E408: HarbourVest: Why Venture Capital Is Chasing Trillion-Dollar Companies

0:00Today, we're joined by one of the world's largest private investor, HarborVest, manages over$160 billion. We discuss why venture capital is strictly a power law business, how HarborVest identifies exceptional investments, what they learn from investing into SpaceX, and where they see the next generation of outliers. Without further ado, here's my conversation with Scott.

0:25When it comes to the power law in venture capital, how important is it? It's everything. It's the business model. I have this conversation with investors all the time who look at venture capital the same way they look at their public market portfolio or their private equity portfolio. They have a hard time getting their head around the losses, but the reality is it's the wins that drive all the performance. And I think as you and I both know, those wins are very concentrated. It's not the wrong intuition if you're a private equity investor, a private credit investor, you should be thinking about that downside.

0:57That's right. But we use the word shooting the moon. Venture capital is shooting the moon and you got to play your deck, your hand the right way, right? I've heard multiple people say that some of the best portfolios actually had significantly more losses than the average portfolio. Is that true? I think every great portfolio looks like that. I recently created a theoretical portfolio that uses both our data and third-party data, extended it back two decades. I think 15 ,000 companies, 15 billion of cost basis. And the reality is of those 15 ,000 companies, one company returned 10 % of the entire value, 3X portfolio on that 15 billion.

1:4010 companies returned a third of all the value and the top 10 % of the companies returned 90 % of the value. That's the assumption, right? That's the business model. As a venture capitalist, what do you do when you hear these kinds of numbers? I just accept it. I realize that is the model, but in order to win, I think you need to be thoughtful about where you concentrate your capital, how you diversify your capital, how you not only make investment decisions, but also how you make divestment decisions. What do you mean by divestment decisions? We all talk about the origination and the original investment, but the way venture capital and private markets in general have evolved over the years is there are points of exit that you can take that are not your traditional exit.

2:26It's not the M &A event or the IPO. We've seen the secondary market evolve, and that's created liquidity decisions, sell decisions for investors that own positions in some of these market-defining companies. And getting that decision right or wrong is consequential. And you invest into some of the top venture capital funds in the world. How do you advise that they use the secondary market in order to divest from some of their positions? There are mechanics that are in place because of how this industry has been built that trigger decisions around liquidity. The reality is most venture funds are 10-year closed-end drawdown funds.

3:07So if you own an amazing asset, but you're getting to the end of the life of your fund, if a natural liquidity event is not there for you to take, I think you need to create one. And that's where you might tap into the secondary market to do it. Nearly$3 trillion is locked up in venture funds that have gone over their 10-year limit. So essentially, they've expired their funds, and now there's$3 trillion sitting around. What options do venture capital funds have in terms of getting liquidity? So this is where I think that the innovation around the secondary market has been critical and important, and it's become kind of a tool and fundamental to venture and venture capital.

3:51You now have an opportunity to continue to hold your interest that sits in a fund that's now past its 10-year term, but either wrap up the fund that has a 10-year term and move your interest into a new vehicle or give your investors the opportunity to take a liquidity event or stay in the fund and extend the life of the fund. I mean, there are funds that are in companies that we can talk about that have been in existence for over 20 years. And the managers consciously went to their LPs in year 13, 14, 15 and extended the life of the fund for 10 years, making it a 25-year fund, which is a bit of an outlier.

4:29It's an anomaly. But when you think of the case, it absolutely made sense. When I talk to a lot of LPs, that's almost the playbook, which they want their managers to take some chips off the table, oftentimes 1x their basis or maybe 2x, 3x their basis, get those chips off the table and let everything else roll. Going back to power laws, you don't want to cut your winners. It seems obvious in hindsight, but the reality is when you're making those decisions, the dispersion of points of views is very broad. And that exists not only like inside investment committees, but it also exists when you have to look your LPs in the eye and tell them what you're doing when you've kind of clearly gone beyond the regular term of your fund.

5:14It's interesting because at the same exact time at the$100 billion valuation, 137 Ventures, which ended up owning roughly a percent of SpaceX at IPO,$20 billion position as reported, they were going around telling investors there was this free ride to this trillion dollars using kind of a bottoms-up model. Free ride meaning no economics on the deal? Free ride meaning essentially even under conservative assumptions, this was going to be a trillion-dollar company. One of the themes across hundreds of conversations with GPs is oftentimes they pick these parallel outcomes, but they almost always underrate how big these companies are going to be.

