E264: The Asymmetric Edge: Generating Alpha in Venture

0:00Jamie, I've been very excited to chat. Welcome to the podcast. Thank you, David. Thank you for having me. Really excited to be here. I listened to you for a long time. And so thank you. You have, according to Ilya Strubelov's unicorn list, you have 19.2 % of your companies end up at the seed stage becoming unicorns. Tell me about your sourcing strategy. How do you go about sourcing such a high quality and high caliber companies? The number one signal that we found, because we've regressed a lot of this data and looked at where the companies that we've invested in, where does it come from? And we crunch these numbers all day.

0:40The most powerful signal has been the founder referral. So not the peer-to-peer, not our other competitors in the space. That tends to be about a third of the time. The majority of the time and the highest signal time and tying it back to the investment process of which companies end up being billion dollar outcomes are when I get a phone call from that five out of five founder. Often they may already be, you know, a multi-billion dollar company. And they say, hey, Jamie, like, hey, I just met this kid. He's an also good. Now, you need to go down and meet with him or her like tomorrow. up. And those are the strongest signals that we get.

1:21And those are the ones where my antenna kind of pop up. And there are only a handful of folks that I will kind of listen to in that regard. But thankfully, some of them are already in the portfolio. But when they say, you need to meet this person, I'm going to see them in the next 24 hours, most likely. Of course, there's many other ways that we source, but I think that's the most powerful one. Why do you think that founders, specifically unicorn founders, are the best source for deal flow? Oftentimes, they're already looking at these companies. They might be developing commercial relationships with them.

2:01They may have actually already worked for them. Tom Mueller was famously the number one employee at SpaceX, if you count Elon as zero, or two, if you count Elon as number one. So you know how many funds that have been spun out of SpaceX, how many companies that have been spun out of SpaceX. Every single one of these companies or kids or funds has worked for Tom in the past. He knows every single one of them. So if we're talking about aerospace or defense and space defense or where those things meet as a category or just as a for example, Tom knows these people. So when he calls me and says, hey, Jamie, you've got to meet this kid, he actually knows the company and says, we use this company.

2:47We don't use this company. This one's great. This one's pretty mediocre. And this kid who worked for me is one of the best engineers I've ever had. Some of the best venture portfolios of all time, literally ranked at the highest, are not actually venture portfolios. They're angel portfolios. They're Mark Andreessen's portfolio, David Sachs' portfolio. some of the super angel portfolios technically some of them took money and that's because they had this asymmetric information where they were investing in friends that they went to at stanford or in business school or engineers or engineers that worked for them and they had the benefit of knowing how effective these employees were over years of working with them to be truly excellent at this game you know if you want to play with it if you want to be in that category with zacks and and Mark Andreessen and those folks, you're not in venture beta.

3:41And there's, you know, venture beta, it's not easy to get to venture beta, but I think there's a lot of firms out there that are offering venture beta. That's good and that's fine. But if you want to be truly excellent, you need asymmetric information. Now that's true in private markets and it's true in public markets. I used to work in public markets at GoTo. What you just said, David, is absolutely true. There has to be something out there, some kernel of truth or some kernel of information that you're getting that not everyone else has. And that's part of the secret sauce of finding the next unicorn or decacorn or major company.

4:19When you find this next unicorn or decacorn that's sourced through you from your very top founders, people that they work with, how do you go about winning? These tend to be extremely competitive rounds. How do you elbow out the other VCs in that round? And what's your secret to winning? It's a terrific question, David. And I think that the honest answer is that we have to out-hustle them as a smaller fund. This is where kind of some of the hedge fund background kind of plays to my advantage and plays to our team's advantage. I'm just riffing a little bit here, but when I first got into venture, I just didn't see the same level of diligence and homework that I saw that was being applied at places like Cove2.

5:14before CO2 had made the habit to become a crossover fund investing in publics and in privates. Because the amount of diligence, the amount of research that we would do to get something in the book, the public book at CO2 before they had a big privates book as well. So when you bring that level of homework to a founder at the earliest stage and you say, hey, listen, I have a 50-page deck, you know, or I have a 50-page memo, rather, on your company, and I am going deep. I'm going almost private equity deep on your company at the seed stage, and I'm going to share this information with the growth players or with the seed, you know, whoever is writing the next check into the next round.

