Top 5 VC funds raise big $, venture capital DPI is back, and Sequoia’s offer to LP’s | E1981

0:00certain percentage of the fund needs to be accredited or qualified purchasers or even institutional capital meaning that non-accredited investors just get to co-invest alongside real institutional capital that's what i've never heard anybody is that your idea have you is that idea been floated before i think i've read that somewhere but yeah it's it's a pretty pretty straightforward i'm pretty well read on this and i've never heard anybody say the percentage of the fund should be let's say 50 non-accredited investors and then the rest could be equal i mean that actually does well no i think it's a good david rule because what it does is it says if half the fund is sophisticated the other half can be unsophisticated is what you're saying you know if half the funds are already rich the other half could be wanting to be rich this week in startups is brought to you by open phone create business phone numbers for you and your team that work through an app on your smartphone or desktop twist listeners can get an extra 20 off any plan for your first six months at openphone.com slash twist.

0:59Assembly AI. Get maximum value from voice data with Assembly AI. Build powerful products and features for your end users on the industry's leading speech-to-text models. Get 100 free hours to start building at assemblyai.com slash twist. And Command Bar. Seamlessly integrate an AI-powered guide into your software, making navigation intuitive and interactive. Visit commandbar.com slash twist to get a custom live demo. Welcome back to this week's Liquidity Podcast. With me today, I have Matt Mulvey from Liquid 2. Next, we have Jamie Rode from Screen Door. Of course, we have Jason Calaganes from The Launch Fund.

1:40I'm your moderator, David Weisberg, co-founder of 10x Capital. We have a busy schedule today. DPI is coming back to Silicon Valley, our return of capital back to LPs. A new report breaks down demographic data on the backgrounds of unicorn founders, and there's several surprising results. And we dissect the trends for limited partners and how they are allocating to VC funds today, and whether we expect that to continue in the latter half of 2024. Let's dive right in. After months of LPs asking for returns, their prayers have finally been answered. One acquisition is Wiz, the AI company that is rumored to be acquired by Google for$23 billion, leading to significant DPI or distributed paid in capital return back to limited partners.

2:34with funds such as Sequoia returning 153.3x on the original investment of$21 million. Other firms also distributing capital back to LPs include Insight, Index, Green Oaks, Lightspeed, A16Z, Andreessen Horowitz, Thrive, and others. On the heels of that distribution, Sequoia is also reporting that they're going to be acquiring back shares of Stripe from LPs that request liquidity. In an unusual move for venture capitals, where venture capital firm is itself buying shares back from limited partners, this is another form of capital that's coming back to VCs. Jason, what do you think about a is dpi back and b are we going to see novel ways that venture capital firms are going to be distributing capital back to lps yeah so good to be back i think this is like an incredible week for silicon valley and the the lps and gps in the wider industry because we have been waiting for distributions and for the last two or three years a lot of lps have been saying hey we could to some dpi here because you guys keep raising funds we want to get you you know uh we want to hit our capital calls but you got to send some money back here and this two or three year pause um that we had since silicon covid and silicon valley bank went under uh and then you know all of this um high interest rate environment uh put the kibosh on exits and then of course you have lena khan and this administration not wanting any m a well here we go sequoia capital has their fingerprints on both of these fantastic good leadership from them i think looking at the whiz um acquisition first i think is a good way to do this this is a four year old company uh as best i can tell and sequoia made this investment in 2020 so they have 153x according to this report uh or so maybe it's less maybe it's more who knows what the dilution is and the preference sack but let's just say it's over well over 100x in four years so let that sink in this isn't in 10 or 12 and stripe is now you know a pretty old company i'm not sure what year they're in but they're well over 10 years since the original investment it's at 14 now so this is an incredibly juicy return in a short period of time even the irr for people who invest it in may is going to be a 2x in four months or you know whenever this closes in under a year so you're looking at like a hundred percent plus uh irr right the rate of return there so this is incredible and so i think maybe we should tackle the whiz story first with our panel and then we'll go to the sequoia uh stripe secondary purchase because that is very complicated as a whole other series of talks but i guess jamie uh as an lp and and watching all this happen this is the outlier of the uh power law isn't it it is i mean this is validation as to why you need consistent vintage year exposure in venture and everyone claimed those prior years were fomo investing or a fake bull market but it shows that you can't really predict or market time tip typically it's a long feedback loop cycle.