5:51Why do you think that's the case? I don't think they always underrate it. Look, this plays both ways. So you can look at some exits that happened last year that were very notable. Klarna,$15 billion value at IPO. I think it trades below$10 billion now. There was a private market financing in Klarna that valued at$50 billion. And there were investors that sold into that financing. So that was a 10x decision, but it was a 10x. And the other direction. Yeah, exactly. So this is where I honestly feel investors like us really earn our keep. These are hard decisions and they're super consequential. I can go back at my 27 years at HarborVest and I can honestly say I've probably made thousands of decisions, investment decisions along the way.

6:38but the ones that are like super consequential, I can count on two hands. SpaceX is this overnight 24-year success where people just started tracking in the last six months, 23 and a half years in. One of the most underrated aspects of some of these best calls, like 137 Ventures, Antonio Gracias reportedly invested 30 times into the company, is just how bottoms up their analysis was. These were not hyperbolic statements that they were making kind of from the outside or reading a headline and wondering whether retail is going to bid it from$1.75 trillion to$2 trillion. This was fundamental bottoms up analysis that they were doing.

7:19SpaceX, unlike many companies, was systematically doing tenders every six months for probably the last five years. So there was price discovery that was happening. It's my understanding that the liquidity that was being provided in those tenders was actually coming, a lot of it was coming from insiders. So when those that are closest to the company are the ones that are buying up the shares, I think that sends another positive signal beyond just the fundamentals of the underwriting. Speaking of these high conviction investments, tell me about Roblox and the high conviction investment that was made there.

7:52I would have never guessed Roblox could have become what it's become, but I'm familiar with investors that were in that company early on. It was their power law deal, and they kept re-upping to the company through either new investments or continuation vehicles, moving all of their earned economics into the continuation vehicles. And I was amazed at what they were doing. And I'm friends with one of the partner, and we were actually going surfing together. And I told him, you got to take some money off the table. Your wife is going to kill you. You need to put some money in the bank. And his answer was like, look, Scott, this keeps us aligned.

8:31It keeps us hungry. I've seen too many venture investors who, when they had that big monetization event, they lose that edge that they had that allowed them to become great. I thought that was interesting. And I don't think that that's a universal thing that applies to everyone, but I thought it was fascinating how this individual knew what motivated him and his partners to generate just phenomenal returns for their LP. Why is it so hard for investors to internalize this concept of the power law? In the end of the day, I think many investors are truly fundamental investors. And if you're doing true venture capital investing in the entrepreneur and the idea, you just have to assume that the mortality is going to be super, super high.

9:11And that's hard for a fundamental investor to get their head around. And then further, as a fundamental investor, your valuation is not based on a revenue multiple or an EBITDA multiple. It's what is the size of the total addressable market going to be and how much market share can I have in that market? And those are things that not a lot of us are conditioned to do. It's probably 15 years ago, I kind of broke down the venture model and I called venture capitalists two types of characters. There was the right brain and the left brain investor. The right brain investor, who I characterize as someone like a Vinod Khosla is a futurist, right?

9:46They can see into the future. They see a market that doesn't yet exist. And then they find an amazing entrepreneur that's going to go own that market. The left brain investor is more like a Mary Meeker, right? You're using fundamental investment criteria to inform yourself on which investments you should be investing into. In venture capital, it's, okay, I can look at revenue growth. I can look at other metrics that define scale that are unique or similar to deals that I've done in the past that have turned out to be great deals. But those are two different DNAs that are tapping into the same sandbox of venture companies at different stages, right?

10:26And is it only the Vino type of investor that's able to capture these power laws? I call it the futurist, the person that can just see something that no one else can see. And there's a lot of great futurists out there that exist. But if you kind of do a personality profile on them, they're different than the ones that are kind of doing the late stage pre-IPO type investing, right? Reminds me, I got invited to the Airbnb Series A party back when I lived in San Francisco, and I went into their office. It was also their home. So the party was both their home and their office. And I still have this email.

11:02I wrote an email to my dad saying, I just met the most amazing founders. This is going to be a billion dollar company one day. And as all great investments unfortunately i didn't invest i didn't have capital at the time i was both right and also off by an order of magnitude of 100 is this not what you see in some of the top futurists if you did have the capital at the time would you have invested i think given the right portfolio construction i think for sure i think also at the series a i believe it was anderson horowitz if i'm remembering correctly i think it was starting to be kind of this early stage consensus i definitely would not have invested as an bed and breakfast, the original pitch, this whole idea of backing founders, going after kind of ridiculous startups and just backing the team was not something that I believed in at the time, but it was certainly an expensive round.

11:55And most people thought that was overpriced at the time. Is that something that you've seen? Any great idea with a great founder and venture capital is going to be perceived as overpriced. If you go in and you underpriced, you're not going to win the deal. And then you win when that company exceeds all of your greatest expectations. So in hindsight, it may look like it's underpriced, but at the time, I feel like everybody who invests probably thinks you're paying too high a price, right? The best companies always look too expensive. I think so. I think so. Yeah. And that's the beauty of investing early because ultimately, you will outgrow that valuation at some point.

