Rethinking Asset Allocation, The Past Present and Future of Venture Capital | Dan Feder, University of Michigan

28:06Turner Novak:So there may be an example of cancer research or like a new material or design implementation on a aerospace product that has never worked before, or there's no research specifically, or there's no consensus around this is the way you do it. But there's people at the university that think it might work or there's a greater chance than whatever the market thinks will work. And then you enact the investment and you do it based on the fact that they're more certain than the market is certain? Yep. Yes, for sure. And the thing I wanted to put in there is that even more valuable is the information that comes in or that we have access to that will tell us what not to do.

28:57Because there's probably a lot,

28:58Turner Novak:like on the other side of that, there's probably a lot of things. There are a lot of things you shouldn't do. And you don't know what sort of trouble you're getting yourself into oftentimes. And so many of the very best decisions, because we don't make that many investments. So many of the very best decisions are decisions of what are the things you shouldn't do and avoiding those mistakes. One thing I think might be helpful for people, I'm assuming probably half people listening understand what an endowment is and kind of the point of it and how you construct the portfolio. But I think probably a good half that are probably like, what are you guys talking about?

29:37Turner Novak:So maybe that might be an interesting thing to just kind of hit on really quick is what are endowments? And then how would you go about putting one together just starting from scratch, day zero? This is an important question because just to make a little confession, I didn't know what endowments were really or what endowment investing was when I got hired to do endowment management. I was hired based on my experience doing something else around investing. So in, I guess, the popular press or the sort of the popular understanding of what an endowment is, you see the headline that says this university or that university has X number of billions of dollars of endowment.

30:16Why don't they just use that money to just give it to the kids? Just dip into the endowment to fund things that are important. The reality is that an endowment, as described in that way, is really not a single endowment. It's an endowment pool. And so the endowment pool is comprised of, in the case of Michigan or any other university, maybe tens of thousands in our case so you know over 13 000 separate endowments and the endowment manager has a responsibility to invest that pool responsibly and to keep the the interests of the endowment itself in mind so the pool in this case is probably like the

31:09Turner Novak:the Dan Fader scholarship for runners or something, or just like different tiny little things, but then also be like the school of nursing or something or like a larger, okay. And they all collect all 13 ,000 to say, this is the Michigan endowment. It's worth X amount of dollars. And each individual single unit is like a 0.01 percentage or 1 % of the total. Exactly. So when you establish the Turner Novak endowment for the betterment of society, What you would do is you'd put in your capital and then every year the endowment pool would distribute out typically between four and five percent of the ballots of that endowment to the recipient.

31:54Turner Novak:And this is something that's kind of mandated to maintain a certain status or something like you have to distribute some cash. So in the case of foundations, there are rules about how much has to be distributed. It's roughly 5 % has to be distributed. In the case of a university endowment, there's a spending rule that's set and they're basically all around 4 % to 5 % of a balance. of a balance and that balance might be smoothed by averaging balances over some period of time. But each one of those endowments is basically, well it is, a unit holder in a mutual fund. So the Turner Novak Endowment for the Betterment of Society will have some number of units and it will distribute a pro rata portion of that overall distribution.

32:47So it's not one unified pool that can just be used You can just be like, cool, just take some money out. It's a really important piece of how the endowments fit in the overall context of how a university is financed.

33:03Turner Novak:And then how do you pull them together? So we have this pool of 13 ,000 different unit holders. There's a pool of capital. Let's just say we're starting from zero. How would you just think about putting one together? Like you just throw it all in, just buy Apple stock or open AI stock and you just call it a day or like, how do you do it? If you could, if you could do that at the right time, you'd probably just do that with perfect foresight. The way I think about it is that the objective of the endowment is a pretty, pretty ambitious one in terms of the return. So the return objective is basically meet that spending rate.

33:43To earn at least 5 % a year. plus or minus just to keep up with the spending. Preserve spending power, so keep up with inflation. In the case of higher ed, there's something called HEPI, which is higher education. Inflation, and it runs higher generally than CPI. So that's usually one or two points higher, but that varies. And then if you're really ambitious or hopeful, then maybe you make some return on top of that. So that solves out to basically like a 7-8 % nominal return. And what you want to do just to make it even harder on yourself is to generate that return with some level of volatility being permitted because you can do some smoothing with averaging the balances over time.

34:34But what you want to do is to have intergenerational equity among students and researchers and so forth so that if we're coming through a really happy time in the markets, you know, sending a whole bunch of capital to those recipients. But if we're going through a less happy time in the capital markets, you don't also want to start really cutting back funding on those students and researchers and so forth. So you want to do 7 % or 8 % nominal return for a period of forever or effectively forever.

35:13Turner Novak:Participate in all the upside and not participate in downsides. Within reason and not have too much volatility. So that's a pretty tall order. Yeah. So the way I think about it is just working backward. So if that's your objective, how do you get there? Kind of a reverse engineering sense. and a starting point is well let's just start with that return objective how do you think you can get there and the only way that i know of and the only way that seems to have been invented so far other than just making stuff up or running a ponzi scheme is but those do collapse but they do make money for a while for somebody if you're running a ponzi scheme yeah but we don't do that and we don't encourage that.

35:59The way you do that is with equity. And... Do you buy stocks? So you start... Throw 100 % in the stock market. Let's just look at where you can make that sort of return over a long period of time. And those are in equities. And so what do we think of? We think of equities. We think of the stock indices or the markets that we all know and love. So the S &P, the Dow Jones, et cetera.

36:24Turner Novak:And I think the S &P's average is something like 8%, 9%, 10 % over the past 100 years, right? Like per year. So it sounds like you just hit your target, right? Right. But not every year and not every, you know, and not even every segment of multiple years. So you run into the problem of, well, wait a minute, what about those students or researchers that get overfunded or underfunded in times of volatility? So this is where asset allocation comes in and the principles of modern portfolio theory, which is if you can start putting together combinations of assets or asset classes in a way that makes sense mathematically, you can reduce that volatility.

37:08Some things go up, some things go down and have a given level of return with less volatility over time. So you start adding on or loosening a constraint around what it is that you're permitted to invest in. So you start adding in. You probably want some bonds in there, right? Well, you also want to have cash so that if things are really funky, you can make your distribution.

37:40Turner Novak:You need at least 5 % probably in a cash-like instrument. It seems to be a pretty sensible and general way it's looked at is sort of 5 % to 10 % in cash or something that looks or behaves like cash. But then you only have 85 % or 90 % of your portfolio getting the equity-like return. So now you've just hurt your ability to make the normal returns. You need to learn a little bit more on that. You need some juice. Yeah. But you also need to simultaneously keep your volatility within SPAC. So you keep adding these asset classes on that can be additive around that. And that's where investment classes like private equity and venture and private real estate and so forth come into play.