6:09Sometimes you get very, very lucky and maybe it's only four years. I think it also goes to show that entry valuation that Sequoia went into was$150 million, which is pretty pricey for a seed. But it goes back to the conversation of it's the first institutional round. It's the cheapest entry point into the life cycle of a company. So sometimes valuations can be very frothy or that's what you think. But when you think about the exit potential and the expected value of exits, that can make you adjust your thinking and make the investment worthwhile. I think that's an incredible point, Jamie, that this occurred in the vintage.

6:49Everybody said is going to be like the DOA vintage. Don't expect much from those four years and here we are. Yeah. It's why from an allocator standpoint, market timing is really, really challenging. I mean, there's multiple studies out there that show about 90 % of your return is driven by your asset allocation. And so it's really, really important if you're going to do venture to make sure that you have exposure to every vintage year, because if you missed out on the whiz, who knows what that 2020 return would be. Matthew, your left? Yeah, I think obviously this is why we play the game of venture capital, right?

7:28I was surprised to see the company was founded in 2020. But I think it's incredible. It's a testament to obviously the founding team there, but also the opportunity that they were going after and the market size and the problems that they were going after. I also love the Sequoia. I think Sequoia is being extremely creative. It's not the first time they've been creative with DPI. But I think as managers, you have to be proactive with DPI. And over the last 18 months, two years, that was a wake-up call. And so I love seeing that. I think they have set the standard for being proactive and always changing and thinking about how they can be the best.

8:10And so I thought that was extremely innovative. And the fact that they're not taking care of interest, or at least that's what I read, on that portion of the$800 million or so that they're going to buy back, I think aligns extremely well with limited partners and is maybe something even uniquely a Sequoia can do. And so I thought that was well done. I have to tell you, coming from a multi-asset class background, reading that, that reminded me of buyout. I mean, that happens a lot of times in private equity land where newer funds by older portfolio companies, so the existing LPs and the older vehicles can get DPI, agreed that I think it's positive that they're not taking carry on it.

8:51It's just a parallel that I've seen in other asset classes. If you use multiple devices and apps to run your business, you need OpenPhone. OpenPhone simplifies your communications with one simple app. And OpenPhone has rethought what a modern business phone can be. What's magical about OpenPhone is that it works through a simple, elegant app right on your existing phone, or you can even use it on your desktop. I know because we use it here at launch and our sales team loves it. And you know what? those phone numbers, those discussions, all those text messages, we need those to be on launch phone numbers.