5:56I'm going to help them underwrite your next round, and oftentimes, you can beat people with the research that you do, and I think that that's something that goes unset or it doesn't get said enough. Maybe I shouldn't even be revealing it publicly here. I had JR from Industry Ventures and he talked about just the meticulous diligence process that they go on, both on funds as well as deals. And a lot of people in pre-seed and seed, they kind of throw their hands up and say, well, it's unknowable. It's unknowable about this market. by the time Bain creates a research report, it's already too late and all these things are unknowable.

6:35And that might be true, but to me, that's also an excuse or a form of laziness to not do as much as you can to try to get more information in the space. The worst case is you end up getting information that is not very useful or that doesn't move the needle. But I think people don't do the necessary hard work that takes to both diligence, both companies, founders and everything and just kind of use this whole framing of a pre-C and C just to be lazy for lack of better work. I agree with you and I don't want to cast shade upon any peers or any peer firms but I do agree with you that there is a tendency or a proclivity for folks out there at the pre-C level to just say hey you know what it's a small check anyways and it's a big end market so let's just kind of see where this thing shakes out and this guy's ex-andral or ex-mock or you know and so it's probably a decent sharp ratio bet but you can go much deeper you just have to get creative you could become your own investigative journalist of sorts and just go down any rabbit hole to find bits and nuggets of information that may surprise you as being incredibly informative and uncovering blind spots and things like that.

7:57Perhaps it's not binary, but one of the main sources of diligence that I think that needs to be uncovered in these pre-seed and seed opportunities is why that individual is leading this name brand startup. Let's say they're at Anduril at SpaceX. Again, it's not binary, but they tend to fit in some continuum as they're not a great employee, they're burning out, or they're the top of the top, and they want to build something even bigger, or they want to build something for themselves. And zeroing in on that diligence on just how quality of an engineer that first one or two employees are at a company, I think, is one of the things that goes under diligence.

8:44You know, I started my career at Goldman Sachs, and it was just the ultimate training ground. It was where you went to cut your teeth. And I think I sort of view SpaceX as the new, as kind of having that ethos. And I think it's their star is so bright, that's shining at what is admittedly now a large institution. Let's use SpaceX as an example, to where they've got bigger dreams and their ambitions are so bright that they can chase those dreams. And that might not be starting another space company. You know, in many cases, it's I want to build small modular reactors in the nuclear realm. And this is my dream.

9:27And due to the beauty of the SpaceX tender process and the liquidity around the name, you might have some of these, you know, younger people. They're in their younger 30s. You know, I'm 41 now, so they seem like kids to me. But, you know, they might be in their young 30s and they've got quite a bit of money in the bank and they can start their own company. And these tend to be very ambitious young people. So I think it's more the latter, that their star is so bright that they're not running into any ceilings at SpaceX. It's just that they can have a much larger outcome for themselves. And I think it's more of that.

10:07When I spoke to Jamie Gull from Wave Function Ventures, he's a former SpaceX guy, He said that people at SpaceX fit in three different camps. One is the ones that burnt out after six months, so they just couldn't take it. They couldn't take this responsible engineer culture, which basically means that every engineer was responsible for everything in their orbit. They couldn't hand it off, and they couldn't kind of say, that's not my job. The other end of the spectrum were these SpaceX lifers. there the people that are there for 10 15 years that just could not see a bigger mission on the planet than making uh the human species multi-planetary going to mars and all this and then there was people in the middle that would go there for five ten years build their skill set build their network and go on to start other great things so he kind of saw this as these three camps Jamie's a good friend so I talk to Jamie all the time and getting his experience is incredibly helpful part of this business and bringing it back to um that sort of asymmetric advantage is collecting people like the Jamie goals out there that are just a phone call away and we just you know chat about this kind of stuff and so that that's you know that all feeds back to those information loops that are, you know, asymmetric and he's got a good, it's good of a take.

11:31Tell me about the humanoid robot space, your investor in figure, which just to bring it back to Elon, directly competes against Tesla. Elon says that the optimist is going to be their biggest product ever. Talk to me about the humanoid space. How big is it? And what's going to determine who wins that space? So let's start from the top. So the labor market, the global labor market is the largest end market in the year. So going back to what I was saying at the beginning, the market for physical labor is about$42 trillion a year. So we'll start there. So we've got a big sandbox to play in. Now, if we look at, you know, many of these applications and many of these jobs within this kind of sector and what are the subsectors, these are not necessarily jobs that we want for Americans in the future, or at least let me say that differently, that I want for Americans in the future.