38:29Venture is the area that we think and should be the case that has the ability to generate real upside. We have really, really robust returns in a way that may be less correlated to other parts of the portfolio. There's some flaws in how that's measured, but let's just stipulate that as a fact that there's potential there. And so that's why we invest in these alternative asset classes, because we think that they relate well to other equity or equity-like investments. and in some cases like venture or private equity, they can provide some return enhancement to the portfolio. In cases like real estate and natural resources or infrastructure, they can provide solid returns that have less upside but less correlated to some other things and more steady over time.

39:33Turner Novak:Yeah, because real estate is interesting because you kind of have the price of the asset probably appreciates over time, generally, but you also get some dividends, some cash flow from it. So it's kind of like a stock mixed with a bond in a way. True. And like with anything, there are many ways to go at this. You can go at it in the way you just described, or you can go at it in other ways. Just like in venture, you can do things late stage, early stage, sector, geo, et cetera. There's not one homogenous way to invest in venture and private equity. And that's where I think the fun is, is that the potential around venture in particular is great, but the variability of outcomes is really, really wide.

40:22And you can really do badly. Yeah. Even most people. Most people on average. Looking at the data, most people don't do great. Most of the industry doesn't deliver. But when it does, if you do it well, it can be really additive.

40:44Turner Novak:So I think that's an interesting, you mentioned that venture is the one that you personally are the most interested in, that you've done the most work in historically. How'd you first get started in it? Well, doing more in venture is the last thing that I've done. So I started my career as a lawyer. So about as far away from venture as possible in the sense that - Yeah, it sounds like the most rules-based, follow the book, don't take risk. Well, I love the study of law. I just say that. I really do. Studying law and the study of law, I just look back at especially the three years in law school.

41:22I love those three years. It was fantastic. It's a time where I really learned how to think in a different way and that's really carried with me. But being a lawyer is a practice in which you are not rewarded for upside and you are punished severely for being wrong. So it is the exact opposite of the way venture really works, which is it's okay to be wrong or to lose every once in a while, but you really do have the potential of being rewarded for being right. So if I were making up a narrative about my career that I was trying to pretend like it was all a grand design, that's what I would do.

42:08You were trying to learn the opposite way to do better. I started here and I moved over to the other end. It was this nice gradual glide path from downside avoidance to upside reward. But the reality of it is that just by luck and maybe some serendipity that's not completely random, I moved from practicing law to moving over to the investment side where I focused on credit, complex transactions and structured transactions, where understanding the language of how businesses operate.

42:52and how to really evaluate businesses. And I mean, if you're working in that realm, you really have to, because you're still in the realm of if you're wrong, it's not going to be made up by upside, because the best you get if you're in credit is you get paid back. Yeah. And I just kept gravitating more and more toward the kind of the risk end of the spectrum. And I had the opportunity when I was at Cigna's investment division, which is where I started doing investing, to restart a program that had been neglected around private equity. So the program that I restarted was an unfunded sponsor program where we'd go out and get or establish relationships with groups that did not have funds and work with them on doing, for the most part, industrial buyouts of family-owned businesses.

43:59Turner Novak:On like a case-by-case, deal-by-deal basis. So we would finance the whole right-hand side of the balance sheet, take equity stakes of 70 % or 80 % of the company. our partner would share their piece of the equity with with a management team but basically it was you think of it in the fund context similar to a fund there's like there's 20 yeah versus 80 and it was great we looked at and worked with companies that were super interesting i'm sure you'll you'll be fat i mean i was fascinated i still am fascinated didn't you say one of them was like the biggest manufacturer of like hot dog toasters or something?

44:41Turner Novak:Am I remembering this right? Conveyor toasters for bagels. Okay. Conveyor toasters. Yeah. Okay. It really is. Great company. It was founded by an entrepreneur named Harrison Holman in Saco, Maine, which is - Never heard of it. I know where Maine is, but never heard of Saco, Maine. Saco, Maine is on the coast. And the conveyor toasters, if you go to a bagel shop, you'll see them there at Holman. It's owned by Star now, but it's Holman cooking equipment. So I know a lot about that. I also know a lot about lead screws and nuts. Those are screws that spin and a nut that travels on the screw to position any number of things, from very large-scale things like subway doors to very tiny things like things within very small pieces of medical testing equipment and the technology around the nut that goes around the screw is really important because the nut can wear out.

45:45Having the technology to have that nut be self-tightening at a constant level is hard. So anyway, those are the things that I started to work on and got more and more interested in the equity piece of how these companies worked, what their prospects were. And then as I got into endowment management, I had more and more exposure to venture. And it's just part of that made up narrative of the logical next progression in my own.

46:14Turner Novak:So then how did you actually transition into doing venture? Because you're doing credit related, well, I guess then more at PE. Like, on paper, looking at a resume, I'd probably just throw it out and go to the next guy who, you know at the time what was it he probably was like an early employee at google or yahoo or something like how did you convince that that worked i was just really really lucky so i was looking for something else to do i i'd been at calpers for a short time that didn't was not a good fit i guess would be the way to say it i i just left because i wouldn't do some of the things that were being asked of me to do around making recommendations that i didn't believe even.

46:55So I left pretty quickly after joining. And I really didn't know what I was going to do next. And I had struck up a friendship with a private equity investor that I really respected named Paul Levy. And he just did a very, very kind thing, which was we had lunch together in New York one day and he said, look, I think you would, you'd like endowment management. And this is in the year 2000. And going back to the beginning of our conversation, I said, that's great. You know, around like what's endowment management? I said, that's fantastic. What's endowment management? And he said, look, what I'm going to do is I'm going to introduce you to someone.

47:42I am a guest lecturer for his course at Yale. His name is Dave Swenson. as most people know Dave Swenson is the he wrote the book he literally wrote the book he literally wrote the book and the second edition of the book on what endowment management is and the best way to do it and that he's the author of the Yale model that really dominates the industry beyond endowments and foundations so he connected me with Dave and then Dave eventually connected me with Andy Golden at Princeton. And Andy at that point was looking for someone to lead venture and private equity. Princeton had outsourced all of its non-marketable investment classes and was bringing them back in-house.

48:27And Andy was looking for someone to lead that. And like you said, I didn't have experience doing this thing. Um, but we got to know each other and just had a series of conversations and Andy eventually hired me on the, the, the premise that he would rather have somebody who would learn on the job in a, in a, in a good way, but who had experience doing things that were relevant. And that's really stuck with me for a long, long time.

48:58Turner Novak:Yeah. I know that's kind of one of your philosophies is that usually the best hires have probably not done the job before. Is that true? It is. But it's not because having specific experience is a bad thing or disqualifying. It is, I think, because the way that people invest and invest in people is to try to narrow the scope of what they're looking at. It's just, it's helpful. You can't constantly look at the whole landscape. And so if you broaden your scope from just looking at people who have X number of years experience doing this specific thing that you're hiring for, you're disqualifying almost everybody else.

