Monique Woodard, Fund of Funds Panel & The Pro-Rata Yacht! | E2018

0:00I've heard that there's some angel investors or syndicate leads here who have been in companies like Uber, Thumbtack, and Robinhood. We modeled out a little simulation and said, Jason, if you just had an extra 250K to go into the Series B of each of those. This is my talk to Mars. What would that have translated to? And you can see the name of the yacht, which is ProRata. Yeah. Thank you. Wow. You know, the wound's still open. So if you could put a little more salt in it, that'd be great. This Week in Startups is brought to you by Squarespace. Turn your idea into a new website. Go to squarespace.com slash twist for a free trial.

0:42When you're ready to launch, use offer code twist to save 10 % off your first purchase of a website or domain. Gusto. Gusto is easy online payroll, benefits, and HR built for modern small businesses. Get three months free when you run your first payroll at gusto.com slash twist. And Runway. Looking to level up your financial planning? Runway is the modern and intuitive way to model, plan, and align your business for everyone on your team. Sign up at runway.com slash twist to get your first three months free. Hey, everybody, Alex here. I have a couple of absolute treats for you today. We have two more talks from our Liquidity Summit.

1:26So up first, we have our Fund of Funds panel. That means you're going to hear from Ben Joy from Next Legacy Ventures, Michael Downing from MDSV, and Se-Yoon Kang from the well-known Stepstone Group. You're going to hear about how everyone thinks they're an above average driver and what that means for venture capital returns, the power of prorata and what you might be leaving on the table, and then of course how fund size impacts returns. If you care about the internal mechanics of how venture works, this is a talk that you really need to hear. This is some venture chat more than founder chat, but I think it's good education for everyone out there in the world of startups and venture.

2:05Then after that, we're going to have Monique Woodard from Cake Ventures. She's fantastic. I've known Monique for a long time. She talks about how to raise a fund and how when you raise that first fund, you're actually raising your next two to three funds as well. Monique's fantastic. The panel is fantastic. Let's start with our friends from the world of LPs, and then we'll hear from monique enjoy okay one of the things we wanted to address uh during this year's liquidity was uh fund to funds we heard before from monique hey these uh play a critical part in our ecosystem uh for helping sovereigns um family offices high net with our individuals and they act as a bridge between those individuals and fund managers and we're going to do the same format we just did uh with family offices which is ask them each to give a position and then have a group discussion.

2:55First up is Ben Choi. Thanks for having us up here, especially after flying cars. Not a great panel to be right after, but I thought I'd take it back down to cars that are on the road. Every year, AAA does a survey of drivers and it finds consistently that most drivers, 73 % in the last survey of US drivers consider themselves better than average drivers. If you cut the data a little more, perhaps to no surprise in this room, eight in 10 men think that they are better than average drivers. I think drivers are a lot like investors, where most investors assume that they are better than average. I looked around for data in venture, and there isn't great data.

3:35But from our own anecdotal experience, it's certainly true. We've invested in about over 100 VC firms over the last 25 years, my partners and I. And every year, we look at around 200 plus VC firms. And you get different levels of self-promotion, but most VCs will tell you that they're above average, or they will be. I thought what I'd bring today is that, which is just human nature, I think, but bring it to what it means in venture specifically. So this chart shows, based on some historical data, the dispersion of performance between comparing global equities, just public equities, compared to venture capital.

4:12So global equities on the left-hand side there in the blue. The dot is the median. The bar is the top and bottom quartile, 75%, 25th percentile. And then the very, the lines go up to something like 95 % and 5%, maybe a little higher. I think drivers are like public equity investors, where if you're above average as a driver or an average driver, the difference is not that much. For venture, it's like a 20-year timeframe. For equities, I'm not sure actually it matters that much. The difference between a great public investor and an average one, not that big of a deal. And same thing. It turns out that if you drive down the road, most drivers are average and people don't crash.

