E364: $90B Limited Partner: Why We're (Still) Bullish on Large VC Funds

0:00Nolan, you're the CIO of FEG Investment Advisors, which has$90 billion in AUA. Tell me about your approach to venture capital today. Venture's been changing rapidly. So there are certain core principles that have remained the same. And then there's other aspects that have changed over the last handful of years. It just says the landscape has changed. There's more assets out there today. And then obviously AI has been the epicenter of all things venture. So the core principles that really haven't changed are viewing it as an access class, not an asset class. Meaning if you're not in the best managers, it's really not worth the risk and it's not worth playing the game.

0:37And at its core, what has also stayed the same is we're trying to capture entrepreneurialism and innovation. And those are the central tenets in our guiding lights. Where that led us historically was primarily towards earlier stage managers. early stage, maybe a little bit of seed, where you can capture a bigger piece of the ownership and you get rewarded for bearing that risk with some outsized returns when it works. When it doesn't work, it's not great. But that was really the playbook that we use for the better part of the last 20 years. And that's primarily in technology. We've also been believers in life sciences, biotechnology, whatever you want to call it.

1:12So that was a component as well. And that was really the playbook. What has changed that we think will continue and we want to at least have some shots on goal is companies are staying private longer. If you look at some of the massive winners from days gone by, Amazon, pick your favorite gigantic publicly traded business, there was a lot of value that accrued in the hands of public shareholders. And today companies are staying private longer and or growing more quickly and creating a ton of wealth as a private business. So what that's led us to do is take a step back and say, all right, some of these brand name VCs that we would somewhat pejoratively call warehouses where they had one of everything, they were multi-stage, they had 20 different funds raising multiples of the capital they had in a prior life.

1:57You may actually want some exposure there to capture some of the growth. If you look at what's going on with SpaceX, OpenAI, Anthropic, you name it. Stripe is another great example of that. You at least want to have some exposure there and not just dismiss it offhand because the greedy venture capitalists are trying to raise$5 billion funds to generate more management fees. There's actually an argument for why you may want to play that game a bit to complement some of that earlier stage where you're really shooting for that IPO or bust type of mandate where you can get 50, 100x on some of those companies.

2:30It's interesting because it's become, no offense, but almost trite or unoriginal to say companies have been staying private longer. And yet, when you talk to a lot of investors and limited partners, a lot of them aren't actually changing their strategy despite everybody agreeing that this is a factor in the market? Part of it is some of the silos that we've created as allocators, where if you just cover venture, it's like, well, I want to find the cool new thing. I want to scratch and claw to get access to this$300 million early stage fund. It almost seems boring. Am I even doing my job if I just say, hey, let's invest in this$10 billion multi-stage VC fund because we want exposure to these companies?

3:06It almost seems too easy. But there's no points for difficulty in investing. Some of it was just disbelief that some of these companies could grow so quickly, much quicker than we've seen in prior cycles. And I think some people are now changing their minds a bit and saying, all right, there is a little bit of a new world order with AI and just the growth rates. So you can see that's been a more recent phenomenon versus the Stripe or the SpaceX example. So LPs are essentially grappling with two conflicting ideas of what it means to be investors. One is when managers, all things being equal, when managers grow and grow AUM and turn into what's disparagingly called asset gatherers versus investors, you want to cycle out of those managers.

3:47That's been tried and true for many decades. On the other hand, if the TAM of total addressable market of a specific category is growing astronomically and sometimes even larger than the size of the AUM, then on a net-to-net basis, it may still make sense to be investing into these managers that are growing. Our view is you don't want to do a 180 and just completely change course, but recognize that that is a potential and you probably want some exposure. I still think you want some of that early stage where you can capture that classic playbook, but recognizing that just because someone's become an asset gatherer in air quotes, there may be a rationale.

