At the Money: Finding Overlooked Private Investments

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1:15How efficient are private markets? As it turns out, it depends where you look. In areas where VC money is plentiful and there are lots of VCs tripping over each other to fund deals, think San Francisco, Boston, New York, and other parts of the country where there are fewer VCs, there are enormous market inefficiencies. As it turns out, fishing in ponds overlooked by everyone else has been a great strategy. Inefficient markets can lead to unexpectedly better returns. I'm Barry Ritholtz, and on today's edition of At The Money, we're going to discuss how investors can identify overlooked startups.

1:56To help us unpack all of this and what it means for your portfolio, let's bring in Soraya Darabi of the venture firm TMV. She's been an early investor in seven unicorns, including firms that went public like Figs, Casper, and Cloudflare, and startups like Gimlet and Lightwell that were later acquired by Spotify and Twitter. So, Soraya, let's begin with the basic premise. AOL founder Steve Case observed 75 % of venture funding has gone to just three states, California, New York, and Massachusetts. How does this affect VC investing? But half the time, VC firms are concentrated into three metropolitan areas, California, New York and Massachusetts.

2:37As you said, this is just a fact. Recently, some well-known LPs, Bezer Clarkson and Jamie Rode, reported that only 3 % of VC funds have been in more than 3 % of unicorns at the seed stage out of 845 that they measured. The TLDR of that insightful research is that seed stage investing remains completely fragmented. WhatsApp was created by Ukrainian, Dropbox by an Iranian, Tesla by a South African, Cloudflare, as you mentioned, by a Canadian woman. And by the way, one quarter of US billion dollar startups have a founder who came here as a student. So we can talk today about some of the exceptional opportunity and really just looking for people who are non-obvious to live from a Silicon Valley term and coming from geographies or backgrounds that have been largely overlooked.

3:22So let's start with geography for a second. So San Francisco and Silicon Valley, Boston and the surrounding areas, New York City. If that's three quarters of the funding, that means that huge amounts of the rest of the country are not getting capital. Competition has to be much less there. Tell us about what you see in the rest of the United States outside of those big three VC regions. I'd brought that to North America and globally great opportunity. But you're absolutely right. Areas with less capital and less competition reflect less efficiency and market returns. But these inefficiencies typically mean that startups in the regions can be undervalued and overlooked.

4:03So we at TMV have invested in the last decade in very specific and academically researched areas, but overlooked verticals as well as overlooked founders. Talking about maritime tech in India and Singapore and Greece. And some of our last most particular deals were sent to us by large organizations like Maersk that said, hey, there's this really interesting company, but would you invest in Athens? And as a matter of fact, we would, as well as we'd invest, of course, in Boston or Toronto or Austin. You think about some of the best engineering schools in the US, just to focus on the United States for a second.

4:38We've got Carnegie Mellon in Pennsylvania, which produced Duolingo, where our venture partner, Tim Shea, just ended a five-year stint and helped them take that business public. And it's going to be one of the best AI ed tech companies of all time. But it began on Carnegie Mellon's campus. And notably, that wasn't Stanford's campus or Harvard. At TMV, we recently found a terrific AI company in the medical scribe space out of Toronto by two Iranian immigrants. And I'm very happy to share that if you invest in AI in the ambient scribe space, particularly for a company that has a path to profitability as ours does, Tali AI, we're looking at potentially upwards of 20 million in capital next year, their third year out of the run.

5:18Typically, the valuations are just hyperbolic in the US. They're really insane. And we were able to invest 1 million US for 10 % of the company just a year ago. That's how sensible the valuations are outside of the major terrains. So we're very happy to ignore San Francisco altogether. So how do you go about looking for potential investments in these other geographies? What's your process like? Well, our process is one part empirical and one part cowboy. And so you have to kind of go where terrific founders are and you need to seek them out. But also you can reap the benefit of having been in this industry as long as we have collectively to some extent.

5:59So, for instance, the last deal I did this month, investing significantly into a round that Andreessen Horowitz, a very well-known VC firm out of Sand Hill Road, is leading. And it's a seed round. But the founder had previously built a unicorn. That founder happens to be an LP in our fund. So we have an unfair advantage there. But the infinite advantage in terms of the relationship, which one might label as cronyism, is really just about having been in this game for quite a long time. We look to our LPs, which don't just include, you know, well-known tech folks, but they do. Includes, you know, five corporate 500s and two pension funds and five banks.

6:33And sometimes we get terrific deal flow from these organizations. And sometimes it really just comes down to being in the right building at the same time as the right fantastic founder. And so to that end, the building in which I work now hosts innumerable, terrific, but sort of out of work, successful folks who are dreaming up their next things. And then Trackstar. Trackstar is a universal API for warehouse management, a company that we seeded last year. The founders happen to live in the same apartment complex as our star principal at TMV, Emma Silverman. So you really can't imagine in venture where your next deal is going to come from.

7:09You have to be open to the serendipity, but you have to be practiced in your approach to deal flow. So for us, that comes down to our tech stack, our CRM, our outreach initiatives to other GPs, and also relying on the kindness of strangers and those big institutional VCs who happen to take a shine to you. It's a mixed bag, Barry, but again, you can't create this bag overnight. The cliche is the traditional startup founders are a couple of geeks who attended the same college and grad schools. They create an idea, they put together a pitch deck, and then they get funded. Is that cliche accurate?

7:44And what's wrong with it? Well, it's accurate and it's not. So one of our LPs at TMB, Adam Grant, I think he's highest rated business school professor out of Wharton, did some research for his book Originals, where he said that actually you do have better odds if you're starting a business on a college campus, as an example, because it gives you access to incredible talent, probably low cost talent, and freedom and space to work on a problem while others aren't really paying attention to it. But then ultimately, people come to your back door, be it venture capitalists for demo days. I was recently at the Harvard Business School Entrepreneurship Demo Day led by Julia Austin, who leads the Rock Center of Entrepreneurship there.