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9:59My Lord, that's affordable. But Twist listeners can get an extra 20 % off for any plan. The first six months, that's incredibly generous. Just head over to openphone.com slash twist. And what if you have an existing number with another service that you hate? Well, Open Phone will port them over at no extra cost easy peasy lemon squeezy so head over to openphone.com slash twist and get a free trial and get 20 off yeah and we'll pull up the letter here um i i this was sort of a breaking news story but i was a little bit aware of it uh because i covered it on a previous episode but essentially what's happening here is there are people who are investors in stripe uh from sequoia at a you know in a time period i think maybe 2010 ish and it's obviously 14 years later they've been sitting for 14 years on this investment and they were told they had the best company after uber and before airbnb of that vintage yet they you know haven't had a ton of liquidity so it looks like sequoia with some of their other vehicles which might very much want to buy shares of stripe pre-IPO and I think this signals an IPO is coming and that was my big insight here is I think this is a bit of a tell but Sequoia Capital from their heritage foundation from their heritage fund and from their growth fund a couple of their different funds they actually mentioned here let me put on my serial killer glasses so we know that each of you has different goals for liquidity and portfolio management we are contemplating a transaction where new purchasers including the expansion fund sequoia capital fund sequoia heritage that's their family office fund and sequoia capital global equities will commit to buying up to 861 million of strife shares held in sequoia funds raised between 2009 and 2012 that what they're calling legacy funds here at the most recent july 2024 409a valuation we explicitly focused on these legacy funds which were organized over a decade oh given the normal 10-year length of the fund so uh this is i think the other key point to this david is there's massive amounts of qualifiers in this offer uh they're saying they're contemplating this they're fully disclosing who the buyers are they're doing the most clear concise way to value the shares a 409 evaluation uh very you know legally accounting binding and they're doing it with the oldest funds with a very explicit purpose they're past their 10-year lifespan and the the final paragraph that we page down there david i think is worth reading as well limited partners of the legacy funds will have the option to hold or sell all portions of their striped shares so you have the choice if you're one of these legacy lps to participate in this or not so you have choice you have to get educated as the lps if you want to do this or not because the people buying it are expecting probably a 50 pop i would say uh by the time they exit and this thing goes public in a year uh or so they say we are pleased to offer this liquidity option to you as limited partners in the legacy funds as each of the legacy funds sequoia capital fund expansion fund heritage and scger funds that are sponsored and managed by sequoia or its affiliates we are also seeking your consent to proceed with the transaction and to make certain amendments to the governing documents of the legacy funds that are required to affect the transaction please complete and return this um and it also says it is important to highlight that sequoia personnel and associated persons will not be offered the option to sell shares previously received as carried interest distributions from the legacy funds and no interest will be payable to the sellers in connection with this transaction uh so that And a piece is smart too, not letting kind of the personnel sell.

13:48Again, aligns how bullish they are and how continued bullish they are in the company. So I think they did a great job on both sides. Aligning with LPs, not taking carried interest, but also signaling, hey, this is a small percentage of our overall holdings. This is not a fire sell. This is not something that we're trying to do behind your backs. We're doing it right in front of you. We're giving you all the facts. And our personnel are not selling as part of this transaction. We are still bullish. I think there's a couple aspects here. If you think of venture capital as a product and LPS customers, Sequoia is being very responsive to their customers.

14:24So customers are saying we want DPI, we want DPI. And instead of saying we can't do that, or there's different restrictions and all these, they've kind of come together with a pretty novel solution, but has a couple aspects. One is the 409A valuation. So they've decided to use this 409A valuations. As you guys know, 409A valuations are typically a depressed valuation. That's where employees typically exercise their options. So they're typically, it has an embedded discount there. But they're also, they're not being coy and they're not taking advantage of their limited partners. They're not forcing people.

14:58They're not double dipping. So they're doing it in a way, essentially saying, look, we hear what you need around DPI, and we want to accommodate you if you're willing to do that. If you don't, that's totally fine as well. We're not being opportunistic around your DPI needs. So I think overall, this is a positive thing. I wonder, Matt and Jamie, whether you think other venture funds will follow and whether this might be a template for other venture funds to solve around the DPI issue. Well, I think it's the reality of our industry right now. The public markets are no longer a fundraising event.

15:31They're a liquidity event in a lot of ways. And so the world of Amazon going public at a$500 million market cap and the value expansion taking place in the public markets has kind of flipped. That's why my old firm, KOTU, went into the private markets in the first place. right. And so I think it's a reality. Will it look like this? I'm not sure. Maybe a lot of the larger funds. I mean, for us as an emerging manager, smaller funds, smaller checks at the pre-season seed, we like to work with our management teams when the company gets to this pre-IPO or right before they go public. If some early investors are taking money off the table, will try and take a portion off, still be kind of leveraged and bullish on the business and keep the majority of our shares in.

16:20But look at it in partnership with the management team and partnership with the other early stage investors to help our LPs get DPI in what has been a really difficult environment over the last 24 months. So I think you have to be proactive is the underlying rule now. I wonder, Jamie, you mentioned you referenced different asset classes like private equity and buyout. And there, if you think about it from a first principles basis, private equity funds are selling their positions to other private equity funds, which are selling to other private equity funds. So you have the same private asset, you know, getting liquidity every three years, but over, you know, three times over nine years.