4:23So it's understanding who's doing it for the right reasons, who has the right strategy, who can play that game, which is a little bit different. If you think about what a business needs to go from zero to 100 million of revenue, it's a really different game than going from 100 million of revenue to a billion. So who are the companies and who are the VCs that have the skill set and the aptitude to do both or just different players, different courses for different horses? double click on the different skill sets that a VC needs to go from zero to a hundred versus a hundred million typically. Well, I'm doing this from the cheap seats.

4:55I was, I was an intern at a venture firm for six months when I still had hair. So you, you may have some thoughts or disagree with some of what I say. Early stage is just cult of personality, sheer hard work, hopefully a good idea of like the original business plan may be wrong. You just pivot, change quickly, fail fast, do whatever you can, scratch and claw. It's not building out organizational charts. So it's a little bit of the Wild West, grind it out and just make it happen through sheer force and a good idea and a good product. Once you're at a hundred billion, now there's organizational management and who's a good operator and delegator, not just I'm the entrepreneur and I'm the head of sales, the head of marketing, the head of product, the head of everything.

5:33Now you're delegating, you're building a team, HR, management, building an organization is very different than building something on your own on nights and weekends in your garage. So some people are good at one, not the other. There's a lot of big personalities in venture and then from entrepreneurs. Do people have the humility to admit what are they good at? What are they not? And can they hire and delegate some of the things they're not good at that maybe they did on that first leg of the journey? the way that i look at it is at the early stage the number one number two things that a venture capitalist could do one is be a good thought partner because there's so much evolving in the business having the right people around you and giving you feedback on what you should and should not be doing from a strategy standpoint is extremely valuable as your company gets larger and larger there becomes less degrees of freedom on the strategy on the platforms and all these decisions matter less and matter more on the margins than they do early stage and then really getting those first true believers into the company.

6:28So recruiting the very top kind of employees, number one through number 10, that's the highest leverage thing. As you grow as a company, you're able to recruit now people with maybe slightly lower risk tolerance. So the first 10 employees, it's built on personal relationships and built on really believing the business. And then as you grow, there's lower risk tolerance. So these employees need actually signal. What works at the series A, series B, a lot of times is the brand that the employee needs to get comfortable around the founders, around joining the startup and what that employee's spouse also needs to be comfortable around that.

7:00So I see seed, thought leadership and personal network, series A and series B, brand and signal into the market. And of course, with customers as well. And as you do that, and now you have different personality types, risk profiles, can you still marry that into a cohesive culture and organizational culture where there's not culture clash of the early believers butting heads continually with maybe the slightly more structured, I needed signal that this is a real business, maybe a little bit more process-oriented folks is not the easiest thing in the world to do. So how do you do that successfully where you have a cohesive culture all rowing in the same direction?

7:41Everybody's worried about DPI and venture capital getting capital back to their LPs and to their underlying investors. Do you worry about DPI and if so, how much? Allocators just need to go into venture with a mentality that it may just take longer. DPI is going to take longer if certain companies, not all, are just going to be private longer. So how do you balance your overall portfolio and the strategy mix? So again, for us, having that venture component, you can get some of those huge outsized returns. It's one of the few places where at a fund level, you will see some five and 10 X funds net.

8:22You're also going to see some one X net that stick around for 15 years, maybe even a little bit less. But I think all in, if you can get maybe a three X net with your winners and losers, the good, the bad, the ugly, get when he's maybe getting a thirties IRR. And then what we've done to balance it out to one, shrink the range of outcomes. And then to get DPI a little bit earlier, compliment venture with what I call small growth equity managers, where you're still capturing that growth and innovation. Characteristics aren't wildly dissimilar of those businesses. You know, think revenue of three to 10 million, growing 50 to 100 % a year, but running it closer to break-even revenue in the early days, not selling rocket fuel where you're just burning cash.

