E342: The Rise of Venture Secondaries

0:00So you built Ultra on the heels of the private markets in the illiquidity in 2022. Tell me about how you built your firm. Ultra Venture Partners invest in the next generation of category-defining technology companies in the private markets. And we largely do so by providing liquidity to early stakeholders through something called secondary transactions. What preceded the opportunity in 2022 was 13 years of close to zero interest rates, followed by interest rates rising from near zero to five plus percent very quickly in starting March of 2022. And while 5 % is still low from a historical standpoint, relative to what was priced in across asset classes at the time, this was hugely disruptive.

0:41And so you saw public equities start to correct very quickly, especially the high growth public tech stocks that had been pricing in close to 0 % discount rates and crazy valuations because of that. The Nasdaq was down like 33 % that year at the low. The S &P was down 25%. Credit markets, which are directly linked to interest rates, adjusted very quickly. Late stage venture, where we sit, is a very illiquid and inefficient asset class and really needs a prolonged period of fear and pain for valuations to capitulate. And so for most of 2022, valuations were still very high. There weren't really new rounds getting done.

1:19Most of the companies had raised and did not need to raise new capital. We actually didn't see the bottom in venture until mid-2023, when it was off about 50 % from the 2021 highs. But over the period of 2022, I was kind of looking at this market and saw a really interesting opportunity emerging, where you had some of the best private tech companies in the world still in the private markets. They didn't need to raise new capital. So how do you take advantage of a market cycle and invest in some of these incredible companies at sometimes hugely discounted or, you know, attractive valuations? There was a lot of fear.

1:50a lot of the buyers had come out of this market. There weren't that many to begin with. And so we came in and we're buying some really incredible companies at like 40 % to 80 % discounts from where they were trading previously. In March 2022, interest rates went from zero to five over a short period of time. Everything just plummeted down in valuation. We're basically looking for the baby in the bathwater and that there were some good assets that were dragged down with the bad assets. To be fair, valuations, I think, did need to reset across the board. But we went from a period where valuations were pretty lofty, multiples were very high.

2:21Obviously, there were very low discount rates kind of being implied in those valuations to great companies that were still growing. A lot were generating free cash flow, growing 50 % year over year. And all of a sudden, valuations looked very reasonable, like very attractive relative to historical norms, relative to public markets. So there was just a lot of opportunities to kind of add to those types of companies. And did you raise in 2022 or were you already in the middle of fundraising? So I actually ended up spinning out and launching what is now UltraVenture Partners at the beginning of 2023.

2:49We made our first investment, I think, in June of that year. And the market bottomed in July of 2023. So the timing was good. Oftentimes, there's corrections in markets and there's so many buying opportunities. But paradoxically, there's no supply of capital for new funds. How did you actually raise in such a market? That's a good question. So if you remember early 2023, it was kind of a delayed impact, but that's when the banks were blowing up, right? Like SVB, whatever, credit suites was acquired. I mean, there were a lot of pretty big failures in the banking system. So there was a lot of fear in the market in early 2023.

3:18I started my career in like a bank failure environment or shortly below or shortly before in the global financial crisis. And so to me, this was actually a really exciting opportunity. But when we went out to raise from our investors who are largely high net worth individuals and family offices, it was really hard. Like, I think we raised$6 million in the entire year for 2023. It has gotten much easier since then. But at the time where we were seeing the biggest opportunities was definitely the most challenging to raise new capital. Do you think that helped you as a fundraiser and helped you build this franchise starting in the most difficult possible market?

3:48It builds resilience. I think, you know, going out and starting your new fund from scratch and kind of a new and nascent market as a first time fund manager, I think takes a little bit of resilience to begin with. But I just saw such an enormous, almost once in a career, once in a lifetime type opportunity emerging here that I had to do it and I just stuck with it. I think about it as a barbell strategy. Really bad markets are great for resilience and really good markets are good because it teaches you that it works. It's like I pitched, I followed up and they invested. Needless to say, it's 2021.