49:43and out in that everybody, almost everybody else, there will likely be somebody who has experience doing something that is relevant and important and who is passionate about doing the thing you're looking for and will come up with ideas or approaches that are novel and that you would never have thought of. And that's worked well. and it makes it harder because now you're looking at a broader universe of people same thing in investing investors will often come up with rules that i mean they make sense on some dimension so for instance an lp may say we just don't invest in first-time funds

50:33Turner Novak:too hard to underwrite we don't know what kind of decisions are going to make too risky. There are all sorts of reasons. There's a valid reasons why you would say no first time funds or no funds over a certain size or below a certain size or geography. And this goes back to having a sense of where you are. Those kinds of rules can be really productive and very helpful depending on where you are. So if you don't have any advantages around what's out there in the the broader universe, but you, you are able to do a good job by constraining the opportunity set down to something that is sensibly organized, then your odds of success are better than if you, if you don't.

51:22So I'm going to try this out on you. It'll probably break down in probably the second sentence of doing it, but this is the risk of trying out something new in front of a microphone. So there's an old joke where a drunk comes out of a bar and he's looking around under a street light and a policeman comes along and says, what are you doing? He says, I'm looking for my car keys. And the cop says, did you lose them under the street light? He says, probably not, but there's a lot of light here. And the first takeaway from that joke is, oh, that's silly. you know, of course you wouldn't look there.

52:00You'd look where you somewhere else. But the reality is that if there's some possibility that you dropped your car keys under the streetlight, you'll find them easier. Well, then you'll find them more easily. Yeah. If it's more likely that you drop them outside the light, but you have almost no chance of finding them there. Well, it is perfectly sensible to look under the streetlight.

52:25Turner Novak:Yeah. Now, if you, this is where I'm going to really try to stretch this, and it may just fall apart. But if you are able to ask a friend and say, hey, did you hear my car keys drop? They go, oh, yeah, I did. Well, where? It was back on that dark corner at the corner of 4th and Main. Well, then you go there. It's kind of like a light. But your odds of finding the keys in the dark improve significantly are way better than looking for them in the light. So it really depends on where you are, what information you have access to. And we do that in investing, in funds, in companies, and in people. So it's not just sort of randomly going out into the world and saying, there's somebody great out here.

53:14I hope I find them. It is, well, who are our friends? Who are our reference points? Who's going to tell us, look over here, this person or this fund or this CEO of a company. These are really special people or these are the people where you ought to spend your time. And don't worry about the rest of it. So if we do that, we're constraining our opportunity set, but in a way that makes more sense for us. But if you don't have those resources, then what you need to do is you need to resource your organization so you can look at the whole universe and then try to pick sensibly across that universe.

53:53Turner Novak:So it's kind of constraining yourself to areas where you can create a light to see. Exactly. Yeah. Is there, speaking of that story, is there some element of a drunk person looking for car keys in front of a cop? Like, is that? Is that what I think of venture capitalists and private equity managers? Just these drunkards that wander out of the bars looking for their car keys? No. But it's the best analogy I can come up with on short notice. I mean, sometimes it maybe feels like that. Whether we're drunk on hype or drunk on FOMO or drunk on whatever the current thing is. Okay, maybe it does work then.

54:29Turner Novak:And who's the cop? Is it like, all right, you found your keys, you put them in your car, you started to drive. What are you doing here? You're really putting me under pressure here. I mean, I think it's a good analogy of like, you know, so some of the stuff you invested in, what were you thinking there? That's the cop. That's the cop. Well, so then how do you do like long-term career planning? Like if I'm 22 to 30, I'm like, I think I like this LP thing. This endowment management seems interesting. what's a way to be thinking about your career and maybe what do people maybe do wrong when they approach that?

55:11I think it depends at what stage of your career where you are. Yeah. For young people, maybe people coming out of college or even coming out of business school or graduate school or, you know, that stage of their career. Yeah. And they're not quite sure what they want to do, which should be, in my case, I'm still not. I'm still working on it, but I think I'm getting there. But certainly when I was in my early 20s,

55:40Turner Novak:you thought you were going to be a lawyer, right? I was convinced. Yeah. Even though I didn't know what being a lawyer was, but it sounded great. At that stage, I think unless you have a really clear point of view about what you're going to do, and this is a little bit of a promotional or advertisement, working at an endowment or foundation or a place where that sort of investment goes on is a great place to figure it out. because if it's the case, we think it is, that we invest with people, whether it's public equity managers, hedge fund managers, venture capitalists, private equity, et cetera, we're investing with some of the best investors in the world.

56:34And so if you're coming in as an analyst or a junior investor into that organization, you get to interact and see in a way that other people just will never be able to observe what it is that it means to do that job. What do these people do? How do they do it? And we have many, many cases that I can think back on where analysts came into an endowment thinking that, oh, public equities is where it's at. And they find their way to venture capital and they think, oh, I never knew that existed. And now I've learned something.

57:11Turner Novak:I mean, that was like pretty much literally me. Like I got a job in endowment. I love investing. This is fun, but man, this, this venture capital thing actually seems more interesting than anything else that's out there. Yeah. And then there are other cases where people come in and they, they look around and they say, you know what, this has been really, really valuable. None of the above. And it also helps, which, which is really just like investing. It's the investments you don't make that are really, really important. Maybe more important than the ones you do. Going into that kind of setting early on is a decision.

57:47So you're deciding to do that versus not a whole bunch of other things. You're not going to go from there necessarily to go be a doctor or a dentist, but you're going into investing. And now you're creating still a lot of flexibility at that stage. And another fork in the road could be, well, do you want to invest as an LP or do you want to invest as a GP? And you can get some perspective around that. Now, as you go further and further in your career, it's much harder on that dimension to do the switch back and forth.

58:22Turner Novak:Yeah. What ways has the venture capital asset class kind of changed over the past 25 years? Like, I don't know if there's like a five-year by five-year evolution, decade by decade evolution that you've seen. but going back to I think 2000 was when you got your first job what have you kind of observed over time? So I'll just give you my own experience and I didn't really appreciate how easy I had it in 2000 versus now. What point in 2000 again? There was something going on. I think it was something called the TMT bust but it actually in hindsight it made things easier for me. So In that era, the industry itself was much, much smaller than what it is today.

59:10The size of some of the fund offerings or offerings across platforms and venture are larger than the whole industry was in 2000.

59:21Turner Novak:Oh, you're saying the ones today are larger than? Oh, yeah. So I won't be able to cite chapter versus what was the size of the whole industry, but it was measured, you know, maybe in the single digit billions. And funds were not measured in the billions. So what was kind of like average down the fairway venture fund size in 2000? Well, in 2000, there was... It probably stretched a little bit. Well, so the thing of it is that in 99, 2000, funds started raising billion dollar funds. But they came back down to their sort of 200 to 300 was sort of a really sensible center of gravity for an early stage fund.

1:00:00But there weren't that many of them. there weren't that many endowments foundations or any other institutions investing in venture or private equity these were really alternative asset classes across the board even you know

1:00:15Turner Novak:down to to hedge funds the returns were pretty good though weren't they returns were great you could you could be average and do really really well yeah so why did more people not why were they're not more LPs putting capital in? Well, they came. They came. And that's what's happened is that the asset class or the investment, I call it an asset class, but it really isn't. It's really an investment class. Because there's some asset classes that are well, you know, we talk about asset allocation involving asset classes and the characteristics of an asset class involve things that are important around optimizing across asset classes.