4:50But in venture, it's a lot different. The difference between a great venture investor and a terrible one is huge. And that's where this very natural human behavior of, well, I'm above average. Most of us think we're above average. It's pretty harmless in driving. It's relatively harmless in public equities also. But it turns out in venture, it actually has a pretty big, significant impact. So what? Well, one of my favorite All In podcast episodes. So who here is a fan of the pod, All In? Not surprising, but awesome. I think my favorite episode actually is, I can't remember how long ago, but there was an episode where you all talked about it, but I think Chamath kind of presented some of his performance data.

5:30And he talked about how hard it is to actually deliver performance and particularly liquidity in venture. And it takes time. You go through this for enough decades and you can see the cycles and realize that you get ups and downs. But delivering 2 to 3x over a long period of time, over a lot of dollars, is hard to do. And a lot of people who are new to venture see this and sort of just see the top of the slide and hear the headlines of the amazing outcomes without really appreciating the risks that we take on the downside. So for me, the so what, and I'll leave you with, the thought I'll leave you with is whether you're an angel investor or a GP investing in founders or an LP looking to allocate into this asset class, I'd encourage you to work with a professional.

6:18If you're going to do it yourself, do it professionally, do it full-time, do it seriously, and be safe out there. Thanks. Okay, well done. All right, next up is Michael Downing from MDSV Capital. Great, thanks Jason. So just quickly, at MDSV, we are a fund of funds, but we focus on an area that we believe is the greatest single opportunity in venture these days, which is also the most overlooked, ignored, and underrated category of venture, which is small, sub -$60 million emerging manager funds. And we focus on this category specifically. And of course, as many of you know, there's a lot of GPs, there's some LPs, but this is a category that has outperformed the market over the last 15 years.

7:10But there's some other data points that we look at specifically that I think not everybody's aware of that really kind of back and inform what we do and the reason why we focus on this part of the market. If you look back across the last 15 years and you identify all those unicorn companies, those high value outlier companies that generated so much return, 92 % of those companies had an emerging manager or a syndicate lead who was an angel investor on their cap table at the earliest moment. That becomes important as you think about what the access point that's represented by these emerging managers is for LPs.

7:52Less than 5 % of those same small emerging managers, less than 5 % of the time, did they invest beyond the seed round? in those companies. And so if you take a look at that and do some kind of complex math, across that pool of unicorns over a 15-year period, there's basically$150 plus billion in unharvested or untapped value that could have been created by those managers. Now, I describe all that because part of what we do and how we work with GPs, like many of you out there, is we allocate 25 % of our capital to backing small emerging manager funds. And then 75 % of our capital is reserved for what we characterize as an opportunity fund to enable small managers to double down on their outliers and continue to invest in those companies.

8:53And it's exactly because of these figures that we have that strategy. And just sometimes these numbers and statistics are a little bit confusing and don't make sense so i'll try to kind of put it in a more human context here i've heard that there's some angel investors or syndicate leads here who have been in companies like uber thumbtack and robin hood we modeled out a little simulation and said jason if you just had an extra 250k to go into the series b of each of those this is my talk tomorrow what would that have translated to and you can see the name of the yacht which is pro rata yeah thank you wow i mean i really appreciate you coming and i guess i'm not getting invited no no i just um you know the wound's still open so if you could put a little more salt in it that'd be great founders i know you're building the next big thing in tech and you probably got some groundbreaking ai solution or a consumer app that's going to take the world by storm.

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10:31And it's all powered by Squarespace, Killer Designs, keeping eyeballs on your website. And you know, there's this expression, don't judge a book by its cover. Do you know why they have that expression? Because people judge books by their cover. That's why when people design books and you go by in the airport, the cover pulls you in. Same thing with your website. Beautifully design templates are waiting for you there, as is the Blueprint AI. Plus, you get built-in analytics, SEO, e-commerce tools. So when you invest in a Squarespace website, you get all of those developers, designers, and brilliant people at Squarespace behind your business.