16:56Do you think maybe there might be an evolution where, you know, secondary becomes almost part of the process rather than this obscure kind of solution for somebody's liquidity needs? Does venture capital in general need to have a different liquidity profile in order to expand the amount of people that are interested in investing? I'd say Sequoia has the benefit of a structure that allows them to execute this type of strategy. And to Matt's point, there's probably larger firms out there that can also leverage their structure to take advantage of these situations. I think a lot of firms out there do not have this structure and need to find alternatives.

17:34But the benefit of investing in emerging managers or pre-seed and seed is when you've gotten to a valuation of potentially$100 billion in the private markets. Taking some money off the table via a secondary is a great way to provide DPI to your underlying LPs while also still keeping capital in the ground, compounding at a high rate, playing the optionality upside that venture still offers. I think that when you look at venture, there's innovation and creativity everywhere. So I imagine that there's going to be more creative and innovative solutions coming out there where, you know, potentially a different structure of a secondary fund or, you know, some type of private equity style player that's adjacent to venture that comes in and buys up because, you know, as LPs start to get desperate, they're willing to potentially go off their first principles and, you know, go for the capital, even though potentially keeping it in the ground for another three to five years could be very advantageous from a multiple standpoint, there's an opportunity cost to putting your dollars to work.

18:41Yeah. And the cleanest way to do this is part of a primary round, right? I haven't seen something too familiar to what Sequoia is doing, but usually you see secondary purchases for fun like myself. When people are excited, there's a big valuation. We already have 100x out of our seed fund, And so we want to take a little bit off the table, but you have ready buyers. If you're going to try and sell and just as you were saying, David, kind of this wild, wild west of the secondary markets outside of a primary round, you could have somebody who's willing to give you par. You could have somebody who's willing to give you a 70 % discount.

19:13You know, the company bylaws and what they actually permit, it's a lot messier. And that's where you get a ton of inefficiencies in these forward contracts and really kind of the wild, wild west. But I think if you're tying it to a primary transaction, it can be much cleaner. I do think this is going to become part of our toolkit here in venture capital land. You're already seeing we had Dave McClure on. He's doing these strip funds trying to buy LP interests to provide this liquidity to LPs. You've got industry ventures doing it as well. It seems to be, you know, that capital finds a way, you know, that Jurassic Park line life finds a way.

19:52like capital finds a way and if mna is taken off the table as i as i pointed out earlier well what is microsoft going to do they're going to just buy the assets of the company the team and leave the shell and they're just going to rip you know the the meat off the bone and just leave this like dismembered you know corporate entity for lena khan to you know uh get to wave some victory flag that it wasn't acquired when meanwhile all the value was ripped out of the the the company and this is a similar kind of situation if we can't do mid-market m &a if we can't get companies public if there's some resistance or headwinds to that you know and adobe can't do their 20 million dollar transaction well there's other ways and capital finds a way life finds a way and here we go capital has found a way the great irony of this is i think that this is occurring, you know, probably six months or a year or less when the IPO is going to occur.

20:50So to your point, Jamie, you know, you have to make a really thoughtful decision here as an LP. And how do you make that decision is an important question because your career could be on the line if you're in an endowment or sovereign wealth fund, a high, you know, family office, if you make the wrong decision here. So you've got to make a very thoughtful decision. Are you selling before a triple up and this thing goes parabolic are you set and that could have been the best investment your firm ever made or are you pairing your position and this thing goes down 30 % in the market and it's an instacart kind of situation so you know sharpen your pencils lps and shareholders here and i don't think you can go wrong selling 10 or 20 nobody's going to blame you but when you start selling larger portions of your position you do need to be very very thoughtful but i'm glad that there's more options here and i was starting to get the sense that you know half the people in our industry did not believe in our industry anymore now i think it's down to 47 percent of people in our industry don't believe in our industry there's a large number of people in our industry who are just like i don't think this is ever going to work and that's kind of what and i'm talking about lps and downwinds are like is this going to work or not you know it seems like a crazy plan we're waiting for whiz and stripe and these power laws it's going to work folks the power law is always going to be there calm down just pace yourself deploy your capital over four years not 18 months you'll be fine i think sometimes it's hard as an lp to just sit and be comfortable with your portfolio you're making investments if you have a great group of curated managers that you feel comfortable re-upping in like a liquid too that doesn't change their fund size very much so it's kind of steady state and it's hard sometimes to just sit there and be like, I'm actually happy with my portfolio and I'm going to do nothing.