1:00:56homogeneity and so forth. But I'll just call them investment classes. So venture became known. It came out of the sort of less known or unknown into the known and knowable. So more investors came to the industry. More smart people came in to do venture capital, which is good. So the geography of a venture expanded, the opportunity set expanded. There's a lot of goodness in capital markets allocating its capital into an area. But it was much, much easier in 2000 in the sense of, one, there were fewer participants, fewer LPs. And so it really wasn't that complicated to figure out where you should invest and with whom.

1:01:52Turner Novak:because there's only maybe like 10, 20, 30 relevant funds that you should meet and talk to. You could do that in a, you could almost do that in a weekend or in a week. Yeah. Be a tough week, but you could get it done in a couple, like a quarter or two. It wasn't that hard to figure that out. Now getting access is much harder because the funds were actually pretty small. They were fully subscribed and so forth. Did they turn people down a lot? So getting into the very best funds was very, very hard. And that was one of the great advantages that I was at Princeton at the time. But a place like Princeton or Michigan or Wash U or I was before, there's some real advantages of access.

1:02:32Those are long horizon pools of capital, alignment of interest, but also alignment of these are good missions. And then people who have gone to those schools or if there's a possession error, they'll give the possession error to their alma mater for an allocation. but I did do this over a period I stopped doing it after a while where I would just go around to people with whom we invested and just ask the basic question of how many firms really matter in venture capital and the answer was always sort of 10 to 12 and in that era of call it 2000 through 2005 2006 somewhere in there the number would kind of bump up a little bit, but basically you could get everybody's top 10 or 12 with 20 names.

1:03:28So pretty tight.

1:03:30Turner Novak:And somebody who maybe they're like eight on one person's list, they'd still be 20 on the other person's list. And I was like, yeah, there's a lot of consensus around that. And it was really based on the idea that there are a certain number of companies that will be funded in a given year or will appear as being important in a given year. And because the industry was pretty consolidated or compact, there were only a handful of good funds who would have access or exposure to those companies. And the name of the game was, as an LP, make sure you're in those because you want to have exposure to those companies.

1:04:16So where we are today is there aren't hundreds of firms. Now there are thousands of firms. And because venture is a bigger and more productive area of investment, there are more companies that emerge that are consequential and there's more dispersion of who has exposure to those companies and so forth. So it's a much harder environment. It's not just simply about access. The other thing that I look back and say was an advantage was it was 2000 and things were falling apart. And it was easy for somebody, looking back, at the time it didn't seem easy, but looking back it actually was. It was easy for someone like me coming in, not knowing a lot, into a situation that was falling knives.

1:05:08because everybody who thought they knew a lot was now thinking, well, I didn't actually know that much. So now you have to go back to like, well, what are the things that are first principles? What are the underlying premises or thoughts about how you do investing well? And then start applying those to the game on the field. And for me, I came in with a perspective that was rooted more in the fundamentals of how do businesses work and what makes a business successful in a durable way. And I think that was helpful in evaluating fund managers and what it is they are doing. It's helpful in evaluating unrealized track records, which is almost everything when you're looking at a recent fund.

1:06:00and it's also helpful in how it is that you discern what is an approach that somebody has and how you have a real conversation around that so looking back on it it was actually helpful that I started in a period in which it was a mess in adventure because it kind of like just shocked you into like hey you have to learn this and how this actually works because it's not

1:06:28Turner Novak:working or it's all breaking and you kind of you kind of get a front row seat to that right away and also you get to see like oh this is this is how things break yeah um the way i got maybe i've transitioned from being a lawyer to being an investor was that i was doing more and more work restructuring some bankruptcies for tech companies no for for really not tech companies but um a lot private equity-backed companies, some project financings that are really, really complicated, some securitized deals, really complicated structures and so forth. But what happens when something goes sideways like that, where you're at a stage of restructuring or bankruptcy, is that the investors basically leave the scene of the accident.

1:07:19Lawyers are here, lawyers take over and what i found was that in those contexts i was running deals and it finally dawned on me after a little while wait a minute i actually like running deals and moved over to to the investment side um similarly around like a broken situation where funds are starting to look things within their documents like, oh my gosh, there's a clawback. Oh, this is rough. We didn't know this was in there. And all these sorts of things. You really get to see how things are pressure tested in the documents, in the behavior of partnerships, in the portfolios that were, I guess, knowable, but really not visible and certainly not visible in a way that investors could internalize those lessons actually empty.

1:08:15Turner Novak:Because you don't think about, especially in venture, you don't think about, I'm going to lose money on this. What happens when things go under? You just think about what's the upside? That is what they tell you. That's what the podcasts tell you to think about. It's kind of right. Is that what you tell people you're a podcaster? I mean, I do feel like that's an element though. Because with venture, it's like, you can only lose your money. but the upside is unbounded. So you should just maximize as much upside as you can get. Like that's what they say. I think it's like a famous Bill Gurley quote, right?

1:08:52Turner Novak:His like, enjoy the upside. Well, I don't think his is the one times your money. His is like when there's bubbles, just enjoy the upside. Something like that. Like, that's... Enjoy the ride. Yeah, it's like... Well, and I think then it comes back to like sound portfolio construction. It's like you probably shouldn't be constructing your portfolio to need the bubble to give people their money back. You should probably be constructing it as in a worst case scenario, we still feel good about like, we'll make some money. But if there is insane upside, we benefit greatly to the extent of like, this is why it fits in a portfolio as a venture fund.

1:09:29Okay. I agree, but I disagree.

1:09:32Turner Novak:Okay. So I'll push back. And this is probably going to come off the wrong way, but I intend it to be nice. I intend to be a nice person anyway. Or to be, at least try to be liked. But I don't think that's the way things work in venture now. I think that the term venture capital is now not all that descriptive. I mean, it was descriptive in the early 2000s. Yeah. Because really all that existed. It's just small, early companies. It's really early stage venture capital. There were some exceptions for the firms that really declared themselves as being later stage and providing financing between later stage and then through to IPO.

1:10:20But today, the term venture capital just covers too much ground. And I think that there's something insidious about that because it allows people to declare themselves or to think of themselves as something they're not.

1:10:39Turner Novak:So you can be a venture capitalist, but it's companies that are doing tens of billions in revenue. So the outcome is that you have an industry or a set of investors who would like to say that they adopt that, well, you can only lose one times your money and really shoot for the upside, enjoy the ride. You know, all those things that there are serious underpinnings to those around what a power law really is and how that works. but there really is a bifurcation in my mind and so i would like us to find a different labeling and for like the different yeah i think it just really really is to be labeling so truth in advertising and it's not a bad thing i think it's just it would just be constructive yeah and so the the term venture capital came about in my looking around in about 1946 and was really rooted in the term adventure capital, which was started by Ben O.