11:04Go to squarespace.com slash twist to get 10 % off your first website or domain purchase. And when you're ready to launch, again, go to squarespace.com slash twist and get that 10 % off your first website or domain purchase, swearspace.com slash twist. No, it is literally, my talk tomorrow is going to be a little bit about our portfolio strategy and how it's, and you know it, and how we've adjusted it because of this really profound insight, which is only 5 % of these winning investments are followed on. So the question becomes, why? Right. I mean, I can tell you from our experience, we have great managers.

11:41I think Martin Tobias is in the audience here, incisive. This is a guy who's made 60 investments has six unicorns. They're writing 200K checks at day zero, at the earliest point, it's going on a safer convertible note. Then all of a sudden the company grows like crazy and is doing a round with day 16 or whoever. They don't have any capital to continue to invest in those winners. They have to allocate every dime they have to just placing bets to see which company is actually going to make it. There's no such thing as keeping reserves. sorry for those of you who have reserves in your deck but at a pre-seed stage for an emerging manager fund you shouldn't be keeping reserves you need to optimize for the hardest challenge which is just finding those outliers and so more often than not they just don't have capital and this idea of you can pass the hat amongst lps and raise four million dollars in a week is usually not so smooth yeah it seems to me there are a multitude of reasons one is bad portfolio construction you're advising don't do it um but not having reserves would be one also um i think you do know your winners that is so one might think it's that the managers don't know the i actually knew the winners in all of these cases um and i when we did our analysis of previous big wins there was only one that i was actually sure was unsure of so like three out of four in that first fund that hit unicorn status were we unsure of so we would have made the bets on three of the four so then it becomes well what's the other reason and i think a lot of it is you know the management fees on small funds are so low that you don't have a team if you don't have a big enough team you it's hard to stay on top of and build the relationships with a large number of investments and so i think a lot of times they just don't have the bandwidth we had monique talking today about her first fund she's talking about lp relations finding founders and then giving to make the primary investment and then doing the support i mean it's a lot to put on your plate so i agree this is this is one of the reasons why we position this as an opportunity fund for the emerging managers where they get economics and that whole what do you do just split 50 50 We split it 50-50.

13:54So we'll put the capital forward. We put it into an SPV. They co-managed the SPV with us. And now you can have a$15 million fund and invest like you have a$50 million fund. Yeah. So you could put in a$2 or$3 million check size on average. $2 million on average. Check size on average. Yeah. That's a clever idea that you came up with. How'd you come up with it? Lots of experimentation and trial and error over the years. And has it worked? How long have you been doing this, deploying this strategy? We've done about six direct deals since Q4 of last year. We're in nine funds. We're going to be in 25 funds by Q2 of next year.

14:28And for this fund, 25 will be the number of funds that we're in. But we're offering that program, that kind of capital extension program to a broader set of managers, to the whole community. Okay, so you don't have to be an LP to get access to that. No, it's not just for our portfolio. Is it codified or is it like a handshake deal? It's a handshake deal. What we learned a long time ago is, you know, you don't want to go to managers and get some kind of written agreement like, hey, I'm going to get your pro rata. There's been all kinds of cautionary stories about that backfiring. And so it's like, look, we're here.

14:58We hope you're, we're your first phone call, but we might not be. All right. Sayon Kang is from Greenspring, which got bought by Stepstone. So now you're at Stepstone officially, and we'll bring your deck up and get your perspective here. And then maybe take a couple of questions from the audience as well. Great. Hi, everybody. Thanks for having me. I will talk a lot about the same kinds of things just from a different angle, which is great because we did not confer in advance. This slide is just to level set just the growth or the explosion in venture that you've seen. Since 2008, the venture share of private capital allocations for institutions has gone from 14 to 25 percent.

15:38You've seen about a 10x increase in the assets under management in this asset class and almost a quadrupling of the number of managers. I think, you know, some LP friends at different annual meetings this season have said we've been joking at some of the platform brands, AGMs like, I don't recognize anybody here. Who are all these people? Because you're seeing a lot of the OG LPs moving down market, if you will, looking for emerging managers. And a lot of the platforms now have a bigger set of LPs, including sovereign funds, you know, etc. Large U.S. public pension plans, etc. With that, though, you know, I think some of the reason why you're seeing this move towards emerging managers is not just because the 20, 25 million dollar LP check that the ENFs or the funds of funds, right, are kind of.

