What Makes a Top VC Fund Today? Dave Neumann at Schroders Capital on LP Thinking, DPI and Venture Returns

0:00Hello and welcome back to Riding Unicorns. Today we have Dave Neumann. Dave is an investment manager at Schroder's Capital and a deep knowledge of the LP space and the GP space backing top tier funds but also participating in direct investments in the likes of Revolut, Synthesia, Eleven Labs etc. So a huge amount of context and knowledge about what's going on in venture capital. So welcome to the show Dave, thanks for joining us. We're going to dive straight in and we're going to ask a key question which is what does a good VC look like today? Yeah, I think it's a good question because the asset has changed a lot and the skills that is required to run a successful firm has also changed.

0:45As you correctly pointed out, we've been doing this since the mid-90s and what we've seen is great houses are not just access restricted, but they're thinking about things in a very long-term capacity so they are geared for not what the competition of venture capital is thinking about today but also how do you run a business how do you run a firm i think that's something that we get to see quite often is there's a difficulty in just being an investor versus running a firm which is how do you interact with LPs today versus understanding that the interaction that you have today is meant to last years over decades and it's not just this it's also running hiring firing reporting which is extremely crucial if you want to build a long lasting institutionalized firm.

1:55So those are the backbones that allow more institutional LPs to come on board and more institutional OPs means more firepower so that the firm keeps hiring and maintains great talent on board, which in turn leads to a continuous cycle of great investment. So, yeah, again, what we've been doing is since the 90s, we've been investing in sort of global firms, US and global firms. And that's what we are trying to bring that sort of mindset to the UK and Europe. And we are seeing that coming through, which we're quite excited about, which is the understanding that is you're not meant to be looking after just your current fund.

2:44But you have to be always on the ball of your legacy funds, thinking about liquidity, thinking about exits, think about the current fund, the deployment of it, and think about the future funds, how the market is changing and how will you adapt the future funds to it. And that's what we want to bring to the market. it and what are the you've been doing this a while now dave and you'll have a lot of pattern matching ability based on what you've seen what are some of the less obvious areas in your mind that separate the top tier vcs from the rest yeah i think again looking at From our US side, we are already on Vintage 12 and on the UK Innovation, we've been doing this for just over 12 months.

3:41So what we are trying to identify is, again, it's about retaining talent. It's about the flywheel effect that really compounds the top tier GPs, but also top tier results. The one stat that I keep referring to and keeps on top of my mind is we ran a data analysis that on average, the top quartile venture capital returns per vintage year versus the lower quartile. there's a 14 percentage gap every year. If you compound this year on year, it is very significant to what you can achieve. So the pattern here, not investing in a fund because you believe that this next fund iteration could be interesting versus backing the firms, the GPs that can show you that they're there year on year, vintage after vintage.

4:49And I think that's what we've seen from our access. And speaking with other LPs, I think that's what we see them potentially getting wrong, which is just going fund after fund and treating funds almost like individual without taking the whole context into consideration. And the difficulty is that just like direct investments, These funds are extremely access restricted. The funds become more institutionalized, become better at fundraising because of the backbone, because of the flywheel and because they are vintage after vintage top quartile. So it becomes extremely access restricted and you start seeing this come through as time and time again.

5:40and you talked about that talent there and there's a there's multiple roles that are needed within a vc you've got the sourcing and allocation selecting securing getting winning actually winning the deals and proving that you can win that allocation supporting the businesses and increasingly bigger funds have got platform teams and things like that and then there's that crucial bit of selling as well. When a team sits in front of you, do you try and break down who brings what or how do you analyze the talent through the lens of what actually matters at a venture fund? Yeah, I think we try to take it from a complete holistic picture.

6:24It's hard to judge a fund purely on the people because you also have to think about the flywheel effect of their own track record, of their own portfolio, which means a part of the flywheel is they can speak about successful investments and so on and so forth. A part of that flywheel is DPI means easier. Again, easier to fundraise. Easier to fundraise means more capital. More capital means better. An easier time for investors to invest. But when it comes to people, we're really trying to understand. One is everyone, are all stakeholders motivated to stay? That is one. And second, are the key drivers of this firm also motivated to stay?