1:11:48Schmidt, who was an early partner or was a co-founding partner of J.H. Whitney.

1:11:54Turner Novak:Is that related to Bessemer? I don't know. Was that one of the old Bessemer partners' names? But it's one of the first, it's like the true venture capital firms, right? Yeah. I mean, they started out as calling themselves private equity, but then adventure capital. So the adventure piece was funding things that involve things that you think of as adventures, where you're going out into the wilderness you don't really know and going back to kind of the uncertainty discussion. You're going out into this uncertainty, this area that involves things that are not known or knowable and things could go well or not.

1:12:32And I think, you know, in our own minds, we can kind of come around to what does that mean? So it was shortened to venture capital. And now it includes all sorts of things. It includes the very, very early stage all the way up to companies that are really well established.

1:12:49Turner Novak:I think I saw Databricks did a$100 billion post-money series K. Is that venture capital? I'm sure people that invested in that round called themselves venture capitalists. Well, they're venture capitalists because, for lack of a better term, that's what they are. But I think at that stage, what the funds or the investors are providing is capital for ventures. And so if we just do the bifurcation of there's adventure capital and there's capital for ventures, there's more of a distinction between what you're doing. But also, it's not always the case that a company at inception or very early stage is, those aren't the only things, the only circumstances where adventure capital comes into play.

1:13:34There can be, and there are many examples of companies that have high valuations that are actually pretty substantial that are doing things that are still on the edge.

1:13:44Turner Novak:They're still on the adventure. And the capitalists going in to fund those companies, that's really adventurous. It just happens to be more capital. On the other hand, you can, I think, envision an early-stage company that requires funding, and it's not really adventurous. So if in order to fund the Turner-Novak Scholarship for the Betterment of Society, you decide you want to open up a plumbing business in Ann Arbor. and you're going to need some money to start the plumbing business. Well, it's fairly clear what the path is to build a good plumbing business. And so the capital that's going in, I wouldn't characterize as adventure capital.

1:14:27That's capital for your venture.

1:14:28Turner Novak:I'm probably going to make a spreadsheet and just tell you that I need the money that's in the spreadsheet, and we just do it, and it probably will work, most likely. I mean, maybe I'm a bad plumber, but... I'm not going to be your first customer. Okay. I'll wait to see how it goes on the reviews. Yeah, the online reviews. Hopefully I got to get my Yelp score high. But I know that you're very good with social media and so forth. And I'm sure that you would figure out a way to manipulate the reviews so that I'm not sure you don't want to be the 10th customer. I'd probably have some plumbers on my podcast and I'd probably make some tweets about how good of a plumber I am or something.

1:15:11This would be bad. Maybe there's a sitcom in here. It's like the VC who decided to be a plumber.

1:15:15Turner Novak:I mean, that's kind of happening though, right? Where people are like, hey, we're buying these legacy, outdated industries and rolling out tech across them. Have you seen that going on? Oh, for sure. I think it's really interesting. It'll be interesting to see how it plays out. There's, I think, a trap in there for that idea. What's the trap? The trap is, let's say, in the case of the local plumbers, you have this thesis that you can go out and acquire local plumbing contractors. Like an existing business. It's profitable. You're going to infuse AI into the system, whether it's customer support or project planning or whatever it is.

1:16:00You're going to infuse technology into it and you're going to expand your operating margin from what has historically been the case of, call it 10 to 12 percent to 25 percent. Because the technology is going to reduce the OPEX to that degree. that's that's great in terms of you know doing the build-up now you're you're acquiring companies that whatever six times ebitda and you're you're doubling the ebitda you might be growing the

1:16:29Turner Novak:company too so the ebitda might grow four five ten x you're rolling things up that is what that would be a productive and sensible strategy the issue i think is that eventually the technology is going to be ubiquitous around all of the plumbing contractors, and margins will gravitate back down to where they kind of settle, which is 10 % to 12%. So if you're banking on the idea that, well, we're just changing the industry, and this industry is no longer a plumbing business, it's a software business, it might have a problem. I think we saw this movie earlier. So we saw this movie, not in roll-ups, but in things like insurance or fintech where investors thought, well, actually, this isn't an insurance company anymore.

1:17:26It's a software company and it's deserving of margins that are like a software company and valuations that are like a software company. And you kind of roll the tape forward and you say, you know what? Similar margin profile. It's still insurance company. or it's still a bank. So those are kind of the traps. I think really good investors know how to navigate that. And there are some really exceptional investors doing some really interesting work around the roll-ups of accounting firms and law firms and so forth.

1:17:58Turner Novak:I think you'd probably need to get some sort of like structural advantage. Like you have better access to data that no one else has or something, or maybe you just get so big, the economy's a scale, you're able to like price lower or something like that. I mean, those maybe seem like ways that it could work, but you probably thought about this more than I have. I guess the general way I think about it is, you know, those are those elements as well. So at what point do you, you know, you build something which you start with from a small base and now it's a larger enterprise. So the scale of the enterprise has value because of the scale.

1:18:36But there's also an aspect of how you navigate that. and let's say you're doing these roll-ups, you're not using financial leverage, you're just buying the businesses and rolling up, there's still leverage embedded in this, right? You're levered to the technology impact. And so if you are, I think, sensible about how it is you manage leverage and therefore risk, you can execute well. If you do something like make the mistake of thinking, oh, there's no financial leverage here.

1:19:10Turner Novak:So we're fine. So no, I can now use a six times acquisition. I can use three times EBITDA. And that's really reasonable leverage. But you're levering to this other thing, which is the impact of technology on expanding your margins. Well, now you've had this insidious over-leveraging of the businesses, if that makes sense. So there might be an element of you actually, you're creating your own technology and you do have the best technology or maybe you're then outsourcing your technology to the rest of the industry, turning your cost center into a revenue driver or something like that. This is where it's, your question at the beginning was, well, does that make sense?

1:19:52And the overall idea, I think makes a ton of sense. Yeah, when you just stop right there, yeah. And it's not that the overall ideas or the macro is easy. is just less hard than the micro. Yeah, that's fair. So a lot of people can be right about the macro and how it is that you go about implementing around that is very, very hard and that's where the rubber meets the road.

1:20:17Turner Novak:One thing I've heard you describe, maybe specifically in venture, being a good investor is related to relevance and then being relevant. Like, what does that kind of mean to you? And maybe I just made that up, but I'm pretty sure you've said that before. I'm not sure I said it, but I'll trust you. No, you really do have to be relevant. So here's an example. And it's a kind of an inconvenient truth, I suppose. So let's go back to 2000 and, you know, the TMT bust. And there were some investors going into 2000, some firms that didn't drink the Kool-Aid. and that was the thing people would say coming out of 2000.

1:21:05It's like, oh, we all drank the Kool-Aid. We overdid it. Now we're coming back to basics, et cetera. And those firms kept raising money because they had that mantra of like, we all did it together, but now we're coming back to the norms that we always believed were true. And people sitting in LP seats would say, okay, yep, true, irrelevant. will back you.