16:38meaningless to some of the platforms today, but also because of this slide, you can see the performance of smaller funds is just better. It's a law of small numbers. I think we all anecdotally have awareness of this, but I just put some numbers to it for folks' benefit. This is a slide that we've created. This is a little bit of a newer one that LPs really like and most GPs at smaller funds don't like. So if you look, the leftmost column is the economics per partner, assuming a 2 % management fee and a 25 % carry for a billion and a half dollar fund size with 10 partners. The middle bubble is a$400 million fund with five partners, same fees.

17:20And then the rightmost is$150 million fund with three partners. And to get$67.5 million per partner For a larger fund, you need a 2x net. For the mid-sized fund, you need a 3x6. And then for the smaller fund, a 5x6. So the alignment for LPs with GPs at the smaller funds is unmistakable. Sorry, is that economics to adding both management fees and carry? Correct. Fees and carry. Is there a distinction between what looks like the differential wave? Assuming the smaller funds, it's much more based on carry than management fees and larger funds, it's probably more management fees. That's right. And another way of saying this is you don't have to perform as well at a big fund and you have to really perform at smaller funds, which then would LPs when they're speaking privately say this group, you know, just can phone it in, in a way.

18:19And then this group has to hunt and fight at a much higher level. So there has to be a level of aggression with one group and a passivity or, you know, whatever. They can just rest and vest. It's like the difference between working at a startup versus at Google. And that's part of why smaller funds are more attractive. We ran some data because we had felt like there has been, along with the explosion of capital coming into venture, there's more funds, et cetera. And we wanted to see how many of those were at the lower end of the market. So there were 2 ,991 funds that were raised in the United States since 2018.

18:54In terms of unique manager count, it was about 1 ,650. You can see here the breakdown by fund size. And then in terms of this may be a little bit self-serving, but really a lot of these funds are starting to look very similar in terms of background. So we ran and we went through GP by GP, education, work experience, demographics. 60 % had attended an Ivy Plus school defined as the Ivys plus Cal, MIT, or Stanford. 55 % of them were former founders. About 17 % had worked at a large tech company, whether a private unicorn or a publicly traded tech company. And then about 15-ish percent were sort of classically trained in financial services, whether PE or investment banking or whatnot.

19:42So if you look at the green bar across the top, about 90 % of the managers hit one or more of those buckets. So on the one hand, you definitely want exposure to the emerging manager landscape because the returns are better. But on the other hand, it's getting harder to differentiate. And to Ben's point about most people think they're above average, I would actually say that in Silicon Valley and in venture, everybody is above average, extremely above average in life, yes. And so we just feel like folks need to be very selective because again, in a vacuum, it's kind of like looking at a startup business plan.

20:21in a vacuum sounds like a great idea, unless you can see the context. You didn't start a company to run payroll, did you? Of course not. And that's okay, because Gusto is here to help. Gusto will help you run payroll and handle your benefits onboarding and HR all in one place. Don't just take my word for it. 300 ,000 businesses trust Gusto today. As your startup scales, Gusto can grow with it. Don't just take my word for it. 300 ,000 businesses trust Gusto today. As your startup scales, Gusto can grow with it. State and federal taxes handled for your staff around the country? Handled. Finally, time to offer 401k plans to your staff?

21:02Gusto's got it. Need to get your compliance sorted out? Well, three out of four employees say Gusto helps them be government compliant. Even better, Gusto is simple, easy-to-use software, so you can focus on what matters, building your company. So, here's a simple call to action. Want all that Gusto has to offer with no hidden fees and a discount to boot? Try Gusto and get three months free at gusto.com slash twist. That's gusto.com slash twist. So I want to end on this slide. I'm sorry, the y-axis is super compressed, but it shows that in venture, if you are with the top companies and by extension, you know, we assume with the top funds and Ben showed a variation of this in the equities versus venture returns.