12:36If you want to bring recency into the discussion, right? Anthropic is top of mind. I think my reaction when investors were investing in Anthropic at just under$20 billion was like, wow, that is a rich price. Well, that deal looks phenomenal right now, right? Most investors don't lose because they lack information. They lose because they can't separate signal from noise. Every day, thousands of earnings calls, SEC filings, expert interviews, and market updates compete for your attention. The challenge isn't finding more research, it's finding the few insights that actually change your investment decisions.

13:10That's exactly what I unpack in my conversation with Ryan Fenerty. Instead of talking about AI in theory, we discuss how leading investors are using it to surface-differentiate research, move faster than competitors, and make more informed investment decisions. If you're an investor looking to gain an edge through AI-enabled insights, I think you'll find this conversation valuable. You can access this limited release episode by going to alpha-sense.com slash how I invest. That's alpha-sense.com slash how I invest. I invested in the Anthropic Series C at$4 billion, and I underwrote it to$100 billion valuation.

13:43I thought, certainly there's going to be a consumer AI, and there's going to be an enterprise, and it's going to be worth$100 billion. And again, I was off by an order of magnitude, hopefully by an order of magnitude of 10. I mean, I have to invest with you, man. That is phenomenal. Congratulations. So speaking of consensus versus non-consensus deals, there's a view in venture today that all the deals are becoming consensus. Do you share this view? What I love is the investment thesis of be short-term contrarian, long-term consensus. That's how you win. You invest in things when everybody doesn't see it.

14:22But If you want to bring the power law back into the discussion around consensus versus non-consensus, and you just look at the current venture market, before SpaceX went public, there was one company that was valued at greater than a trillion dollars. If you go below the trillion dollar mark and pick a universe of a$100 billion valuation to a trillion, there's roughly 10 companies in that universe. And then 10 billion to 100 billion, there's 100 companies in that universe. I define those 100 companies or those 120 companies, whatever they are, that is the consensus, right? And there's a lot of capital, both venture capital and other types of institutional capital that's chasing all of those same companies.

15:03I think where you start to move out of the consensus is when you move to those companies that are worth, let's call it a billion to 10 billion. It's the unicorn club, but I think there's 1 ,500 of those. And how many of those companies are actually going to matriculate? They're going to move north of 100 billion or maybe even a trillion if they're really ambitious. So as an investor, a great venture capital who's a great investor, I think the money around is if you can go find those companies in that 1 ,500 company universe that are going to matriculate to the 100 company universe. And then look, when you go beyond that, you're talking tens of thousands of companies.

15:43And that's where traditional venture is really how we've all defined it, right? It's probably more the futurist that's investing in those types of ideas. Is this a question about picking or is it an access game at that point? It's probably a little bit of both, right? So I think the best brands in Silicon Valley are going to see the best deals and their challenge is to select the best deals, right? There are some venture firms that just will never see the deals. And this is where brand matters, right? But there's lots of great firms that have missed. They saw the deal and they passed and they missed, right?

16:18Right. And at HarborVest, you have three sides to the business. You have the primary business, which you're investing into funds. You have the secondary business where you're investing into companies via secondary. And you also have the direct part of the business where you're picking and choosing different companies. What's your strategy across those $1 to$10 billion companies? So first of all, in venture, when you combine those three things, it's a bit different than when you define them in private equity, for example, where I think They tend to be more verticals and are sometimes more mutually exclusive.

16:49On the venture side, your goal is just to access the cap table of the companies that matter, the power law deals, the best way you can. And you can do it through those three entry points. If you look at our fund investment strategy, that's where we're heavily indexing towards the early stage with the firms that have proven to be the firms that have defined success in the venture capital market. I want to double click on something you said that essentially you're structure agnostic on how you access these companies? Why? I think you have to be, right? What you want is economic interest in the short list of companies that matter.

17:25So if it's the 10 % of companies that are going to return 90 % of the market over the next decade, how do you kind of gain access to those companies? The profile that lives in your portfolio is going to look very different. In our multi-manager fund-to-funds, you're clearly going to have higher loss ratios, but your earlier access is going to drive upside when you have a breakout company. There's liquidity that's available to you for whatever reason. And then your decision is, is this a good valuation for me to enter the cap table of this company? And if you can do that, you might have the primary portfolio that invested in, call it WIZ, that had 100x return.

18:09And then you have the direct portfolio that had a 3x return and the secondary portfolio that had a 2x return. Said another way, if you're in the company's cap table, you could have accessed it via a pre-seed investor. You could have accessed it via co-invest from one of your Series A funds that don't have the capital to deploy into the Series B. You could have accessed it through a secondary. Essentially, you're getting access to the same asset, and then the question becomes fees. And what are you paying? Yeah, that's right. On the fees, you're paying the highest fee in the market is on the LP commitment.