1:21:33Turner Novak:Because you were seeing that good deal flow. That was all super. But then there were firms and investors who said, this is crazy. I'm not participating. This makes no sense. The bust happens on the other side of the bust. Those people didn't get funded because they weren't relevant. And that's sort of the dark side of it. But it really matters. And there's a balance in that sense of what it is you're doing and when, because you do have to be, I think, whether you're an LP, GP, founder, you have to be in the game. You can't just sit in a windowless room with great thoughts, not interacting with the world and being right.

1:22:19You'll just be frustrated and alone. Yeah. And it won't make any difference. You have to be in. And it's really kind of a tricky thing. It's very tricky. Like, how do you maintain relevance? When I look at it from the seat of an LP, looking at funds or investor groups, what are they doing to be relevant in winning the deals they want to win, being in the places they want to be? in times that are really exciting and maybe overly optimistic and in times that are really rough and where pessimism is the order of the day.

1:22:59Turner Novak:Yeah. Yeah. I mean, one thing I like, I don't know if struggled with is the right word, but I kind of went through throughout 2020, 2021, 2022 was I like multiple LPs that are like, you know, why haven't you pivoted to Web3? Like you should be a Web3 investor. And it's easy to kind of look back on that in 2025 and be like, yeah, that was a pretty... I mean, it was like a good call back then. But at the time, I remember like, it was like kind of hard because that was the thing. And that was how you were relevant. And I think maybe one way I've maintained relevance through it was I just kind of made fun of how ridiculous it was.

1:23:40Turner Novak:And there were actually a lot of people that kind of agreed with that. And one thing that I found a lot of times talking with people, they're like, oh yeah, we know that there's nothing here, but don't you want to make money? We're making so much money. And I was like, yeah, I do want to make money, but this is not real. It was a tricky thing to balance. So I don't know. I mean, I feel like as a venture investor, you do have to stay relevant. So that's kind of one thing I've been just trying to think about for a long, sustained period of time is like, how do you, how do you navigate those extreme periods of where only maybe certain things are irrelevant or not?

1:24:19Turner Novak:Like manage those like hype and bubble cycles. I don't know. I don't know what you've seen that's worked well or not, but. I think what works well, or at least the way that, a way that I try to evaluate people with whom we invest is how do they think about these things? Are they thoughtful about though? Are they self-aware in terms of, these are behavioral flaws or characteristics because we're human beings. Yeah. Like you want to be popular. You want to be associated. How do you go about investing in times that are sort of crazy and you know they're crazy? How do you go about actually having the conviction to invest in areas that are not well-traveled?

1:25:00And I think it was a Buffett who said, you know, it's better to be basically wrong with the crowd than right by yourself or something along those lines. That's kind of true. It is true. It's very uncomfortable to deviate, but you can't just be completely independent because you need to maintain this relevance in order to do the thing you want to do long term. if you don't i guess if if you have the the ability or self-awareness to to make those decisions intentionally and to understand what it is you're doing that's a really important piece of it as opposed to well all the other cool kids are doing it so maybe i should too i want to be

1:25:48Turner Novak:cool too yeah and then i think there were i mean the the crypto web3 stuff i mean the stuff that working is basically casinos. Casinos are really good businesses. If you're the house. Yeah, if you're the house. Yeah, so it's like, I should have been investing in some of the casinos and maybe some... Coinbase, I guess, is up since then. Actually, maybe Bitcoin is too. Actually, maybe not. I don't even check the price of Bitcoin. I don't know. So you're a healthy person. Well, so what do you think are some other traits of good investors that you've come across? Just venture, maybe other asset classes?

1:26:24Turner Novak:What do they usually look like? What are the things that you think typically stand out from your perspective? I think a real common denominator is... I'm struggling. I'm not struggling. I go back and forth between thinking, well, it's really about people who are contrarian thinkers, but it's really... That's misunderstood, I think, often because... I mean, that's kind of become a non-contrarian word now. Like contrarian is so... Yeah, contrarian is not contrarian. Yeah, the word has been kind of ruined. Well, it's ruined also because people think that contrarian just means doing the opposite of what everyone else is doing.

1:27:00But actually, that's not the... It can't be what it is because that means that you're just letting everybody else tell you what to do. It's just... Exactly. They're just telling you, just do the inverse.

1:27:10Turner Novak:So, you know, then you're not actually... You're still doing exactly... You're just listening to other people to give opinions. I think it's more along the lines of independent thinking and really rigorous and careful thinking around what it is and why. Because being a good contrarian, I think, means that you're willing to do things that other people aren't doing. But when you do them, do the things that other people are doing, you're doing it based on your own thinking. Even if the thinking ends up being the same, you're actually doing the work around why are we doing this and how. It's probably like you know the thesis even better than what the current mantra is.

1:27:54Turner Novak:And you know that there's maybe more upside than what the average down the fairway thinking is. I mean, I could see that being... I mean, that's how I would get comfortable with investing in something that's pretty well known. It's just like, oh, actually, for me, I'm not just like reciting a blog post. It's like, you know, I'm writing the next blog post. Like I kind of know what the next level of this is. I feel like you need to have something like that. So if I'm starting a fund, have a fund, I'm starting to get within the strike zone of when it might make sense to talk to you or an endowment more broadly.

1:28:31Turner Novak:How should I position myself for a fundraise? Do I just... It sounds like I need to get introduced to you probably within the network. But do we just... Do I send you a deck? We have a Zoom call for 30 minutes and then you wire me some money. Like what's, what is the general process kind of look like typically that I should approach? I'll take a crack at it from my perspective, but I don't know really the other, other, other perspectives all that well. But going back to the, the idea that, you know, investors or people in my seat ought to have a sense of where they are. people approaching an LP should have a sense of where the LP is.

1:29:17And that sounds pretty basic, but really understanding what it is that they're trying to do with their portfolio. What is the composition of their portfolio? How might what you're offering fit? And why is it that the thing you're doing is a good complement to everything else and why it is that you think you're the best in the world at doing that thing. Now, how you get actually into that conversation is also super important. In our case, we only invest with people for whom we're introduced by somebody we know and trust and so forth. And even that is a subset of those people. We don't have a big team, but we do have good networks and we have great relationships, we think, with our partners.

1:30:10So that's where we are. And that's how we source opportunities in order to work with us. That's a starting point. Sounds like trust is pretty important. Trust is super. That is absolutely important. And we rely on people we trust to put us in touch with people they trust. That's really, really important. I don't know, you know, sort of in general, like what the winning combination is, but those are, I think those would be the things that have to be there is how do you get in front of people? Just like the way a founder would get in front of a VC is you need an intro, you need a way in. There's so much out in the world.

1:30:58How do you get yourself further down the funnel so that you're having a serious conversation as early as possible? And then again, how is it that the thing you're doing is a good fit for the person to whom you're speaking?

