E287: What Separates Top Decile Managers from Everyone Else

22:05People are trying to figure out how to come up with something. What's an example of that? It could be anything from product extensions. It could be product structuring like evergreen. It could be investment thesis development, right? As much as we as an industry like to articulate that we're really good at investment thesis development from a top-down standpoint, and then we go out and execute deals against it. The reality is, again, we're reactive in many ways. We kind of generally know a sector we want to be in. We dynamically, because we have good fingers into the market, understand where the best opportunities are.

22:34We go execute against those. We make money. That's great. But over the long run, I think those who are more thoughtful over a multi-year period around, here are trends that are emerging that are going to create investable opportunities. we either can't access those through our existing structures and strategies today, or we need to come up with something new. Those are the people that you're seeing capitalize on those opportunities versus others who are reactively looking into their LPA when the market shifts and saying, how do we figure out a way to do that? How do you know when a GP is too early or too late to a specific trend?

23:08And is it a mark that they should be a little bit too early in order to become a market mover? or should you try to time the market in terms of product innovation? This is a big one. I would say, based on the last thing you said, timing the market is not something that anyone does well in any context, right? On an individual basis, clearly there are investors and firms that have made some great trades. It's almost a pejorative word, timing the market. Maybe I should say going into the market at the right time. No, but it's a great point because people see, I'll give you an example. I get the call all the time, five years ago was, should we get in, or three to five years ago, It was, should we get into infrastructure renewables?

23:44You know, two years ago, it was, boy, this private credit thing is really cooking. We know our space well because we're equity investors. Wouldn't it make sense for us to adjacently move into private credit? Or, you know, these evergreen things are really attractive for a lot of reasons nowadays, and they seem to be scaling quickly. Why don't we extend into that? I think people, it's good to ask those questions, but you don't want to be doing it on a reactive basis. But because by the time people have picked up on that and are asking that for themselves, there's probably some clear modes around key competitors and there's also a much bigger question you have to ask yourself around you know should i be extending into that space and i know i'm taking this in a little bit of a direction here but it's kind of a key thing that we see with a lot of our clients on product development right support for today's episode comes from square the all-in-one way for business owners to take payments book appointments man and staff and keep everything running in one place whether you're selling lattes cutting hair running boutique or managing a service business square helps you run your business without running yourself into the ground.

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25:47We've been part of many dozens of product launches over the years. We've seen success, we've seen failure, we've seen what works, we've seen what doesn't work. We've created this proprietary 23-point new product criteria that don't worry, I won't walk you through on this podcast. But I always get asked, what are the top two or three things that really sink people when they're launching new products. The top one is getting led into a strategy by an LP passively. And that's not to say you can't make money by having a great LP partner come to you with an idea and say, hey, we're going to, we want to invest in widgets.

26:17You guys should raise a widget fund and do that. It's doing it reactively and falling into what I call the anchor trap, which is you've got an established LP in your flagship fund. They come to you and say, there's some new strategy we want to be in. We're going to do it with somebody, whether it's you guys or one of your competitors, here's what size fund we think is interesting we're willing to be 10 to 20 percent of that as an anchor out of the gate and the gp says wow we can launch an adjacent strategy we have an anchor coming out of the gate the math we've run on the fees they'll pay us allow us to hire those one or two people to actually go execute against that this feels like a free option on growth and that's not to say you can't make money or it can't be a good decision but i see a lot of people kind of that's where the depth of the decision making goes and then they kind of structure around how to launch this product.

27:01Where that kind of leads to is the second biggest fallacy that comes up, which is miscalculation of the distraction cost. When anyone launches a product, we all do the same math, right? We sensitize how much money we think we can raise, what range of fees we think we can charge, what size team we need and what that's going to cost, maybe what our excess org costs are and a couple of other things. And we say that math works or it doesn't work at a certain size. What we don't do is ask ourselves, how much is the organization going to have to change to be able to operate two strategies instead of one, right?

27:31When we're in the market talking with existing LPs, how do we handle two products instead of one? Do we have to build a whole new pipeline of LPs for that strategy that don't overlap? We have to manage multiple deal teams, multiple portfolios. We have to get up to speed on a sector as an investment committee that we might not be as familiar with as our core strategy. We have to build a network of portfolio company executives and board members that we can recruit in. The list goes on. And I find over time, the distraction costs can be much greater than the on paper tangible costs of extending into new products, which isn't to say you shouldn't do it.