7:17We all know that there are many firms in which, unfortunately, the cycle of the feedback loop, And we all know this, the feedback loop for us to understand whether a deal or not has been successful. And for that matter of fact, a person's on track record has been successful takes a while. So it's important to always keep a judgment of that. And the benefit of an institution like Schroeder's is we have the benefit of time. so we've been able to speak with many of these GPs for a while now we either have invested in them for a while and we keep on coming back to conversations that we've been having since early 2000s with the same people or we passed on a fund and then we get to see actually that the junior partner did go on to do a great investment so for us is that it is a little bit more difficult to judge whether a specific person has had the impact on liquidity.

8:27There are firms out there that have a specific role, but it becomes a little bit more tricky. But it's important also, and maybe a little bit less on skills, but it's important to understand how the firm is playing across the different required skills. One thing that I keep on mentioning is about 10, 15 years ago, the world of venture, as we know, was about seed stage. The skills required was taking the companies from zero to one. Then you had a whole different skills that was to take the companies from one to 10 at series A, series B, and then the company would go on to IPO. And as we know, the companies are staying private for much, much longer, which means that the skills required for you to be a successful investor is understanding where you're going to play.

9:24The same person might find it difficult to be a successful investor at both seed, taking the company 0 to 1, 1 to 10, 10 to 50, 50 to 100 plus. So it's also understanding if the firm has the required tools and capabilities to play at the field that they're going to play. So if they see they're doing series A plus, that means the firm has to have the skills that is required both to help the company on product market fit, go to market, but that plus means at series C, D onwards, that means the skills required are thinking about liquidity, thinking about at what point or stage would you ever consider credit, debt, facilities, would you consider corporate development, acquisitions, expansions, international, which are skills that was before not really considered in the world of venture until quite recent.

10:32And Dave, how much do you think about and care about portfolio construction? But actually, it's both from the perspective of you as an LP and which VCs you invest in, but also I think there's a parallel discussion around the sort of underlying portfolios of those VCs that you back. Because what strikes me is that there are, in the same way there are VCs with different strategies that work, whether it's a highly concentrated portfolio with no follow-on or a highly concentrated portfolio with lots of follow-on reserves or an index fund with no reserves. There are examples in each of those buckets and every other bucket of great funds with very smart people delivering great returns.

11:13Now, when you speak to LPs as a VC, they have strategies. They often have strong opinions on what the right kind of portfolio construction is. the VC should always be buying big stake in companies. Great. If you can consistently buy 15 or 10, 15 % in a company, that's great. But how much does it really matter? Have you crunched the numbers? How much does portfolio construction matter for the underlying VC funds, but then also for you guys when you're selecting your basket of funds? I think to be honest, we are not really geared. We're not really thinking about this. The way we're thinking is purely driven by we are wanting to make at least 2.5x return, if not 3x MOIC onwards.

11:59So every time that we make an investment, whether that is LP, tickets, secondaries, or direct investment, the one thing that Northstar for us is conservatively speaking, do we see a path to at least 3x here. Time horizon must come into that, right? Because a 2.5x over two years is different from two and a half x over 15 years and that would play into investing in synthesia series c versus a pretty c fund in deep tech exactly we do take that into consideration we are thinking of like the bare minimum for us is this because i think on our and this is our track is very much delivering that 3 to 5x and going for the 10x as a cherry on top of the cake.

12:47But for us is if we constantly do this and because we're somewhat always investing, we are able to tap into that institutional capital pool, both as from different products that we create. So for example, we have the usual sort of LPGP structure. The current vehicle, which we're also investing from, is a semi-liquid one. So we're constantly investing. So we are diversified across time. So if every single time we're thinking about this, that is bare minimum 3x, we believe that on a grand scheme of things, we can generate. It's hard to create when will a company exit. But of course, we take the risk return profile very seriously.

13:37So in a company that requires a little bit more capital, it is a little bit more early stage, we would be pushing that sort of minimum barrier upwards. But yeah, it's very hard time. We are trying to just think about the next five years. There was a great interview from someone from KOTU who said he understands that doesn't matter what the next five years brings to the company. If it is a secondary transaction, if it is an acquisition, if it is IPO, the next investor in five years' time is thinking of making 3x. So the company must be on a path to deliver in the next 10 years around 6x at the point that you're investing.