1:31:15Turner Novak:Yeah. Because in a sense, you are selling them a product at the end of the day. And then there needs to be a level of trust. Do they trust the product? Exactly. Or the service. Exactly. Or whatever, yeah. Yeah. It's hard. I really don't envy people starting out and raising a fund. It is hard. And I just have a lot of respect for people who are doing that. Yeah. That's why I tell people. When people ask me for advice, I'm like, it's way harder than you think to raise a fund. Like, it's 10 times harder than you think. Even if it ends up being easy, it's still that step of going out and saying, I'm stepping off the curb into the middle of this busy street to try to do something in competition with all sorts of other people and against the odds.

1:31:59I just have a lot of respect for people who have the, you know, the passion, drive, et cetera, to go do that.

1:32:07Turner Novak:And it's interesting that talking about the network thing, you definitely talked about a little bit, it's like investing from a position of strength. So it's not necessarily like picking like you're going out into the dark looking for your keys picking things out of nowhere it's like you're you're figuring out what is where's your what's your network where are those lights shining and then can you rely on your network to make better decisions yeah and that as an investor the this idea of being in a position of strength is maybe that goes to me what are the other things that i think need to be articulated even though people in venture are really friendly and nice and seem pretty chill.

1:32:53Turner Novak:Yeah. I think venture is the most ruthless investment class there is. It is really hard. It's super competitive. It's true. Yeah. Yeah. I think it is. I mean, because in contrast to a real estate transaction or a private equity transaction, which is certainly a contrast to a public equity purchase of stock. Each one of those deals can operate independently of the next one. And you are bidding for the asset or the business or what have you, or the investment on a one-off basis. So buying a building over here doesn't really impact your ability to win the purchase of the building across town or across the country in venture, syndicates exist.

1:33:48There are rounds of investors. There are pro rata rights across rounds. And whether you're winning the hearts and minds of a specific founder or founders will impact whether you're going to have deal flow across town, basically. And so the stakes are super high. It becomes really, really competitive. And the only way, even though people are friendly and collaborative, at least on one level, the only way you can really win, I think, in venture is to play from a position of strength. And that can be defined in any number of ways. But at the end of the day, you have to be able to win and invest in the investments that you want to be in.

1:34:33And you need to be able to defend your position as if you're an early stage investor, as things go on. Whether that means being able to exercise your pro rata rights or having influence with the founder and so forth. If you don't have that, I think you'll just get blown to the side of the road.

1:34:53Turner Novak:Your returns get eroded away over time. You're just not going to compete well. it's a very hard business and it's hard because the outcomes can be fantastic so it should be hard but if you're coming in saying I think I'm sort of middle of the road and I don't really I think I'm you know I don't offend people you know I'm just sort of playing on the sidelines I just don't think that's a recipe for success interesting and one other thing I know that I feel like maybe you've told me this before maybe I'm actually making this up. I'm pretty sure you told this before you and you actually kind of referenced a little bit earlier in the conversation with like the relevancy of firms over time, like the persistency of performance.

1:35:36Turner Novak:I feel like the kind of general consensus is that returns are pretty consistent over time. Like the good firms of yesterday will be the good firms of tomorrow. Do you think that was true, is true or will be true? I think going back 25 or 20, 25 years, 30 years, that was true because there weren't that many firms and there really was a consolidation of power, I think, of which firms would have access to the companies that… Did it consolidate going into 2000? Well, 2000, the companies that people thought were the companies of consequence turned out to be. Not so. Not so much. Yeah. I think it's sort of a convenient thing for people in my seat to say, which is, well, top quartile firms will be top quartile firms forever.

1:36:28Turner Novak:And we're in them. So just, you know. Yes. So we can observe that in the past, this was a top quartile firm. So returns are persistent over time for firms. I don't really buy it. And I think there's some quantification around that. The thing that is, in terms of being quantified, that has been true is that firms in the bottom quartile, if they continue to exist, actually stay in the bottom quartile. They don't actually come out. There's movement between the top three, but not the bottom. There's certainly persistence at the bottom. At the top, I think it's harder for there to be persistence. And the experiment that I mentioned earlier on, which is doing the informal survey of how many firms really matter, the thing that shifted around that over time and continues to is, well, the firms within that top 10 or top 20 have moved around a little bit.

1:37:27And if you think about who the big brands are, the firms that are by sort of consensus, these are the important firms or the high performing firms. Some of those didn't exist until fairly recently. So Andreessen Horowitz, I think it was 2009. That's not that long ago. But they weren't around in that 2000, 2005 era. thrives is sort of that era. There's probably like a newest entry. There is movement in that. So the persistence really I think there is some aspects of persistence but it's not you're not entitled to it and it's not necessarily going to be something that as an investor you should just say like oh top quartile once top quartile forever.

1:38:25Yeah.

1:38:26Turner Novak:How do you think the venture as an asset class is going to change over the next 5, 10, 15, 20 years? I don't know if you have a good view. I hope it changes a lot. I've been a little bit frustrated, I guess, in my own thinking about how persistent. Here's some persistence. That there is one basic model for how firms are structured. It's essentially the PE fund model of some percentage of carry, some percentage of management fee. whether you're a big firm, small firm, big fund, small fund, tech fund, private equity fund. It's not that clever of a model in the sense it should solve every single strategy, structure, et cetera.

1:39:12And so what I'm starting to see now is that there's movement around, well, what are the the vehicles, what do they look like for how investments are done? And I hope, and I think it will be the case that over the next five, 10 years and then beyond, the industry will sort of gravitate toward their firms that are using the standard contract. And I think that will be the realm in which returns are a little bit more concentrated around the central tendency. and then there will be fewer by number and maybe fewer by dollars. Firms that have structures and ways of approaching the market, including people who sit in LP seats, about how their investment vehicles are structured and they'll be much more tuned to what the underlying investment opportunity is.

1:40:10And that's going to be harder for people who sit in institutional investor seats because that won't really fit into a model that tries to do asset allocation or, you know, like-to-like comparisons. But it will be the place, I think, where the outlier returns are going to tend to be. Interesting. So would this be an example, like general catalysts, ad financing, marketing financing?

1:40:40Turner Novak:Have you seen this thing? there's a you know there's a lot that goes around like you know you'd see it whether it's on twitter or blog posts or just you know in a room with lps or with gps about oh so-and-so's sort of deviating they're doing something they're doing they have a platform or they're doing something over here it's different isn't that isn't that weird or bad i think it's really i think it's really productive just that they're trying something new they're they're innovating on the model. Some of those innovations either aren't going to work or they're going to require mid-course corrections, but that is the way the markets are supposed to work.

1:41:16There really should be innovation around how capital is raised, how it's invested, and how companies and capital interact with one another. And so I think that those innovations are fantastic. It doesn't mean they're all good. It just means I think net net, that is good for the, for the ecosystem or the industry such as it is.

1:41:44Turner Novak:Our guest of the show, his name's Will O 'Brien, a company called Ulysses. They do like underwater robots based like robots for the ocean, autonomous robots for the ocean. And he kind of made an interesting point of like, there's a lot of cases where as a founder, like you might need a hundred million dollars or you might raise a hundred million dollars, but you only use 20 million of it. What if you could just raise 20 million and it's like a draw, a draw, a line you could draw on up to the next hundred? Like, is it equity? Is it debt? Not sure. But did you really need to raise the hundred million?