9:03And the exit plan from the jump for the business is sale to a strategic. So you're never gonna get these huge outcomes, but you get proof of concept earlier, you get DPI earlier, and I still think you can get done right something similar as far as returns on TVPI and IRR, but you get DPI back quicker if your goal from the get-go is build this to be a big enough business, 100, 200 million revenue, and just sell it to a strategic. That doesn't take as long as building the next world-class business that's going to IPO at maybe a trillion dollars. You're just not going to see DPI for a long, long time.

9:38When I think about the DPI crisis, there are essentially two different components of it. One is literal, which is endowment, suspension funds, foundations, family offices are not getting their capital back. That obviously is very problematic. The Swenson model, which was created in the 1980s, modeled roughly a 24 % return on capital on a yearly basis. 2024 was 9%, 2025 was also 9%, according to the Allocator Training Institute. So there is this cash flow issue where you need to have the cash flow come back to fund your unfunded liabilities and your commitments into funds. That's a real issue. That's nothing to sneeze on.

10:13The second issue, I would categorize it as whether people trust their marks or not. So it's one thing to have a 5X TVPI with a low DPI, and you are certain that it's a 5X. That lends itself to being more patient versus if you're not sure. And one of the most interesting studies that I've seen is from Virtus, which is the family office of the DuPont family at the CIO, Jamie Biddle, and the head of venture, Steve Kim. And they actually found, I was surprised by this, but very high correlation between TVPI and DPI in the long run. So they did not see too much gamification on the long run. Now, of course, there's a lot of gamification when it comes before fundraisers and going out to markets.

10:52We all know about this. But all things being equal, the TVPI proved to be more or less accurate in the long term. I directionally agree. I think there's a couple of nuances that might be worthwhile digging into. So on the first point, yeah, there's just a literal cash flow of you got to pay some bills. is you got to be able to rebalance. If you're not getting distributions, you lose degrees of freedom of managing a long-term pool of capital. It's harder to pace commitments. It's harder to do a lot of things. So reassessing, in particular in venture, how much you should be deploying and what is a reasonable expectation for cash to come back to manage the total portfolio is important.

11:27So that's point one. Point two, the secondary market has evolved and matured where it can be a tool. When I started over 20 years ago, it was kind of a pox upon your house. If you sold, it was almost an admission of guilt that you did something wrong. It is a tool in venture. You still have to take some tough discounts, but it's an option that is helpful. It's a much more liquid market than it was 20 years ago. On the second point, which I think is super interesting of in the long run, DPI and TVPI being correlated. I think that's an aggregate likely true. If you find there's not that many amazing businesses that just compound capital.

12:07so it's in many ways foolish to sell it just because or be sad that you're not getting cash back because if they do sell and you get dpi now you got to go find another world-class business and there's there ain't that many of them around so like why not hold on to it in compound capital uh and and let it's kind of like the classic charlie munger line of like sit on your new what you're you know what investing just sit there and get rich this is a great business it's got a mode it's doing something different it doesn't have a lot of competition just own it and and And you'll likely generate higher returns on invested capital than going out and trying to find the next amazing business.

12:39The asterisk on that is that's the average, but there will be some exceptions where that is not the case. And the biggest question mark around that, we've already seen some of this play out in the current environment, is SaaS businesses that can't pivot to AI. so whether it's market fears re-rating the multiple or real competition stealing their customers you could have a business with an amazing tvpi or a venture fund and one or two of their big winners was a sas model that is now being disrupted and can't figure out how to pivot and integrate ai there i think that correlation breaks down and that's not going to be good for the vc it's not going to be for the good for the lps that are invested in those types of situations Expert calls have always been one of the most powerful ways to build conviction.

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15:20This especially is compounded if you are a taxable investor. So if you're a taxable investor and you have a 3X, if you sell it, not only do you have to find another great investment, you're now paying sometimes 38 % of your New York resident, and then you have to reinvest on a net basis. So you destroy your compounding in a way that institutional investors don't have to worry about. That's very true. We're fortunate we work primarily with nonprofits and tax exempts that defy the two certainties in life, death and taxes. So we don't worry about that. We just worry about, can we punch our card with another great idea?