22:42You want to start to make tactical decisions. You want to start making changes to a portfolio so you feel like you're significantly adding value, but sometimes patience is the best value you can add. So, so well said, Jamie. And I think when you read the letter from Sequoia, it just instills in you like, okay, these are adults. They know what they're doing. They've done it before. And they're making very thoughtful decisions in terms of capital allocation and portfolio management and strategy. So I just A++ on the leadership from Sequoia here. And I think it's just fantastic for the industry. Lots of lessons.

23:20I do wonder, a bit of a contrarian point, but of course, we want a healthy M &A market and we want private companies being able to transact with private companies. But what would happen if some of these M &A deals had not been consummated historically? What if PayPal had not sold for and a half billion what if youtube had not sold for 1.65 billion what if instagram hadn't sold for a billion dollars are there power laws there would instagram be a half trillion dollar company and what would be the total returns of venture i don't think anyone's really run the numbers on that but oh maybe most yeah yeah i mean if you look at the youtube i would tell you because i was there and i know chad and ruloff you know had just invested in mahalo right after he did youtube and I remember reading his deal memo when he was in his first year or two at Sequoia.

24:08And I believe YouTube would have gone out of business. No venture-backed company ever survived a lawsuit of that scale in history. And so I believe Google made the asymmetric risk bet of all time with that one. With Instagram, yeah, that one would have gone 100x from the billion-dollar valuation. That was a huge mistake. And everybody knew it at the time. Every single person knew it at the time, including Sequoia, which had just put money in, I believe, at$500 and doubled their money in three months. I believe the back channel I heard was they begged them not to sell. Begged them. And so that's Instacart.

24:50Wait, that's a... And then PayPal, you know, that was a different era. The concept of secondary at that period of time. And then they were also under the sword of Damocles, I think they call it. Like, you know, like, you're about to get beheaded because of fraud. And I don't think, you know, it's not like Elon and Peter Thiel and those folks had a lot of cash in their bank accounts to fight that fight. And it just shows you having partners with deep pockets who can weather storms and have been through it before actually matters. So if you're a founder listening to this, pick your partners wisely because, you know, founders who get a little skittish, I'm sorry, partners who get skittish and founders who have 99.999 % of their net worth in a company leads to a bad outcome long term.

25:33That's the playbook that I've seen work really well. Don't sell. Sell 20 % of your company to us via secondary. We'll back you and let's roll the dice. Oh, my Lord. Podcasts, audiobooks, virtual meetings. endless videos. We're producing and consuming more voice data than we ever have. And if your startup is building a product that uses voice data, you need to check out Assembly AI. Assembly AI builds speech to text AI models that can turn your voice data into new product capabilities. All you need is voice data and a few lines of code. For example, Vita.io makes video editing tools that generate the captions you see on our video clips, right?

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26:55Moving on, a new study by Defiance Capital titled the Unicorn Founder DNA Report showed that 70 % of founders are underdog founders defined as immigrants, women, or people of color. Diving deeper into the numbers, we find that only 53 % had degrees from top 10 universities. Only 49 % or less than half of CEOs have STEM degrees. And surprisingly, outside of SV Angel YC and Liquid 2 from this podcast, not a single venture fund has invested in over 3 % of unicorns. Jamie, I know you've done a lot of research on this, on underdog founders and managers, and you invest in them. And tell me about what you've seen in the data.