4:21It's the easiest market of all time. But there's something there of seeing success over and over that's really helpful as well. When you look at the secondary market, specifically in the venture asset class, why are so many people just buying portfolios? why won't anyone underwrite a single company? It's interesting that you say that. I actually feel like I see more people focused on the single company, single asset type acquisitions in the market where we're playing, which is very late stage venture. The portfolio acquisitions are a little bit more like a private equity strategy where you can come in, provide liquidity to an LP.

4:47It's a very illiquid market. You have to underwrite the entire portfolio, the GP, the exit profile of all of these companies. You usually come in and buy these at a discount. You can mark it up right away, or most people do mark it up right away. And then you have to manage all of those out. So I think it's just a very different piece of the market. And there's a lot of big players and private equity-like players that are doing that. That's not where we're playing. We are heavily concentrated and have a goal of building positions in the best private tech companies in the world. We have a fund that does this.

5:13We also do it on an individual basis through some of our co-investment opportunities that are really targeting building that concentrated portfolio of the companies that will create the most value and generate those power law dynamics. Expert calls have always been one of the most powerful ways to build conviction. But today, investors are asked to cover more companies, move faster, and do it with leaner teams. With AlphaSense AI-led expert calls, their Tejas call service team sources experts based on your research criteria and lets the AI interviewer get to work. The magic is in the AI interviewer, purpose-built and knowledgeable-based information to conduct high-quality context-rich conversations on your behalf, acting as a trusted extension of team.

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7:11Double click on that. Tell me about your strategy today. The underlying goal is to continue to build positions in the companies that we think will create the most value in the late-stage private markets. And we're very flexible. So I say it's opportunistic in terms of how we do this. So this is not traditional venture capital. Like where we're playing, late-stage venture and secondaries are really their own asset class and their own set of players that are emerging. And we invest kind of across a broad variety of transactions. So we can come in as a minority investor in primary rounds. We can help fill pro rata for early stage funds in later stage rounds.

7:42We do a lot of secondary transactions. So we can do direct secondaries where we come in and provide liquidity to early investors. So early funds, it could be angel investors. It could be executives or early employees of the company. We come into company-led tenders and we can team up with other funds and do large transactions. We're like, maybe we can't do a$300 million transaction, but we can team up with one or two other large funds to do a large secondary block in the market. So we're very flexible. We're very collaborative. We've also done equity swaps with company executives where they actually become an LP in our funds.

8:13In return for shares. Yes. So they would swap in shares of the company and then they get - Is that some tax efficient structure? Why would someone do that? It can be. It depends how you structure it. It becomes a little bit more complicated. When we've done it, we've basically paid cash for the tax component and just let them crystallize it at that point in time. And then they swap in the rest of the equity and then they get exposure to a diversified portfolio of another It's like these exchange traded funds in the public markets, but you've taken it to a private market. And it's very unique to our strategy.

8:41I don't know if we created it. When I mention it, people are often surprised. Like, I don't think that it is widely done in the market. The corollary in the public market. So if you have$100 million in Robinhood, let's say you were on the founding team and you don't want to be exposed$100 million to Robinhood. In the public markets, they have these vehicles called exchange traded funds. You could put in your$100 million in kind and you get a portfolio of S &P 500. the reason people do that is you don't have to pay taxes on it. You get diversified and then you could defer your taxes while minimizing your concentration.

9:10So that's been around for a while, but private markets, it's the first time I'm hearing about that. I don't think it really exists outside of a secondary transaction rate. So this is kind of growing in prevalence. And I do think if we expand that piece of our program, there are ways to layer in more tax-efficient ways to do it. Secondaries are famous for having lower information rates. How do you deal with that? And is there ever a case where you're able to underwrite an opportunity with low or no informationers? Ooh, good question. The secondary markets and late-stage venture as a whole are very opaque.