14:22So that's what we're trying to think. It's hard to predict over five years, but that's what we're thinking about. Yeah. And so for VCs in VC land, do you see typically a VC will have their strategy? It's going to be an index fund where they do lots of tiny tickets or it's going to be a high conviction, highly concentrated fund. And they'll do that relatively consistently. Are there examples where VCs have a complete mixture of strategies and it works that you find appealing? Or is that just off the table in most cases? Because you could argue that funds like Thrive, to some extent, have that kind of strategy and aren't fussy about ownership stake and are not fussy about stage.

15:12Yeah, I think it's very difficult to predict because you also don't know what your portfolio is going to bring. I mean, from what I've seen, emerging managers where they thought their portfolio construction was going to go one way and believe that they could raise SPVs on the back of successful companies. And they ended up spending so much time on the road having to go through and fundraise SPVs and create the back office and everything that they just said, I can't do this anymore. So it's hard to say. I think that the funds that we back are typically nothing overly, they don't change their strategy.

15:57Like the funds that we typically like to back are the ones that the strategy of that current fund has been proven out a few different vintages. and i wanted to ask about fund size so there's often data out there about smaller funds perform better in terms of returns and things like that but equally we're in a period where advantage capital or just loads of money into late stage stuff that regardless of price almost these are the top logos but they're still 10xing in a year and so you've got this kind of you've this kind of mix of like smaller funds perform better but then there's loads of money still to be made at late stage companies staying private for longer and is there like a death zone in the middle and how are you thinking about all of this complexity with AI almost accelerating and exaggerating the whole mix what's your view on fund sizes and where the best place to play is at the moment to be honest fund size is something that I've seen that internally we just think about Now, again, because we are backing established GPs, they don't deviate too much from their previous strategy.

17:09We see that they are increasing from time to time. Their fund size, but it doesn't tend to be that much more. On average, I would say 5-10 % maximum. But it is interesting. I used to be someone who was 100 % on the camp of if you want to derive alpha from venture, you have to go for sub X million. But to be honest, since I started here and I've seen the track record of some of these brand names, access restricted funds, and they deliver consistently top quartile, even though they raise multiple hundreds of millions, if not billions of dollars. So you stop and think, what are they doing that is different?

17:54And I think the one thing that they understand is, again, I believe we come back to companies are staying private for longer. They are not staying private because they're not being successful. They're staying private because they continue to grow again and again. And if we look at Stripe, it's a great classic example. But if we look at, we backed Revolut, and that's been for us like a constant winner. By thinking about Eleven Labs, Synthesia, and these companies, what AI has transformed is suddenly you're unlocking huge TAMs. That doesn't necessarily mean that it's here forever. It doesn't mean that the business models are winning today are going to be the winners forever.

18:45But what I do think is the firms who understand where they're playing at, understand the dynamics of the market that we are in, they are the ones who are winning. So whether that is we are seeing more follower tickets from micro funds who come in at precede seed stage, they're great because they understand that if they provide a little bit of value add, they are not bothering anyone on the fundraise. and they understand that from the get-go, founders, the great founders and the great companies get to choose who they want to work with. The thing goes across. Any fund, in my opinion, and what we've seen be successful are these funds, they understand that it does seem sometimes that it's chucking money at the winners, but it's also, if you take a step back, it's not just chucking, it's about understanding that these companies are creating more of an incremental aggregate traction that we've never seen before.

19:57So these are the ones who can generate massive return. And hopefully we are seeing lots of them coming out of Europe, out of the UK. And the ones who understand that an exit below 2.5x is not something that we should be aiming for. yeah yeah 100 and then let's talk a little bit about liquidity and dpi in europe this is probably the least talked about subject i think in venture is vcs returning capital and dpi and some founders would never even heard of the acronym of dpi but it is what is driving everything what is your experience of the european ecosystem and also how should they be thinking about managing their dpi over timelines when they're thinking about the next fund and fundraising for the next fund?

20:52How artificial should they be in generating DPI in order to fundraise versus letting their winners actually run the full length? So it is an absolute crucial point. Again, I keep bringing back to our own experience, which is because we have a global exposure to the world of venture. So we have the US, we've been investing across Europe, across India, Asia. So what we've seen is in the US, there are more firms has become a little bit more expected that you get to see track records with DPI. In Europe, what we are seeing is that the top tier funds are already thinking about it, they are understanding this.