28:04But the exercise around evaluating how it will change your firm is something that fewer people do than they should. And then the last point I would make is the internal alignment piece around what partners want to extend into adjacent strategies versus not. Usually within the GPs that I see in the industry, there's a group of some partners who've maybe made money, maybe their track record's a little more seasoned. And they tend to be more interested in extending into new products, building the business, playing for enterprise value. There's a lot of reasons behind that. Many of them good. There tends to be the other side of the table, which are maybe less experienced partners who are still trying to build their own personal brand and track record.

28:40Maybe the clearest line of sight on wealth they have is from the current fund that they're investing out of. They're more resistant to new product. What happens if you don't acknowledge that gap and work to manage it is you get passive aggressiveness, whether intentional or not. and you end up launching products that are suboptimal. There's confusion in the market. They're kind of half-assed. I see this all the time. And so when you have any group of people, you can't always 100 % bridge the gap of alignment because if you have two or more people in the room, they're never gonna be 100 % aligned on what they want and what their life circumstances dictate.

29:12But if you're not getting ahead of that and understanding that and very open discussions among the partnership, this is where I see people making a lot of these strategic decisions suboptimally. I think calling out the misalignment and saying we're aligned 80 % here and here's where we're misaligned, I think it could be extremely powerful and extremely trust building to show where you might be misaligned and that's okay. But as long as everyone understands the misalignment, it actually ironically tends to align people better. When I think about like stability versus instability among partnerships that I work with, it seems counterintuitive, but the more stable partnerships, maybe like a lot of the relationships we have outside of the professional world are the ones where there's more honest and candid communication.

29:52there's a willingness and intentionality around for bubbling issues up, addressing them head on, even if there's disagreement about it, having tough conversations, even if they're iterative. You know, the teams that come to me that are very clear about strengths and weaknesses, warts and all are the ones that I think have the best base to be able to navigate problems going forward. It's the ones that come to me who might be great. You know, they might have billions under management, be highly successful, have great track records. You sit in the room, and you say, wow, these people love each other.

30:20They're friends at work. They're friends outside of work. They seem like they have everything figured out. What I worry about the most with them through experience over time is that often when people tell me they have a really collegial partnership, when I dig in, there's always some element of avoidance that comes with the toughest conversations. And while that might've worked until now, what happens is as your firm grows, maybe you have more fun products, maybe you don't, but the stakes get higher, people's lives progress, the gaps between individuals widen, right? People's individual desires about what they want the firm to be, what they want their day-to-day look like, economic incentives, those gaps widen.

30:54And what happens is you get to a point where if you haven't been working on that openly over the years, you get to a point where there's this, kind of going back to what kills products, the number three thing I said in the last question was this misalignment of partners on what you're trying to build. And so you don't want to be in a position where there's a market opportunity to pivot the business or launch a new strategy. You get everyone in the room and say, here's the on paper perfect playbook for us to execute this. And half the room goes, we have no interest in doing that. And we're not going to lend our full effort into doing that.

31:21It's kind of a terrible time to be figuring that out. Maybe it doesn't sound the best, but I think all relationships are transactional to a point. There's transaction value going back and forth. And the only times people realize their transaction is when it's off. When it's one plus one equals 3.5 and it fluctuates from 3.5 to 3.2, everybody's happy. But when it starts to be one plus one equals 1.5, people are like, well, you did this, I did this. Whereas if you look at relationships for example with my business partner curtis i'm oftentimes very explicit i i just had a podcast i wanted to do it it had no strategic value to us and i'm just like i want to do this this is a passion of mine i think you'll make a good episode and he's like sure happy to do that and then when he wants something we just again a lot we call out this misalignment and we're we have a super good relationship because a we have trust but b the pie is so big that even taking a small slice it just no one even notices it's almost like this this uh invisible force oftentimes Sometimes GPs will come to you with their hairiest problems, things that they would never bring up to their LPs.

32:19What are these problems that GPs, for lack of a better word, hide from LPs that LPs should be aware of? It's a great question. People come to me typically with issues around product roadmapping, building enterprise value at the firm level, and succession. Of the three, succession is by far the most common issue because it permeates every aspect of our business. What do I mean by that? Most people think succession is transferring governance and economics 12 to 18 months out from a founder stepping back from a business. In our view, succession is the transference of knowledge and vision. And this might sound pedantic, but it's actually a really big thing.

32:58And so when you unpack it, when you look at most partnerships around the industry, there's a founder, a couple founders, and then a group of next generation partners who are positioned to take over the business, typically the people who've led deals within that business for a good amount of time. When you look at the professional backgrounds and expertise of those two groups, founders of successful GPs that are in a position to go through succession are typically both successful investors and successful entrepreneurs, right? They started their firm and built it. In many cases, the next generation of partners, even if they have the capability of becoming successful entrepreneurs from an experience standpoint, they're primarily successful investors.