12:31So like picking and packing, you know, there's about 150 % a year turnover for laborers in this kind of space. These are jobs that can be automated. I believe they should be automated. And I believe in its inevitability that major corporations will have no choice but to automate. I'm on many of these jobs, especially if we want to re-industrialize and relearn how to build things in America again. One of the things that I'm trying to figure out is whether the humanoid robot space is going to be more of industrial or a residential product. In other words, are we going to get these maids that are cleaning the house and doing the laundry?

13:15Or is it more production lines and automation? Elon has said that this is going to be the largest asset class in the world. It's going to be bigger than the smartphone market. It's going to be bigger than the auto market. I think it's both and it's beyond that. And the math pencils for the reasons we just discussed. So you think about industrial applications and repetitive tasks like, you know, in the 3PL space, worker 247 moved this pallet, you know, that contains two sticks of deodorant over to this area. There's that job, right? Think about cleaning hotel rooms. How many hotel rooms around the world need to be turned on a daily basis?

13:59All those sheets need to be cleaned. All those towels need to be cleaned and re-hung. You think about all the office spaces out there that are cleaned each day. The minimum wage in the United States right now is, call it like$52 ,000 or$53 ,000, I want to say. Maybe it's a little bit higher than that. So you tack on, I'm going back to the industrial application, like the industrial kind of worker or the logistics worker. You tack on disability and insurance, and then you factor in that they work about a six-hour day, but they show up for work half the time. and there's 150 % turnover, when you talk to some of these warehouse owners, their total cost for each of these employees is closer to$150 ,000 or$200 ,000 a year.

14:43And so when you present to them something that might be$100 ,000 a year or$80 ,000 a year, but guess what? The thing can work for 15 hours. It can work for seven days a week. It can work in the dark. It can work in the cold or the extreme heat. You know, there's no COVID, there's no unions, there's no problem, there's no complaints. There's a big 3PL player that's already expressed interest for 85 ,000 humanoids from figure. So at$100 ,000 a robot per year, that's$8.5 billion in ARR right there. So that's from one customer. So I think that's why if you get really excited very quickly, and that they'll play a big role in the future.

15:34You've deployed now two funds into the ground, $35 million first fund with a total of$100 million deployed, including CoInvest, and$75 million with$200 million with CoInvest. What were your learnings going from fund one, fund two, and what do you plan to do different for fund three? The main learnings from fund one to fund two was that we got quite a bit more concentrated in fund two. So we started to get a little bit more aggressive. And what do I mean by that? I don't mean aggressive like, you know, I'm going to argue down on this term sheet and I want this lick breath. And I want, you know, I don't mean aggressive in that sense.

16:09I mean, like preempting rounds at inflection points where, you know, your typical VC might, you know, come to you and say, hey, well, they're not going to raise their Series A until next year. and you know i sort of hear that and my first thought is like well okay fine i don't you know that's maybe that's what they told you but if you ask the question you know will they will they take a little money you know will they take a little more money now so what what is something that we've done very successfully in fund two is identified those companies that are you know exhibiting some sort of like escape velocity or just true velocity to the upside and they're hit it, just won a few big contracts, or they're going to about to win some big strat five program or whatever it is, calling them up.

16:59And they say, Oh, yeah, we're going to raise our series A next year. And you say, Okay, great. Well, how about you take another couple bucks from us now, you know, on a safe, and we'll do it at a, you know, a discount to the next round or whatever it is. More often than not, you'd be shocked at the response. And the response at first is like, well, I don't know. I don't want to take the, you know, and then you say, well, what could you do with another$3 million and make it the number up? So, well, I could, I could advance this program. I could advance this program. I could hire eight more engineers.

17:31Um, and so more often than not, people come to, yeah, a little bit extra capital right now would be nice. And so, and then that series A happens and we've already added, you know, more to our breakout winners. And, um, And that's another thing that we've really changed about our process is just really playing offense as opposed to defense. After spending eight years at Goldman Sachs, you went to CO2 and you got to work with Philip LaFont, who's co-founder of CO2. What did he teach you about investing? Oh, my gosh, Philip, so much. It's hard to even boil it. So I'll give you a bunch of four examples because he taught me so much and his brother Thomas as well.

18:19Philippe is a true savant in terms of boiling down very, very complicated things into the two or three things that really, really matter. And so I'll give you sort of a hypothetical and then an actual. The amount of times, for example, that I would come to him with some really complex model and laundry list about a certain company of the 45 things that this company would have to just nail. All 45 of them they would have to nail and then it could get in the book. And he'd look at me and be like, Jamie, this feels like something with too much sole supplier risk. And I would sort of double click on that.