9:40It is hard to get access to information. I have a very institutional background, and we try and bring a more institutional level of diligence to what we do. So if we can't get access to enough information to underwrite what we're buying and project out exit value and likely financial forecasts and things like that, then we just don't do it until we can get access to more information. So there are companies that we haven't invested in that I would have loved to invest in, and we just didn't get the opportunity along the way to get access to enough information to really underwrite what we were buying and our long-term views on the company.

10:10With that said, the amount of information we get varies on the type of transaction, who we're working with, whether it's directly with the company, whether it's coming into a tender that the company's running and there's a data room. So it varies dramatically. Once we get access to information, we can underwrite it. I'll say that view, unless something changes materially in the market, can kind of hold for some period of time, whether it's six months or something. And so maybe we can then do transactions where we don't have additional information because we've already done this diligence and form of this view.

10:36The biggest issue for a lot of smaller investors in this market is that they literally don't know what they're buying. You see share prices on marketplaces. I don't even know how they calculate what the valuation is associated with it because they don't have the cap table. They don't have the share count. And actually, I see sellers coming in to me frequently who quote a share price and evaluation that's completely wrong. And we often have access to more information than the sellers that we're buying from. It's a very asymmetric market in terms of who has information and who doesn't. Speaking of the market, venture secondaries, specifically single stock venture secondaries, who are the investors there?

11:15Are they the same investors as typical venture capital LPs? Primary investments and private companies fall under a venture exemption with the SEC. So when I started Ultra, only 2 % of venture capital companies were registered as an RIA with the SEC. Today, it's closer to 9 % or 10%. So it has grown dramatically over the last three or four years. And you're seeing a lot of the later stage players register. I think a big driver of this is secondary opportunities. So secondaries are not venture exempt. So we'll have to register. Other funds that are playing in this space in any meaningful way, we'll have to register.

11:46But what that means is that the rest of the venture capital industry, who knows these companies the best, who have been investing in them all along the way, are not the natural buyers or players in this space. And so you're actually seeing capital come in from different parts of the market to kind of create this late stage and secondary ecosystem. So the big venture capital companies are now kind of becoming these big cross-asset RIAs. You're seeing a lot of public crossover funds come into the market, like really large institutions, Franklin, Tiro, Fidelity, Newburgh, like really big names are starting to play here.

12:15Co2, Tiger have always kind of been in the space. Family offices, sovereign wealth funds, and even like the major strategic. So like we're seeing Amazon and Microsoft and NVIDIA are now all massive late stage venture investors. And so So it's a different set of players than traditional venture. But I think the opportunity in late-stage venture and secondaries is so interesting that there is a lot of capital coming. Are the limited partners different than in traditional venture capital, limited partners in these venture capital examples? It's a different asset class in terms of risk, in terms of duration, in terms of potential returns.

12:47There's definitely some crossover in the LP base. People that are naturally interested in early-stage tech, I think, inherently understand what we're going for in later-stage tech. Like, we also have a lot of public market investors. And here's why. The way that I think about it, like for my own portfolio, like if you go back to the mid 2000s, the best venture backed private technology companies would go public after five to six years on average at sub$500 million valuations. And so Amazon, Apple, Netflix, Google, they had to go public to access growth capital. So venture capital or venture capital as an industry was still a pretty niche industry that really funded the creation of companies.

13:24once they hit scaling mode, they had to go public to access enough capital to grow, which means that investors, both retail and institutional investors, got to participate in all of that upside. So if you bought Amazon at the IPO, it's sub$500 million. It's now a$2.3 trillion company. That's like 4 ,000 X plus return. I can't quite do the math in my head. Today, those companies are staying private for 10, 15 plus years and are worth hundreds of billions. We've now seen a trillion-dollar-plus company created in the private markets. And so much of that value creation is happening in the private markets behind closed doors.

14:01And so the way we think about it from a portfolio construction standpoint is that investors need to shift some capital from public markets into late-stage private just to recapture the same type of innovation and growth profile, compounding upside that they used to be able to get in the public markets. So Ultra exists because some of the best private tech companies in the world are staying private for longer. And so much of that value creation is happening behind closed doors. Small traditional public growth companies are now late stage private companies. It's the same risk return kind of dynamics.