21:39But most importantly, and again, bringing back to the company staying private for longer, a Series A, Series B fund cannot possibly expect to get the IPO or M &A result the same timeline as they used to. So for us, we're seeing a very good opportunity, not in a sense of taking assets at a rescue valuation. We are seeing the opportunity to take on the next mantle. We're seeing the opportunity of getting to back great European companies at a point in time in which the GPs have maximized their time and then their ability to generate their own alpha, whereas for us, we can take that sort of 2.534x going forward.

22:30DPI is absolutely important. It is, again, understanding the world in which we live in and that great companies do stay private for a lot longer or they attract acquisition. And I've always been in the camp. And again, coming back to the great GPs that we back and something that I've seen a lot is it's a lot better to be positioned going out in the market to speak and try to address the liquidity situation before it has to be addressed, right? So it's a lot better for you to be the one initiating these conversations, whether that is trying to dip your toes into potential acquirers, whether that is for portfolio companies, or it is to speak about potential secondaries.

23:21It is a lot better to start their relationship, start the conversation, and be positioned in a way that is you will only take things forward if it makes sense rather than being in a position where you do end up being in a rescue mode where you do end up being in a little bit of a crisis mode in which case that is absolutely detrimental so david it's been just scratching the surface really about what lps think about fund size liquidity etc these are really important topics for anyone listening, whether you're a founder, angel, VC, these are all the things that we need to be thinking about, because this is actually what we're in the business of, we're in the business of generating money.

24:05And yeah, this is central to that conversation. So thank you for sharing what you have so far. Our first last question is our future unicorn prediction. So obviously, you do direct investing as well. And there may be companies that you're in, but the earlier, the better, but it can be any business. If there was a business that you've seen that's not yet a unicorn that you think will go all the way that's doing something cool who would they be i've noted it down just to make sure so my first one is a company called trace bit and i think that was a very interesting case and a lot of enterprises that we talked to all of them said it is extremely difficult to deploy canaries that are on the cloud so normally it's either on-prem or you have to manually create them.

24:53And Tracebit is doing something really cool, which is the automatic, automated deployment of constant canneries on the cloud. So I thought that was pretty cool. And if I have time for, because they raised already their series A, there's one sort of seed company called Geordi AI. They are giving insight into agents' adoption. So whenever an enterprise starts adopting AI agents, they monitor them, and what they're doing, where they're coming from, and what's been their impact. Super cool. And thank you for picking a very early stage one, because it's always useful for Hector and I. And just on Tracebit, Tessian has been a real talent factory, I think, for some really amazing companies.

25:40I think Harriet Mays was there as well. And it's just that they've just got great engineering and product people coming out and launching things. It's been a really interesting company to keep an eye on for new businesses coming out the back of. So thank you for sharing those. That's really helpful. And that plays into some of the flywheel stuff you were talking about earlier. And then our final question, Dave, is our dinner party guest game. So if you could have dinner with any three people, who would they be? So I'll give a very sappy answer first, and then I'll give you my sort of career answer.

26:09My sappy answer would be have dinner with my two granddads who passed away and never got to meet my wife. So I would say my three guests would be my wife and my two granddads. If I was talking a little bit more life and career, then it would be Dario from Anthropic, Bernard Arnault from LVMH, and Anthony Bourdain. So a mix of the next future of AI with Bernard Arnault being like the absolute, for me a titan of acquisitions and conglomerates and getting a little bit of the Anthony Bourdain sort of outlook in life so yeah that would be my part and the food and wine as well exactly I'll give the wine list I think there will be a fight between Arnaud Bourdain but but we'll settle with whatever Dario has to say awesome we'll put it on the club yeah no that was really great and And obviously, Dario is becoming more and more of a figure that's front of everyone's mind.

27:13But I think he might actually be a unique answer. That's how new Anthropic really is as a powerhouse in the last couple of years. So thank you for sharing that. That would be a fascinating dinner for sure. Dave, thank you so much for coming on. It's been great. As I said, we've really scratched the surface. But I think you've opened up topics that are important and need to be discussed more. and I'm sure it will be a lot of food for thought for people to go and do further research and reading around how venture works and the incentives that we all have and what really drives the industry. So thank you so much for sharing that.

27:49Thank you both. Thank you for having me on. Appreciate it. Thanks, Dave. That's it for this week. Thanks very much for listening. To stay up to date with the latest episodes, please follow or subscribe on your favorite podcast platform. We also have a newsletter called Reading Unicorns, which is another great way to get every episode direct to your inbox. Please tell your friends about it and engage with us on social media. And we'll see you on the next episode.