33:31And so we expect them overnight if they get handed the keys and overnight could be a multi-year period to somehow be able to make all these firm level decisions. And we talked about this a little bit earlier around emerging managers, right? There's a deal related skill set around thesis development and sourcing and value creation and portfolio management and all of the sub kind of topics within that. And then there's firm level around strategy and vision and capital formation and people and compensation and a whole bunch of other issues. And if we say, and we do this as an industry, I've got a bunch of great smart people around the table who've kind of seen all the information I've taken in.

34:05They've seen the decisions I've made and they've seen the outcomes, they should know how this works. We have a really bad understanding of how the apprenticeship model works. We're in the apprenticeship industry, whether we realize it or not. And I think we overestimate how much learning by absorption happens, right? The art of being a top decile investor, some of that is articulable on paper. A lot of that sits between our ears, between the information we take in and the decisions we make and how we affect that. And so one of the things that we've done to try and help a lot of our clients with this is we actually just publicly published a deep dive recently on succession where we said, okay, if the problem at hand is knowledge and vision transfer, who else has figured this out?

34:42And so we partnered with a great guy, Hazard Lee. He was a Wall Street Journal bestselling author, former chief of F-35 training systems, former F-35, F-16 flight commander. And what Hazard helped with is the fighter pilot community over decades has focused on judgment transfer. They're empowering individuals to make thousands of decisions and very costly plans with lives at stake. So they're highly focused on how you transfer this judgment over time and measure it. And so he helped us put together this framework that we think is applicable for the industry around how you navigate this thing. And we break it down into five different topics.

35:15I won't go through all of them, but the two that we bookend the deep dive on that I think are most relevant for GP founders are define the why and the debrief. So on define the why, I come back to when I say the art of being a top decile investor is between your two ears, it's not just going to your analysts and associates and mid-level deal team professionals and explaining to them as the chair of the IC, you know, why you gave a go or no go decision on a deal. That's part of it. But it goes all the way up to your number two or number three partners, explaining to them, here's why we're going to make this concession or not to this LP and the side letter.

35:46Here's how I'm going to communicate that. And I think we, the best investors in this industry are experts at multi-stage, multi-level negotiation. But what I see around a lot of deal teams is kind of a version of you anchor low, I anchor high, we meet somewhere in the middle. And we're not transferring that knowledge. And so explaining why and how we're making these decisions as we communicate, not just to our junior folks, but also to our partners, how we help transfer that knowledge. You mentioned earlier in the interview, GP stakes. What role do GP stakes play in the GP market today? And how does selling a GP stake factor into the role of managers today.

36:24If you're an emerging manager, if you spin out today and you actually deliver on the investment performance, you think you will, there's a world in which you sell 10 or 20 % of your firm before you see a dollar of carry payout, which is not a bad thing, right? That could just be a timing of carry and a duration question. But I bring that up to highlight that it's changed how people think about building their businesses. And it's also driven this bifurcation in the market that I mentioned earlier between independent sponsors and emerging managers. So when you're talking about newer firms, people who want to focus on deals versus the deal business, you have the independent sponsor route.

36:57If you want to focus on the deal business, you have all the challenges we walked through earlier that are unique to zero to billion AUM firms. But the flip side of that is if you can navigate that well and you get to a billion of AUM, you're going to start getting inbounded by some great GP staking firms out there that want to explore partnerships with you on a minority basis. And so I think it's shifted how people think about building a firm versus doing deals and seeing a firm as a vessel through which they can do deals and earn carry. And it's gotten people, I think, to crystallize in their minds that maybe vision, maybe strategy, maybe systems, maybe processes, maybe culture, more critical than you think, because you can monetize it.

37:32Back in the day, if you and I started a fund, we're either going to keep it relatively small, do great deals, earn carry, everyone's happy, or we're going to try and build a large firm that we could one day IPO and actually sell a piece of the firm itself in addition to our other economic currencies. Today, because of staking, there's obviously a third route that didn't exist before. And so again, I think it's helped focus people on running GPs more like businesses rather than ecosystems through which deals can get done. And I think it's great for the industry. I think it's helped focus us in a really big way.