19:07and let's go deeper on that. And that would probably most of the time he'd be kind of right. The other big thing, which I think is very applicable in the sort of the crossover space, if you think about playing sort of the hedge fund mentality to venture that he taught me was, he always thought it was crazy that sell side analysts and the rest of the street and Warren Buffett thinks this way, Jamie Dimon thinks this way, that measuring companies on quarters is just absurd. even measuring companies on on t plus one year or t plus two years is kind of absurd um and so he would look at a certain company and let's make up a company like netflix um i don't know what it trades at right now but i'm going to make up a number from a few years ago maybe it traded at 20 times or 25 times um earnings and you know and people would say you know maybe that looks expensive optically and philippe would challenge the assumption but he wouldn't challenge the assumption on the 20 or 30 times T plus one or T plus two years.

20:10He would say, well, in five to seven years, do you think that they can grow at this rate? And do you think that they can get to X hundred million dollar stops? And then say, because I think if you just should think about it this way and this way, if you think about it on a five year or a seven year or a nine year time horizon, I think you're buying this company at three times earnings, or I think you're buying this company at two times EBITDA. And then I think he was able to apply that same lens of thinking to venture. And I think he taught all of us that because it's really not that different.

20:49We're not really looking at the next one or two years in venture. We're looking at, you know, obviously five, 10 years down the road. What can this company be? and so those are the some of the things that i think philippe taught i had dan ives on the podcast he he thinks about public markets very much like a vc he thinks about if you froze the market for five years what would you invest in he was early at apple he was early at tesla he was early in palantir and he takes this private market lens into the public markets what else did you learn from philippe another thing that i'm i i sort of blatantly ripped out of the philippe lafont playbook but i'm proud to say that i did is that he would have us rank every investment that we brought to him as a one two five from a gut score and that was literally what it was identified in in the internal kind of crm and you know portfolio tracking tools you actually had to input a number one through five.

21:54And so I think, you know, and I think that the best investors in the world will admit that intuition, which is really what kind of gut, you know, meant plays a huge part, if not probably one of the biggest parts of true alpha. And because whenever we brought something to Philippe, we actually had to put in that gut score of one through five and five being the best. And then, of course, that would give him the benefit of being able to say, well, Jamie brought this five to me and I can regress that versus the performance of his stock picks. And, you know, it would give him a good lens into our own sense of intuition.

22:31We've taken the same thing to Tamarack. We take the same level of approach and the results and the correlations are pretty striking. And, you know, I'll just give you an example, David, that if you're just if you're debating whether it's a four or a five, you kind of know that in your head. You're like, well, they kind of were, they were kind of so-so on this and they were kind of a four on that. But I really did like this part of the business and that's more of a five. You can talk yourself into it being a five and make the investment. And most of the time it doesn't work out. But when you see a five and you know a five, it's like every fiber of your being, you know, you feel it at the deepest part of your gut.

23:16and you just know it's a five and you take a look at that data versus the ones where you were at like a 4.5 or talk to yourself and do a five it's pretty striking and you know i read a um an interesting quote from i think it was from josh kushner from thrive recently i'm gonna paraphrase here he said something basically like my deepest insecurity is that i will oftentimes have intuitions about a certain thing or a certain company that I cannot explain to anybody else, but I just have to invest and I love it. And he rattled off a few, uh, four examples and they were, I think it was Instagram, Spotify, and open AI.

24:03And, and I think that that was a big learning that, you know, it basically goes back to what we're saying, which is an intuition. And, you Do you have it or do you not have it? And I think the best have it. And it's something that, it's another thing I'll be eternally thankful that Philippe Tomming. I think about two things there. One is the Ashton Kutcher rule. So Ashton Kutcher has this rule that if during a pitch with a startup, even for one second, he has the idea of, I should quit what I'm doing and go work for this founder. That's a signal for him to invest because the hardest thing at the seed stage is recruiting.

24:40That is the highest form of alpha. Taken to the extreme, you could have a completely nonsensical business, recruit the greatest minds in Silicon Valley, and you'll iterate your way into a$100 billion company. The second aspect of that is this mismatch between gut and words. So if you think about what does it mean you have this gut instinct, it's not something that comes from outer space or from outside of your body. it's inside your brain. Our brains are fully encapsulated systems. So we have parts of our neurobiology that's syncing together to tell us that this is good. What we lack is actually the ability to fully articulate why we're feeling this way.