15:52And it's not that easy. So if you find a couple, hold on and write it. One other nuance to sprinkle in there on DVPI and DPI. Professor Steve Goplin, previous guest, did an entire study on marks and whether they're believable. and he found a very interesting distinction is that managers on their fourth fund and above a emerged manager has much more conservative marks than an emerging manager. And the intuition there is if you're on your second fund, it might be existential. You might be more aggressive hoping to raise the third fund. But if you're in your fifth fund, then you want to make sure that you're conservative so that you don't disappoint your LPs because the one reason LPs will withdraw from a fund is if they don't trust the manager or if the manager didn't do what they said they were going to do.

16:32So there is this, I guess, gamification, whether it's conscious or subconscious, that takes place between emerging managers and their marks. It makes sense. People respond to incentives. And if you're on fund two or three, you probably haven't sold a lot of things yet. So you kind of have to lean on what is the TVPI and the unrealized gain. So there is an incentive, as you mentioned. And then once you've already on fund four or five, you can at least point to fund one and two. Like the story's fully written. Returns are fully baked. We're doing what we said we did. So I think as LPs, I think it's helpful to dig a layer deeper in the re-underwriting to see on the unrealized portfolio companies, how much of the markup is from organic revenue growth and how much is a change in the multiple.

17:18If a GP buys a business for 10 times revenue, and then just mark it up to 20 times and say they've got a 2x on that deal, that's very different than if they bought it at 10 times or holding it at 10 times and they've just doubled revenue. So So that is the gamification and it's just math. You can actually, you can look at the math. And that's assuming that company is not dramatically increased in revenue. In other words, there's no legitimate multiple there. Exactly. So what was the revenue at purchase? What was the price paid? And how much has revenue gone up? Hopefully you're down. And then they changed the multiple.

17:51So if they didn't change the multiple and revenue just doubled or tripled and you write it up, that's a fair mark. If it's flat or up a little bit, but most of the markup is just, well, we think it's worth 20 now because we own it and we're really smart and we're going to do great things. That's harder to believe. Support for today's episode comes from Square, the all-in-one way for business owners to take payments, book appointments, manage staff, and keep everything running in one place. Whether you're selling lattes, cutting hair, running a boutique, or managing a service business, Square helps you run your business without running yourself into the ground.

18:20I was actually thinking about this the other day when I stopped by a local cafe here. They use Square and everything just works. Checkout is fast, receipts are instant, and sometimes I even get loyalty rewards automatically. There's something about businesses that use Square. They just feel more put together. The experience is smoother for them and it's smoother for me as a customer. Square makes it easy to sell wherever your customers are, in-store, online, on your phone, or even at pop-ups and everything stays synced in real time. You could track sales, manage inventory, book appointments, and see reports instantly whether you're in your shop or on the go.

18:55And when you make a sale, you don't have to wait days to get paid. Square gives you fast access to your earnings through Square checking. They also have built-in tools like loyalty and marketing, so your best customers keep coming back. And right now, you can get up to$200 off Square hardware when you sign up at square.com slash go slash how I invest. At Square, you get all the tools to run your business with none of the contracts nor complexity. Run your business smarter with Square. Get started today. Support for today's episode comes from Square, the all-in-one way for business owners to take payments, book appointments, manage staff, and keep everything running in one place.

19:28Whether you're selling lattes, cutting hair, running a boutique, or managing a service business, Square helps you run your business without running yourself into the ground. I was actually thinking about this the other day when I stopped by a local cafe here. They use Square, and everything just works. Checkout is fast, receipts are instant, and sometimes I even get loyalty rewards automatically. There's something about businesses that use Square. They just feel more put together. The experience is smoother for them, and it's smoother for me as a customer. Square makes it easy to sell wherever your customers are, in-store, online, on your phone, or even at pop-ups, and everything stays synced in real time.