38:04GP stakes work well. What problem are they solving for managers? I'd say most people in the stakes space today would say it's still primarily a financial transaction, right? There's secondary liquidity on the one hand, and there's primary capital going in on the other, whether it's to fund GP commitments or working capital to build new strategies or scale the flagship. I think the industry is still figuring out what the value add piece looks like. It's different depending on which staking firm you partner with. It's different as the firm receiving the stake in terms of what you need. there's kind of an evolving universe of kind of what type of help can be provided which i think is great because again all of this is to the benefit of lps uh who are having folks focus on gps being a business itself and although that seems counterintuitive because as an lp you say i just want that focused on my deals i go back to a point i made earlier you're going to get commit capital to somebody for 15 years what are the odds that any team at any company is going to look the same in 15 years as it does today you need to be betting more on whether that company is going to to be in a good shape in 15 years, regardless of what they're focused on, to have confidence that there's going to be good talent and currency around the table, managing your money.

39:10And I think staking has helped people do that. But there's a financial component, but also on the value add piece, which again, is evolving and emerging. And year by year, you're seeing a lot of new and interesting things pop up there. As you mentioned, year by year, GP staking is evolving. It's over$70 billion market today. But a lot of LPs are still skeptical of the misalignment. I sell 10 % of my GP. Am I not less motivated to grow the business and to invest into great companies? What do you say to the LP skepticism around GP stakes? I can't speak for anyone else, but if I'm an LP and I think about alignment and I think about key person, what I don't want is to worry at night that if one single person, the founder of a firm decides they're less interested in putting a hundred percent effort in because they've taken some money off the table, that my capital isn't going to be invested and managed and steward in the way that I expected.

40:03I think that's a mistake on my end for committing capital to a firm that's predicated on a single person. And this is where I go back to, you know, a lot of times I push on this with my clients, you know, as GPs, we seek to be more valuable as a whole than we are as the sum of our parts, right? That's kind of what any business wants to be more valuable as a whole than the sum of your parts. But you have to ask yourself, why is that? Is it because you have vision and strategy and process and infrastructure and culture and incentives that tie it together? Or is it because you have one or two founders that are kind of holding together a group of fiefdoms within a fund?

40:38And without those founders, you're going to see a degradation in performance. And that's not to say that that doesn't exist everywhere. But I think if I, as an LP, we're going to pick on the alignment piece, look, we always have to focus on alignment. But at the end of the day, I'm probably more focused on underwriting a team than I am one person. Because over a 15-year period, you can't really count on any one person to be able to deliver whatever your target returns on for a total portfolio. I think one of the biggest misconceptions about GP Stakes is that the money is primarily for secondaries.

41:09That is typically a yellow or red flag. The majority of money is still going into the business. And we have this consolidation in the market between the haves and the have-nots. And if GP Stakes would come in and help the emerging managers, the managers with a billion, two, three,$4 billion compete with the large managers when it comes to talent, systems, LP management tools, all these things, I think it'd be net effect. But the devil's in the details. And I think every single deal should be looked upon kind of on a one-off basis in terms of whether it's a creative or destructive to the current LPs.

41:42We have kind of a three-pronged currency pool in the alt space, right? Cash, carried interest, firm equity. Most other sectors, it's cash and it's firm equity and you look at series a b c d and beyond venture rounds and growth rounds after that there are secondary trades that happen there as well founders do get liquidity and i just bring that up to highlight that alignment is a bespoke thing between two groups and to your point it really depends on the situation but we actually have more variables at play that we can use to tweak and hone that alignment in our industry than in others If I were an LP, I'd be less worried about alignment as it relates to secondary interests out of GP stakes transactions and more about what LPs are already focused on from an alignment standpoint, which is where's the carry in the fund coming from?

42:33How is it allocated among the team? How is it being used to incentivize, attract, and retain really good talent? LP is already diligence that. The value in staking transactions is calculated in a lot of ways, but part of that is the ability to continually raise and successfully deploy funds and generate carry that helps you retain talent that allow you to continue to raise funds and deploy capital and generate more carry. And so carry kind of ends up being the equalizer here to balance out that consideration in my view. What have you changed your views on in the past 12 months?

43:06I think a higher percentage of firms are not going to raise the next fund than maybe people have thought about in the past. And I don't think that means we're contracting as an industry per se. I think competition for capital and deals and talents at an all time high. I think barriers are lower than ever in a good way for people to be able to launch independent sponsors, launch emerging managers, build emerging managers, compete on a number of different planes. but it also means you know for those who are even historically top quartile top desk style strategies and relying on existing LP relationships to continue to re-up and those strategies I think your lunch might be slowly getting eaten by your competitors whether you realize it or not and I think there's a lot more folks that have come to realize that as I mentioned earlier that are focusing on innovation because if you're an LP at the end of the day discretion has become more important than ever right like we always focus on fees and we focus on the ability for people to co-invest, which dovetails with discretion.