25:30So the information is there, the information, our gut is essentially our information. Step two is being able to articulate that information, but step two is not necessary. What's necessary is that you have that gut, because the gut is the synthesis of all the information that you have as an investor. And as long as you have it in your gut, you could articulate it. This applies to factors outside of investing. If you're in a subway, a woman sometimes will be on a subway and will feel uncomfortable. She may or may not be able to articulate why she feels uncomfortable. But more often than not, there's a good reason for why she feels uncomfortable.

26:08And it's, again, this intuition, the synthesization of information in her head that leads her to this uncomfort. So the gut is an undervalued aspect. Now, you could obviously corrupt that and you could say, this is my gut. This is why I'm banging a table. Maybe it's really your ego or you have an incentive that's not aligned with the rest of your partnership. And you could obviously corrupt this ability to say it's my gut. When taken in the positive and when not misaligned with incentives, it could be extremely powerful. that's all 100 true and i think that where you nailed it is in that inability to communicate it but you just sort of know it but you you may have trouble synthesizing it i i remember taking a social psychology course back in undergrad and it was basically a finding that people on average when in when there's public speaking you know if somebody's watching somebody speak at a panel or something like that, they typically make their decision on if they're going to listen to the person or not within the first three to eight seconds.

27:17And that's what the studies show is that in that first three to eight seconds, the person either grabbed their attention and had that sort of, you know, I go back again to that idea of gravitas and poise, or they didn't. And if you ask those people, like, why did you listen to that person? Or why did you not listen to that person, my sense is that they would not be able to articulate it. They just see they made a snap judgment of like, this person's interesting or they're not. A lot of what becomes being a better investor, one is the input of more information, more aeration, more use cases, seeing what excellence looks like.

27:59But some of it is also learning to trust your instincts. and sometimes to this point you just don't have you can't wordsmith exactly where you're feeling i had a funny example i was at brunch with my business partner and we were meeting with someone and she was she just spent too much energy smiling and i just learned kind of i learned to read micro facial expressions i literally told my business partner he said well she seems nice what did you think? I'm like, she spends too much energy, too much facial expressions smiling. I don't think she's authentic. And I ended up being correct. Not that I'm always correct.

28:41But, you know, these absurd kind of reasons for why you trust or distrust someone is actually wired in millions of years of evolutionary psychology and evolution biology. So sometimes they might be misleading, but sometimes they might be exactly on point, even if it sounds arbitrary or sounds like you're being hypersensitive? I don't think you're being hypersensitive at all. And I think those are exactly the cues that we kind of look for. And, you know, and I think in some sense being an investor, you are sort of like a social psychologist or you are sort of an anthropologist or you are, you know, you're looking for all those cues.

29:22And I think, you know, excess, I love that. I love that as a, as a potential, you know, negative signal where, where, you know, of course the optimist in me wants to say, oh, maybe David, she was just a really friendly person and you kind of missed the mark on that one. But, you know, my sense is you, you probably didn't. And maybe, yeah. What's kind of a mind fuck for lack of a better word is I would always excuse these kinds of behaviors and I would always kind of judge myself. Oh man, you're being so harsh. Maybe she's just, maybe her muscles are just more developed in her face, but the, the degree of precision and the degree of accuracy in these microfacial expressions may not be a hundred percent, but it might as well be a hundred percent.

30:11I'm also remembered in diligence. The only guest that's been on the podcast three times, Alex Edelson from Slipstream. He's extremely good at diligencing. And through him, I've actually learned that diligencing managers and CEOs is certainly a skill. And one of the reasons for his edge is because he started out actually as a lawyer. And part of his job was to interrogate people. And he learned, to your point, these micro facial expressions, how to phrase questions in certain ways. And the reason it's such an important skill is one is I would argue, especially in manager selection and references in general, I would argue references are one of the most important sources of alpha.

30:56And because references are essentially game theory where the other person is disincentivized to tell you the truth, being able to be a top 10 % or top 1 % reference interviewer, I guess, is a seriously underrated skill and a significant source of alpha, in my opinion. I think what you said is 100 % true. And I think it translates directly into what makes a great interviewer, because it's like, it's kind of like jazz, right? We're kind of riffing off of one another, right? You're kind of reading what I'm putting out, feeling what I'm putting out. And I'm, you know, trying to do the same with you.