1:42:13Turner Novak:Like we didn't need to crown that much in the company. So it's like, as an investor who's getting management fees on that money, like, let's put as much as we can, let's deploy it. But as a founder, it's like, I probably want to raise, I want to figure out what my optimal amount of dilution and just hit that and not sell more of the company if I don't have to. Yeah, I think that's exactly right. It goes all the way through the system. Yeah. That what you're describing is something that's an inefficiency in the way that capital is allocated or invested or deployed. And so there should be someone on the other side of that equation who's a great investor, assuming that's a good investment.

1:42:52Yeah, who knows? boy, this is what the company needs. This is how you would optimize around the prospects for success of this company.

1:43:01Turner Novak:Yeah. Let's do an investment that's structured in this way. But then you need that investor to have access to capital that allows for that flexibility. Yeah. I think that's exactly right. Yeah, it'll be... Yeah, so you think over time we'll get just a little bit different sort of financing mechanisms around startups? I like disruption. Everyone should like disruption in venture land. Yeah. Until they're disrupted against. Then maybe they're not so happy with disruption, but I think it's good. You have this framework called the Newman cycle, which maybe there's where we're at a certain point on it today.

1:43:43Turner Novak:So what's the Newman cycle? Well, you're the, you're kind of the, if you're not the master, you're a master of memes. And And I don't have a Twitter game, so I just do things in small audiences. But I put together, this is in 2019, when WeWork had filed their S1. And I thought, this is not making sense. So how do I articulate this to our board? And so it just dawned on me there are a lot of Newmans in the world, and not all of them behave the same way. So I created a graphic that involved a few Newmans. Yeah, we'll throw it up on the screen for people. So just envision a typical cycle graph. At the beginning of the cycle, you have Paul Newman.

1:44:33Paul Newman's a famous actor from mostly the 60s, 70s, and 80s. Really handsome man, very elegant, drove race cars, and everything is... So there's Paul Newman at the beginning. Everything is wonderful and looks great. And things kind of go along. And then I don't know if you're a fan of Mad Magazine, but there's a...

1:44:57Turner Novak:I've heard of it, but I'm not a... Yeah, this is the problem. You know, it's sort of a generational thing. But Mad Magazine has a cartoonish spokesperson named Alfred E. Newman, and his tagline is, What Me Worry? so you know the world could be sort of going crazy and it's you know what me worry and then from there we you know we we we run into adam newman as we go up to towards the cycle starting to crest and then you're right at the top um we have john von neumann who is It's part of the Manhattan Project. And at the very, very peak is when you get maybe a—and maybe not a nuclear explosion, but an explosion that ruins everything.

1:45:45And then on the downside, we have Newman from Seinfeld. And in my mind, I'm thinking, oh, there's Jerry. He comes in and he just says, oh, Newman. And the way that that kind of relates to our discussion earlier about leverage and so forth is that applying that cycle to economic thought and the principles of the use of leverage also aligns with a construct that was put in place by an economist named Hyman Minsky. And the way Hyman Minsky describes economic cycles is really based on financial leverage, and people think of financial leverage as debt. And so there are three phases of Minsky's cycle.

1:46:41So you have a regime that's hedge financed, and then you go to a regime from there that's speculative financed, and then from there up to a regime that's Ponzi financed. And those three regimes involve, in the hedge-financed realm, you have debt where current income can pay principal and interest when due. and then from there people become more and more comfortable with the risks they took in that realm and they allow for debt that that involves income covering interest only and then you assume some appreciation of assets or appreciation of income over time so that you can pay off the principal and then you go to ponzi financed where you're saying well i'm just going to rely on appreciation of asset values because my current income cannot pay principal or interest.

1:47:44And then you do too much of that.

1:47:45Turner Novak:So you need prices to continue going up. You just do up and up and up because it's Ponzi financing. It's like you keep having to, you're capitalizing your interest expense and eventually you have a Minsky moment and everything collapses and you go back to a hedge financed regime. And the lessons from that, I think would be useful. It was useful for me to look back on because in venture, we generally don't think that we're in a regime or a structure that involves financial leverage. And the reality is, is that higher and higher priced rounds are leverage. You're getting less and less ownership for each dollar invested.

1:48:33And your return is now becoming increasingly reliant on bigger and bigger outcomes. So during the course of a cycle, sometimes, and I've heard this a bunch of times, a manager will say, this is fine. The company's great. The valuation is only a year or maybe two years ahead of itself. And that is an exact description of when you're moving towards Ponzi-financed regimes because the higher valuations are leverage, and you're saying, now I have to look at two years out for the valuation to actually justify today's leverage, and two years out from there, you've got to do the same thing over and over again until the thing...

1:49:15On like a 2x greater scale. It just keeps... And then it collapses, and you have this Minsky moment. And for me, going back again to the beginning of our conversation around my own sort of journey, most of it by accident and maybe not completely accidental, is that going from a position where you're learning the fundamentals of how businesses work, how financial leverage works, what leverage is, was important to me in understanding maybe a little bit better. or maybe in a satisfactory way, what a good investor looks like and what a good investment looks like and how risk actually comes into the system and where are we in the cycle.

1:50:06So where are we in this cycle? I think we're kind of in Alfred E. Newman space. We're kind of in speculative finance, but we might be bumping up into the Ponzi finance regime or the Adam Newman regime. But my guess is that now we're in the speculative finance area. And if we could just stay there, then you'd say, okay, this is nice. We're at this nice little equilibrium.

1:50:36Turner Novak:But that's not the way markets work. And just to go back to Minsky, he has a framing, which I'll get wrong. But I think in general terms is that investors in capital markets, as a result, are myopic about the past and really unstable or not reliable about the future. So you end up with a situation where we just inevitably repeat the cycle over and over again. And having a sense of where we are, I think, is important in evaluating how much to invest, when to invest, how much relevance we want to have at a particular time and so forth. Interesting. Yeah, I mean, I like the framework. I think that's a good way to think about things.

1:51:26I think, yeah, this has been a lot of fun. Thanks for coming on the podcast.

1:51:30Turner Novak:Oh, this is great. I love it. We got to do it again sometime. Whenever you want. We can always just hang out. Yeah. Well, cool. This is a lot of fun. And I hope you had fun. A quick thank you to Hanover Park and Ramp for supporting this episode. Head to ramp.com slash thepeel for$250 on your first set of cards. If you missed it, make sure to check out last week's episode with Owen McCabe, founder of Intercom, on how you became one of the first late-stage scaled software companies to successfully become AI native. If you enjoyed this conversation, please like, comment, subscribe, and name your next asset class after me.

1:52:06Turner Novak:If you don't want to miss a feature episode, subscribe to my newsletter, The Split, linked in the description to get each episode plus a transcript emailed directly to your inbox every week. Thanks again for listening. See you next time.