44:02I think what I see around the market is LPs seem to be more focused on discretion now than ever. Meaning, historically, you have to raise a fund, your track record is the biggest and most important thing you can talk about. While that can be true, especially if you're a top quartile or top decile investor, the reality is nowadays, LPs are underwriting, from what I see, your pipeline a lot more, right? And your ability to source proprietary deals and to whatever differentiated value out against that pipeline. And the track record itself can kind of be an albatross, but it also ends up kind of representing that there's a lot of firms that have fully ingrained themselves in one singular strategy, right?

44:36I have a series of funds in a particular subsector with a deal team that's really deep in that sector, a stable of operating executives, another talent in that sector, connectivity in that network in that sector. If things slow down, I think you're seeing fewer LPs that say, well, let's, you know, you guys have been a longtime partner. Let's figure out how to manage this across different business cycles. I think they're getting more efficient at saying, is there someone else we can be allocating to who maybe isn't starting from a position of having a lot of deals in that sector they need to harvest before they're ready to deploy again.

45:06Going back to when you started in 2009, what is one timeless piece of advice you would have given yourself that would have either helped you accelerate your career or helped you avoid causing mistakes? It's a great question. There are mentors throughout my career, David Rubenstein among them who I think have pushed on the fact that we should all be a little bit more risk tolerant when it comes to experimenting in our careers and taking risks and trying new things. I think as a lot of us move throughout our careers, we really appreciate the non-linearity that is the reality of building a career and building an expertise.

45:39I think in hindsight, what I appreciate now is that at a certain point, all of us in our careers are truly an expert in something and the decision becomes how we want to employ that expertise in the market and compensated for it. I think if I could start my career by focusing on figuring out what that expertise is, which I found today, but which I think I could have probably mentally honed in on earlier, I think it positions you to be able to take more risk in the seat you're in, to take more risk into moving into new seats, to ask yourself, if my career is predicated on building the following expertise and creating optionality for me to employ that in whatever ways I want to as time goes on, what decisions would I make differently?

46:22Would I be less myopic? Would I be less focused on my bonus this year? Would I be more focused on building expertise and taking risk knowing that it might close certain doors but open others? It's kind of that longer term view of what you're trying to build in your personal career that I think is hard to get a grasp of early on. Something that I think a lot of us find as we get into the middle of our career, but something I certainly would encourage everyone to be focused on regardless of where you are. Being more strategic thinking, maybe not in decades, but in five-year periods, earlier on in your career versus year-by-year, promotion to promotion.

46:55I would actually think about it in terms of a lifelong timeline. The answer will change, but if you had to triangulate around one type of expertise, something you're both good at and that fulfills you. Even if you can't answer the question today, but if you held that question up every month, every quarter, every year in your career, over time, you'll hone in on, here's the thing I think I'm good at and enjoy and that I can be an expert in, what decisions would you make differently? And I think people are surprised about the risks they might be willing to take professionally if they knew it was an effort of building a 50-year career around an expertise versus achieving a certain title or a certain economic outcome in the near term.

47:37I think a lot of people chase titles. In our world, I see a lot of people chase the managing director title in the first third of their career. And then guess what? You're a managing director for the rest of your career and you're measured entirely on the success of your investment skillset and your track record. And I've mentored a lot of people along the way where I've really had to hammer that point home on, don't chase the title, don't chase the near-term economic incentive. If you have confidence that you can become an expert in something and you're confident that you'll make the money that you need to in the very long run, then take a hard nose towards how do I build that expertise?

48:07Because the rest will come. The world and specifically finance world is constantly trying to commoditize everybody into one track. You must be a generalist at everything. And yet the people like David Rubenstein that end up being these three standard deviation outliers are the ones that hone in and double down on their strengths. And I think part of that is coming back to something I said earlier, having a high level and elite level of intellectual curiosity, not only helps you to understand other people's expertise and to learn from it every day, but it really helps shape the universe of the different types of expertise that are out there.

48:41And you can really start to map out where you fit within all of that, where you can make yourself indispensable, where you think you really are better than other people in the industry who you consider experts. And you say, hey, I'm at least as good at them at this thing. Maybe that's my expertise. And so I look at that intellectual curiosity and that constant learning from others is kind of a key tenant that I've learned from great mentors and something that I try and hold true in everything I do. That's it for today's episode of How to Invest. If you're a GP with over$1 billion in AUM and thinking about long-term strategic partners to support your growth, we'd love to connect.

49:11Please email me at david at weisbergcapital.com.