't happen that often. Alternatively, we would argue that our model, and if you go on defseans.com and you look up this, we wrote an essay called Heroic Assumptions and Heroic Outcomes. We talk about that our model has the same outcomes at far, has the same multiples on a net and gross basis for our LPs at far smaller dollars of outcome. And of course, I want the whizzes. I want$32 billion M &A. I want$50,$100 billion IPOs. But I don't need them.

24:49We can build incredible portfolios. have great returns for our LPs, help our entrepreneurs build game-changing companies. And we don't need heroic assumptions to have heroic outcomes. David, you were asking another question, which I think is also really germane. I think part of the issue in venture capital is that there is a conflation of two concepts. One concept is the concept of liquidity, and the other is the concept of exiting. Those are sometimes related, but they're not always related. And I think what we have observed is that we want to be able to invest in some companies that can generate liquidity without exits in the form of dividends or other ways of returning capital to stakeholders.

25:50And so I think just in general, I would just encourage all market participants to just think about, like, there's liquidity, there's exits, there are scenarios where there's both, and there are scenarios which there are neither. And so I'm just, we always want to be thinking about generating liquidity. Of course, it's very important to generate liquidity for our limited partners. But in a world where we can generate liquidity and not sell our position, we've actually had our cake and eat it. You know, we're having our cake and eating it, too, as the proverb says. The counter narrative to this fund size argument to a small fund size argument is that if you look at some of the biggest winners, they are from the largest funds.

26:39So most recently, Figma had Index, Sequoia, Kleiner, and also Raylock. Yeah. This is kind of a consistent theme in a lot of the big winners. So they would argue that they're avoiding adverse selection at the Series A, Series B, that the smaller funds may be going after. There's also an argument that the main reason to do venture is for the asymmetry, meaning that if you just consistently got 3x returns or 2.5x returns, you'd rather just invest into private equity, specifically kind of lower middle market. The main reason to do venture versus lower middle market private equity is because once every blue moon, you'll get a 10x, 15x, 20x return.

27:28I don't know this for a fact, but, you know, urban legend has it that, you know, there's a Chris Saka's lowercase funds or like, you know, 100 bagger funds or whatever they may be. I think there are incredible scaled institutional platforms, of course. You know, you mentioned some. There are others that are incredible. and I'm sure that their LPs are very happy to be in them. David, you said it yourself. There are many ways to make money in venture capital. I think that we have an approach that provides that asymmetry because although, you know, basically our approach says that if we have$3 billion of outcomes, we'll return a 5X fund.

28:24we're not we don't want to stop at three billion dollars of outcomes we want to stop at you know 300 billion or three trillion whatever it may be um i just think that in a world where

28:44there's an alternative world where you're not raising money every 24 months where you're not getting diluted over and over and over again, where it's actually better for all stakeholders, LPs, GPs, founders. We started this conversation by talking about the spouses of founders and the other stakeholders, employees, their spouses and families. And you don't have to give up upside for that. That's the thing. You don't have to give up upside. to have a better alternative approach to venture capital. Summer is here, which for me means occasionally trying to escape New York City on the weekend. When I get time off, the last thing I want to do is worry about keeping my personal finances organized and my budget in balance.

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30:04I also like monarchs AI assistant. You can ask questions like how much I spent on travel last summer or how many subscriptions am I paying for and get answers instantly. Use code invest at monarch.com to get your first year off Monarch Core half off at just$50. That's 50 % off your first year at monarch.com with code invest. Today, 2025, there's this focus on DPI, whether funds like it or not. And you, interesting enough, are actually signing up your LPs for 14-year timelines. How do you get away with having a 14-year timeline in this kind of market? well i i mean we're we're very transparent about it so i don't think we're quote unquote getting away with anything but you know the the thing about it is

30:55you know one of our big lps is a pension plan of a large group of public service workers and if you talk to the cio of this pension plan he talks about his obligation to these public service workers and their families being 70 years 70 year long liabilities

31:26and when you think about big families charitable organizations public pensions sovereigns they are the kinds of groups that can go long duration. And that's what we really provide, you know, a long duration product. I think of it in kind of the way of we want to actually be co-owners of companies along with their management teams and have an extremely long duration view of that relationship. And that is like completely opposite to a world in which there are more and more venture capitalists who are operating like traders. You know, they want to get in and they want to get out. Get in, get out.

32:12And maybe those trading operations can make money. I hope they do well, but it's not what we want. I don't actually think it's what most LPs want. And this, I think, comes back to maybe like what's been implicit in the conversation all along. but just this idea of compound growth so david how you compound money is by having it grow year after year after year not taking high default risk not having the chances of it going to zero be very high and when you look at the math of that what you see is that you can generate you know i was just looking at this for NVIDIA, you just look at how like NVIDIA is 32 years old.

33:02For 25 or 27 years, it was like not the most important company in the world. But if you just compound year after year after year, you can build a$4 trillion company. And when you talk about being able to deliver asymmetric upside, the kind of asymmetric upside that venture capitalists are in the business of, at least notionally in the business of providing, it's because you can find these compounding machines and you can stay with them for the long term. You don't become a forced seller after six, eight, ten years. If you sold NVIDIA after six, eight, ten years, you would have been very disappointed.