8:22It's a terrific event, brought 70 different VCs to her campus. But why doesn't every university in the United States have a similarly run program. Harvard just happens to be well-tuned to the fact that billion-dollar businesses a la Cloudflare, a la Meta, happen to start. And so VC funds have been predicated on that thesis alone. Let's have an index fund just to invest in everything Harvard does. That was the X fund concept. It's a good concept. But one would imagine that that same practice could be applied for every great engineering program, every great business school for that matter in the US.

8:55But it's just about the combination of a concentration of talent and capital. And Sand Hill Road at the end of the day is really just a strip mall. It's a strip mall where it is. It's a strip mall of money, but it's also lazy fishing, honestly. And if you think about every great eng program from UT Austin to obviously MIT out of Boston and what they're doing there with the Media Lab, you're going to find some exceptional talent that doesn't have as rate of an immediate access to capital. And there are some funds, Steve Case's fund, Rise of the Rest, being a good example, that are conditioned entirely to seek out those non-obvious GOs.

9:33And we're more than happy to co-invest alongside them. So let's talk about some of those areas. Obviously, Harvard, Stanford, Wharton, MIT, Big Four, that's a lot. When you're looking outside of those three or four cities, where else are you looking at? You mentioned Carnegie Mellon is, I think Pittsburgh and Austin and Texas. What other parts of the country are you finding potentially unicorn ideas that couldn't either get acquired or go public eventually? We're not ignoring California. We just think some better valuations are available in Los Angeles or Berkeley for that matter versus San Francisco proper.

10:09We have a great company out of Berkeley called Millie, and it's an exceptional healthcare business for women dealing with high-risk pregnancies. And their first clinic was opened in Berkeley for the very fact that it's less expensive to operate a business there, one zip code away from probably the most expensive spot in America to operate a business. So we're looking pretty much everywhere. We have a diverse pool of founders and funds who send us deals, but we're specifically not swimming in San Francisco or Palo Alto for that matter, because we think that it's overly commodified and the valuations are is dangerous at this point.

10:43That makes a lot of sense. So this isn't just theory. You guys were early investors in FIGS. You were an early investor in Casper. You were a subsequent investor in Cloudflare, as well as startups like Gimlet and Lightwell. Were these companies from the traditional IVs? Where else are you fishing outside of the well-known fishing holes? Well, those examples you cited, a couple of them were. FIGS and Cloudflare, three of those four founders came from HBS specifically. So not just the top university in the US, but the top business school or among the top. But Casper, this is a fun story. I met the founders at a concert in Williamsburg, I think.

11:23In Brooklyn. Brooklyn, yeah. The band was Blonde Redhead. I can't remember, but it was a good concert. And they were setting up their first ever display of the mattresses. And by the way, I'm the first to admit that I think I got in and got out at the right time with Casper. I sold my shares at the Series D, which was their peak valve. But I met them because they were giving out free beer for people who would sit on the mattresses while listening to music. And I thought, that sounds like fun. And we started talking about venture. And I had been in the industry for about five years at that point.

11:50And it led to them sending over term sheets the next day. And I made a decision with 30 minutes notice. So no diligence. That's how fast it was. With FIGS, I think it was more premeditated. That was the first deal I really diligenced with my now partner, Marina Haji Pateras. And I'm very proud of that original memo we wrote, which stated that a lot of people are going to overlook this, not because it's two women, but by the way, first two women ever to take a company public on the New York Stock Exchange. That's pretty powerful. We thought people were going to overlook it because they would assume that it's a consumer business and an e-commerce business.

12:21And what FIGS does is, to this day, very well, they make comfortable and functional medical apparel. And we saw it more as an enterprise play, selling into hospitals and giving back to a community that's largely overlooked, nurses primarily. We continue to invest along that thesis today. In fact, my last deal was an AI nurse staffing company called In-House Health, led by a founder who previously built a tech unicorn called Stellar Health. But going back to figs, we saw around corners with that deal. And we wrote in our original memo that this could eventually end up in med spas and dentist offices, which to this day it does.

12:57But we also wrote it could be on the boiler room of ships because Marina, my business partner, comes from a 200-year-old shipping family. And sure enough, her family is buying figs, uniforms now to give to their workers. And so it's really cool when you feel like a prophet or you have some sort of clairvoyance simply by doing your homework. So when you're fishing in geographies outside of the big three or investing in founders, who are not what we think of as typical founders, what have the returns been like? What should VC investors be expecting? Well, on SPVs in non-traditional founders before I started TMV, it's 172 % realized IRR on those SPVs.

13:37And so I think most investors would like those returns. And those are collective SPVs. But more or less, I think you're looking at the same returns and you're underwriting for venture returns. And traditionally, VCs underwrite 100x for a seed investment, 10x for a series A investment, if you're talking about early stage specifically. We do the same at TMB. You're also underwriting for a 40 % fail rate, 50 % success rate, and 10 % super success rate. And it's those 10 % of companies that really deliver all of the alpha for any given fund, not just mine. So to wrap up, markets are mostly kind of, sort of, eventually efficient, but not everywhere and not with everyone.

14:19Venture capitalists who are looking at non-traditional founders and in locations away from New York, San Francisco and Boston are finding some fantastic investment opportunities.

14:34You can listen to At The Money every week. Find it in our Masters in Business feed at Bloomberg.com, Apple Podcasts, and Spotify. Each week, we'll be here to discuss the issues that matter most to you as an investor. I'm Barry Ritholtz. You've been listening to At The Money on Bloomberg Radio.

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