20:04You can track sales, manage inventory, book appointments, and see reports instantly whether you're in your shop or on the go. And when you make a sale, you don't have to wait days to get paid. Square gives you fast access to your earnings through Square checking. They also have built-in tools like loyalty and marketing, so your best customers keep coming back. And right now, you can get up to$200 off Square hardware when you sign up at square.com slash go slash how I invest. At Square, you get all the tools to run your business with none of the contracts nor complexity. Run your business smarter with Square.

20:36Get started today. Support for today's episode comes from Square, the all-in-one way for business owners to take payments, book appointments, manage staff, and keep everything running in one place. Whether you're selling lattes, cutting hair, running a boutique, or managing a service business, Square helps you run your business without running yourself into the ground. I was actually thinking about this the other day when I stopped by a local cafe here. They use Square, and everything just works. Checkout is fast, receipts are instant, and sometimes I even get loyalty rewards automatically. There's something about businesses that use Square.

21:07They just feel more put together. The experience is smoother for them, and it's smoother for me as a customer. Square makes it easy to sell wherever your customers are, in-store, online, on your phone, or even at pop-ups, and everything stays synced in real time. You can track sales, manage inventory, book appointments, and see reports instantly whether you're in your shop or on the go. And when you make a sale, you don't have to wait days to get paid. Square gives you fast access to your earnings through Square checking. They also have built-in tools like loyalty and marketing, so your best customers keep coming back.

21:39And right now, you can get up to$200 off Square hardware when you sign up at square.com slash go slash how I invest. At Square, you get all the tools to run your business with none of the contracts nor complexity. Run your business smarter with Square. Get started today. So FEG, as I mentioned, you have$70 billion asset center advisement, and you manage 30 people on your investment team. And you have both a public side and a private side. Given that these two asset classes, I would argue, are almost converging or evolving at the very least, How do you go about managing your team and how do you go about adjusting to this new reality in the market?

22:13And depending on what the market's doing today, we did cross$100 billion in assets under advisement. But that's a tweet away from going back down. So it has become more complex as you grow because if you are good people, you want to give them something they can own and lead. So you end up, by definition, creating smaller universes with which people are experts in a smaller niche. So the one, and this ties back to the beginning of the conversation that we've been grappling with more, is within equities, the delineation between our public equity team, our private venture team, and really our hedge fund team, or what we call diversifying strategies.

22:50Because as companies stay private longer, again, if you're a venture person, and it's like, well, that's like the easy button, just invest in this late stage fund, I don't really want to do it. but maybe it's a good investment. If you're a public equity manager, it's like, all right, I'm worried about the FAANG stocks, but I don't have to think about Anthropic or OpenAI or SpaceX because our managers can't buy it. But now you're saying you have some crossover funds that do that. How do you get the knowledge share to have an intellectually honest view of what is that business worth that looks and feels and from a size and revenue standpoint is akin, is really a comp to a publicly traded business, but it's still in private hands and venture backed hands.

23:30So how do you, one, encourage people to collaborate, two, have an informed view, and then three, which bucket do you put it in? Is it in your venture bucket? Is it in your public equity bucket? If it's a long-street equity hedge fund, does it go in your hedge fund bucket? Are we tripling up on it if all of them like it at the same time? So it's forced more collaboration and have an informed view and a thought process of, if we're locking up capital in an illiquid strategy on venture, we want to beat the public markets by widespread for that risk. They don't all work. So you'd have a great, large venture-backed company that might look good on that metric of we still think we can substantially trounce what's available in public markets.

24:10And you would put in that bucket if it's like, I don't know if it's worth the illiquidity, but I still think it's a better business. We want to own it and it can beat the S &P by two or 3 % than maybe it's in the public bucket. So you got to, you have to start thinking through what are we trying to achieve? Does it meet our return underwriting thresholds? and how do we force folks to collaborate that historically, you know, if it was levered by out of a manufacturing business in Indiana, it doesn't really have a big impact on the overall macro economy and what the Mag-7 is doing. And there was less to talk about.