21:48You can see here the black line on the top is the 95th percentile of deal returns for venture. Buyout is the orange and then growth equity is the gray. You see that there's actually very little in the way of market cycles. And we have a view that a lot of investing in venture is driven by innovation, not by economic cycles. And so I wanted to kind of leave on a high note in that if you believe, as everyone says, that we are entering this fourth or fifth, however you want to call it, in terms of wave of extremely impactful value-creating innovation with AI, with new companies, with reimagined companies, then you could expect that this will extend and be the case going forward as well.

22:34The bottom half is the kind of to your point about the median returns. But again, that the identification and the selection is extremely critical. Let's talk about which managers in the emerging class you'd think are the archetype that wins today, maybe portfolio structure, their background, et cetera. And we'll just go right down the line. Sure. I think we've been investing in emerging managers for the last 17 or so years. We're always looking for a manager that has an edge and it's across three dimensions. It's deal sourcing, investment selection, or value add. One of those three things. and you just have to have an edge um we were investors in um andreuson fund one and every fund since then andreuson today looks very different than what they were then their edge today is very different from their edge then what is their edge today just the scale the scale they continue to um operate with 500 employees um on the value add side at a scale larger than than all their peers got it so d uh deal flow decision making and what was your third value add value add so support of the company you can slice them more times but yeah that's the rough three yeah on on the emerging managers i mean we have some very kind of hard line quantitative quantitative concepts that we look at making sure they understand just how much of our portfolio is required for us it's at least 30 companies per fund to even be able to find an outlier that's a hard concept some kind of unique sourcing methodology and then there's this kind of soft concept that we look at which is in many ways what we've experienced with emerging managers is a lot like what we experienced investing in startups throughout the 2000s and 90s, where sometimes the best CEO, the best founder is also kind of an awkward, difficult, obstinate, maybe even stubborn person.

24:20I'm sitting right here, bro. I didn't want to bring it up. And it's not necessarily somebody you want to hang out with all the time, but for whatever reason, they're so driven. None of you guys are like this, by the way. None of you guys are like this. It's some other person I'm referencing. but you know they're difficult on the shoulder agree disagreeable absolutely chippy and they're driven like they're gonna make it work no matter what kind of like those ceos that we know that were a little difficult yeah i met a couple soon what do you think in terms of emerging managers and like your own signaling and then maybe you know question i had for you since you get to see so much from step zones data etc is this were there too many managers and maybe not enough work ethic you're gonna have had conversations about just how big this got for a peak zurp era like just maybe you talk about how big this got and then what you don't look for and what you do look for you know like both of those so i'll add something to what ben said in terms of uh if you kind of break the venture job down into its component pieces.

25:27There's sourcing, there's investment judgment, there's winning the deal that you want to do, and then there's the value add after the fact. And I think some of the data that we laid out, part of why we asked our team to run it was because it's starting to get more and more difficult to differentiate on the sourcing or the value add. Like the sourcing, a lot of folks, again, you can see it can tell a good story about the network where I worked. And then on the value add side, whether you ran a team at Meta, or you were a founder yourself, you have some primary experience or advice that you can offer to somebody that is valuable to a founder.

26:05And so I think the picking and the winning the the problem with it. And the thing that makes it so hard is the picking, it takes so long to see whether you're good at this job. And, you know, seven years, maybe minimally. And I'll come back to your second question on that point. And the winning is actually a little bit easier to see in real time. The picking piece, I think, you know, up until 2021, there was, I think it's very, this is a great job. I mean, investing in companies being pitched, who wouldn't like that? And it's very empowering. Technology is really fun to dream about and think about what could go right.