14:30The companies we invest in look like mid and large cap public companies from a size stage and risk standpoint. They're just really inaccessible to most investors. Just to demonstrate that this concept, both SpaceX and Anthropic going public, both of my portfolio companies, full disclosure, are trying to get into the S &P 500 ahead of being listed. Sorry, they're trying to get into the NASDAQ index ahead of being listed, which obviously categorically means you're one of the largest companies. So they're trying to get into the largest pool of large growth companies at the time of listing, just to show you how crazy it is.

15:03Which I think makes perfect sense, right? Given the scale that they're at, it doesn't really make sense for there to be this kind of arbitrary delay just because that was baked in historically. What about DPI? How do you underwrite DPI in secondaries versus a traditional venture fund? How do you think about that? A traditional venture fund is a 10-year fund. The average life of a traditional venture fund is actually 14-plus years. So the 10 years is kind of made up, right? It's out the window. Our first fund is a five-year fund with three potential one-year extensions, just depending on the market and so forth.

15:34And it's fairly concentrated intentionally. We're two years into our fund one. One, we've already started returning capital to our investors through exits and IPOs and secondary liquidity. So it's a much shorter duration. Liquidity is higher. It's not liquid. It's still an illiquid asset class, but it is more liquid than early stage venture, right? And the duration is certainly shorter. I think most of the companies in our portfolio are likely or have the potential to go public in the next two to five years. If you've been considering futures trading, now might be the time to take a closer look.

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19:18I think one of the necessary components is you don't want to start in emerging managers to begin. And that's even for the benefit of emerging managers, because if you invest and then you wait until year 10 to get your money back, you're not going to keep on investing in asset class. There's a couple of alternatives that there's late state, there's secondary funds with minimized J curves. You can invest later stage as well. So it's a really critical success factors because as the retail comes into venture capital, if they start going into the very early stage, it's not going to be good for the industry.

19:44That's right. I think if you are new to it, you get kind of burnt out waiting for those returns that really come 8 to 14 years out. People talk a lot about, well, we educate our clients, but I don't know if you could educate someone on a 10-year PPI. It's something that must be experienced. My very first investment in 2008 in a startup took me seven years to get back my money. Obviously, I was 22 years old, so I was more impatient, but it didn't feel like seven years. It felt like 70 years. Seven years is a pretty good outcome too. A lot of my early angel investments were, gosh, about nine years ago now.

20:17I mean, we're just starting to see a few exits. It's easier said than done. And of course, once you get the money, you're like, oh, I love this. That wasn't hard at all. Let me do it again. Well, and along the way, so many of them fail that you just feel like you've - It's a lot of negative reinforcement before you even get the money. You've emphasized your concentrated portfolio a couple of times. Talk to me about your portfolio construction and what the principles behind it. What we've seen is that power law dynamics hold true throughout the equity market. So from early stage venture capital, it's one to 2 % of early stage companies create the vast majority of returns for early stage funds.

20:52In the public markets, it's the MAG-7 has generated a vast proportion of the returns, both across the S &P and the NASDAQ over the last five or 10 years. The same has held true in late stage private markets, where the top 10 and really like the top seven companies have generated an enormous amount of the growth and value over the last five years. And so we are intentionally very concentrated. A percent of our portfolio is in our top 10 positions, and we have maybe 25 investments in total. And so it's intentionally very concentrated in the companies that we think will continue to create that power law dynamic and create the most value.

21:31And we'll start to build positions in companies that we think could move into that over time, but don't want to dilute our exposure much kind of outside of that group. The best public investors tell me the same thing. I was honestly surprised to hear that, that they think about it as power laws. They think about it as a buy and hold strategy. So they're thinking about it like venture investors, maybe not 14 year timeline, but what asset would I want to own for five to seven years? And you invest in kind of the trading up and down as noise, but they're looking at it very much like private investors.