18:43It's a two and a half and 25 is kind of where it starts, and it goes up from there. Yeah, I've heard two and a half and 30. You're getting a better deal. Yeah. So look, on that topic, I learned a long time ago from the guy that hired me and trained me and ran our group 25 years ago. A good term sheet does not make a bad deal good, and a bad term sheet does not make a good deal bad. And I think that's true. But anyway, on the primary side, that's where you're paying$2.5 and$25, let's call it. As a direct co-investor, terms vary there. Sometimes as a co-investor, we will get fee-free, carry-free access.

19:21Sometimes it's fee and carry. Sometimes it's just carry. And then on the secondary side, there is a fee for the manager that manages the secondary fund, but there's usually not a fee associated with the interest that you're buying. If you're an executive who's looking for liquidity, you're selling out and who's ever buying it might be charging their investor a fee that you're not paying a fee to access that. It goes back to the SpaceX situation. Some LP wants liquidity or the GPs are past their fund life. You're coming in and you're solving their problem of liquidity and return you get access to the asset.

19:58That's right. Right. An underrated trend that I see sitting right where you were sitting a couple of days ago was Michael Gilroy from Marathon Venture Partners. And they have a$400 million fund, by no means a small fund. And in order for them to get into the very top opportunities, they're also partnering with their LPs for CoInvest. And part of their sales pitch to companies is that we're going to be a capital partner at scale as the company gets bigger. Is that something you see in the market where some of the smaller funds, maybe not two, three billion dollar funds, but in the hundreds of millions of dollars are partnering with institutions like HarborVest in order to close that gap?

20:35It is. And if you think about it, it's a really it's a very elegant solution. So if you have a five billion dollar fund, you have to run a certain type of fund model to satisfy the portfolio construction and volume that five billion dollar fund requires. If you've got a$500 million fund or a$300 million fund, but you have sophisticated LPs around the table who have hunger for co-invest and are predictable and how they'll behave with that co-invest, it allows you to run your fund in more of a boutique way, like a$300 million fund. But when you need to scale up, you've got that optionality available to you through your limited partners.

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22:13But as you know, that is only a small piece of the financial puzzle. Managing your money takes more than just checking your bank account every once in a while and great financial decisions come from having a complete picture and proactive management of your income, expenses, and investments. Take control of your finances with Monarch. It brings together all of your accounts, investments, saving goals, and spending into one place, making it much easier to understand where your money is going and whether you're actually on track to achieve your financial goals. What I like most about Monarch is that it doesn't just tell me what already happened, it helps me plan ahead.

22:41The AI assistant lets me ask questions about my finances in plain English. And the AI weekly recap highlights spending changes or upcoming expenses before they become surprises. It's like having a financial advisor in your pocket. Write your own money story with Monarch. Use co-invest at monarch.com to get your first year of Monarch Core half off at just$50. That's 50 % off your first year at monarch.com with code invest. Growing up, I thought managing money meant paying bills and balancing a checkbook. But as you know, that is only a small piece of the financial puzzle. Managing your money takes more than just checking your bank account every once in a while.

23:14And great financial decisions come from having a complete picture and proactive management of your income, expenses, and investments. Take control of your finances with Monarch. It brings together all of your accounts, investments, saving goals, and spending into one place, making it much easier to understand where your money is going and whether you're actually on track to achieve your financial goals. What I like most about Monarch is that it doesn't just tell me what already happened, it helps me plan ahead. The AI assistant lets me ask questions about my finances in plain English. And the AI weekly recap highlights spending changes or upcoming expenses before they become surprises.

23:46It's like having a financial advisor in your pocket. Write your own money story with Monarch. Use co-invest at monarch.com to get your first year of Monarch Core half off at just$50. That's 50 % off your first year at monarch.com with code invest. And that, frankly, is a benefit for the limited partner because they're probably getting similar access to companies at reduced economics because of the co-invest that they're deploying. Co-invest in venture capital is significantly more difficult than private equity because oftentimes with private equity, private equity fund is investing for the first time.

24:20They're investing$50 million. They go to their LPs for another$50 million. Everyone's aligned. Everyone's coming in with the same entry point. And oftentimes you have much more time. How do you solve for these different issues when it comes to venture co-invest? First, in venture co-invest, you have to have much more of an informed point of view before you even see the deal, right? So it's not like KKR is bringing you a buyout deal. You've never seen it before, but you can underwrite the fundamentals. I think in venture, yes, the fundraisers are shorter. You have to move quicker. So in order to do that, you need to be informed on the universe of companies that you have interest in.