26:49There's so many, you know, jobs that you can have where you're paid to think about what can go wrong and other asset classes in particular. And you're getting markups every six weeks. And so a lot of people thought they were really good at it. And what we're seeing now in the last couple of years is just these markdowns have been significant. That people, I think there is an element, you know, in life with luck and timing. I think folks who raised their first funds in 2020 2021 are going to have a pretty hard time yeah i think they're done well no i mean i i attribute a lot of my success was the timing i started in 20 2009 10 11 and it wasn't as crowded and it was after the great financial crisis and companies were four five six million dollars to invest in the same companies with weaker founders let's be candid were getting 16 or 60 million for some period of time and i think the entry price kind of matters the one other thing i'll add and then i'll stop talking um was i've had a couple of sort of early stage or seed stage gps who've been in the business a while the last just in the last few weeks say you know the days of getting 20 ownership for a four million dollar check or whatever the check numbers, but the days of getting that ownership are over.

28:09And so in terms of that slide, in terms of the portfolio construction math and how much ownership you can get, you know, to assume that you're going to get a, you know, 55 billion of market cap and own 10 % of a company at exit, it's a pretty big assumption to own the 10 % at exit. So I think all of that, we're seeing something, we're seeing the reckoning of it now because those days are kind of. Yeah. One thing I always found peculiar was people sending me their LP updates when things got marked up of funds I wasn't in. And there was one fund in particular who I knew the founder, they were up like 7x or something year over year.

28:48And they just started. And I was like, is there any secondary opportunity in this company that's 50x that's major entire, you know, whatever$10 million fund be worth 70. You're kind of obligated to just get some DPI here. and they're like are you crazy this crypto project's going to the moon and i was like and it was like and there were like three crypto wins out of seven and i was like bro i'm just giving you one piece of advice 10 every time these go 10 20x sell 10 10 20x sell 10 just cover your you know basis and then some you can't go wrong so when you are evaluating founders and this discussion of secondary has become a bit more um acute or like i get the sense some lps are a little pissed off about this like dreamy it's only going to ever go up and not taking advantage of secondaries for especially for emerging managers yeah i think i think dpi seems like a not that difficult to spell but it's a foreign concept like to a lot of new investors so it's a challenge.

29:53On your earlier point when they're done, I actually don't think that in some ways it'll be hard to raise the next fund but a GP can make the last dregs of their fund last a long time and so I think there's going to be noise in the market for a lot longer than the fundraising environment might indicate. I started an venture about 20 years ago and I felt like I was late to the game and I graduated right into the bubble so I missed the venture part of the dot-com bubble. And all these big brand names, they're clearly all done. They all lost a lot of money. And it felt like it took another five years before some of these stayed firms that were so famous, like finally started to, you just didn't hear from us as much.

30:35I think it's going to happen again. Yeah, I think it's a really good point about DPI though. And how, I mean, it's just not even a topic most small managers talk about. It's just like, everything's going to keep moving. And then, you know, year eight, year nine, year 10 turns into year 12. and i i think likely what we're going to see is that ecosystem of how you even execute let's say on secondary sales or getting early liquidity it's been so limited um i don't know if you saw michael michael kim at sandana you know put together i think a hundred million dollar fund it was purely for buying out lp interests and small funds and i think you're going to see a lot more of that um that benefits i think everybody the small fund managers the lps everybody and just gets the capital recycling quicker, which I think would be healthy for the ecosystem.

31:24Awesome. You had something you wanted to add? Oh, I was just going to say, that question keeps coming up about funds shutting down and people are kind of surprised that you haven't heard more about it, but I agree with you. I think it's going to be a very slow burn. Right, because they have management fees. Exactly. And so they have to burn off the management fees and what if something hits in that dormant portfolio yeah you could like all of a sudden have something pop and then all of a sudden you're back in the game that's it literally is like chip in a chair in a poker tournament crypto recently crypto's back i think bitcoin's back i don't know if anybody's apes are up apes are back oh eat this back how are your apes doing folks man that was a weird moment in time we had like a year or two here where they got a lot of crypto going.

32:06All right, let's give it up for our fund of funds.