27:42Yeah, I'd say I think this unicorn report does a great job of showing how diverse founders create winners and why it's so crucial to find managers that are willing to back these kind of founders. So no plan B, a chip on the shoulder, unlimited self-belief is key. And it's really why Screen Door was started in 2021 by Satie and Hunter at Homebrew. They recruited eight other GPs with diverse perspectives who used to be emerging managers that are now established brands and pretty access constrained. You can think of Kirsten Green from Forerunner, Charles Hutz from Precursor, Leah Sullivan from Fuel.

28:18And they really started Screen Door because they wish they had an LP like Screen Door to invest in them when they were just starting out. And what I would say, not just from myself or my two other colleagues that have been allocators their whole careers, but from the 14 GP advisors that we work with, is that the winners in venture come out of the tails. And I know this group absolutely knows it. I've chatted with all of you about it. The winners really come out of the tails or the edges. And, you know, to get that power law return, it's really, really important to be embracing non-consensus investing.

28:53You need to find GPs that have had journeys that provide them with perspectives to be able to pick out that non-consensus founder from the crowd. To really think and invest differently than everyone else in the room, they need to embody what that report showed is that grit, that chip on the shoulder, unlimited self-belief, you know, those obvious networks and geographies, you know, a lot of the multi-stage firms, they pile into those early stage rounds or they try to get in as quickly as possible. But when you think about it, hot rounds or those high-flying founders that everyone wants to get access to, you know, that means you're actually consensus or technically part of the crowd.

29:37But to win in venture, you need to be non-consensus and right. So kind of following the crowd, following those big brand names into the hot founders is not actually the way to potentially be producing those outlier style returns. One of my favorite founders on the planet is Tracy Young from PlanGrid. And actually, my wife was their head of people at PlanGrid, helped them scale to 20 through 450 people. She had a$900 million exit to almost a unicorn company and has now founded TigerEye and almost half of her company are underdogs at Tiger Eye. Is that because they're underdogs? No, it's because they're fantastic technologists that happen to be underdogs, right?

30:15And so I thought that the research was fantastic. I think we're going to see more diversity, which is a positive. In this data, I do think the one that's worth looking at is it's actually based upon desperation. And I think people who are already wealthy or who have safety nets behave differently in the world um and i know i certainly did i had a you know different kind of drive than the people i met when i first came to manhattan who were trust fund kids you know and who had their apartments paid for and their colleges paid for and i didn't have those things and so i just had a chip on my shoulder that was very different uh because i had to fight to meet everybody and they had knew everybody from darien connecticut and the hamptons and i didn't so i you you will see that a lot in terms of immigrant founders which is why i pushed former president trump and future president trump apparently on the issue when he was on all in of green cards and you know recruiting the best talent to come here we want to win on a global basis recruiting immigrants is the greatest thing you can do there are many more smart people outside the u.s than inside the u.s statistically there's nothing to do with any judgment on any particular, you know, society or country or culture.

31:36There's just 300 million people here and 7 billion people out there. Therefore, every person here, there's 20 people out there. I think what this report also highlights is that you can succeed when you come from a different background. I think that's an important thing that people are aware. 70 % are underdogs. 53 % don't go to top 10 schools. You mentioned, Jason, you didn't go to Stanford. A lot of people think that if they didn't go to Stanford, they didn't go to Harvard, they don't have a chance. So I think it's important that this information is out there, that there are different ways to get to success, which in this case is defined as a billion-dollar-plus company.

32:13It's true success at its highest form. So I think that should be exciting to many people. And networks, right? Maybe a little bit outside of the diversity component, it's networks, right? I mean, Ron has been an OG of Silicon Valley, was one of the first super angels ever, right? You look at Y Combinator, had over 20 ,000 applications for that. They're only getting stronger and stronger. The two people that put us in business, or the three people, were Jessica Livingston and Paul Graham from YC and Ron Conway from SV Angel. So it's almost like a little SV Angel, YC, look with two mafia there at the top with similar strategies.

32:50Jason, similar to your strategy. So I think some of these network-based strategies where you have these pockets of great people are so diverse and everywhere to where if you're just a vertical-specific fund or just focused on people coming out of Google or Facebook or just focused on people coming out of Stanford, you're missing a large portion of great founders. So that was the other takeaway I had, obviously, as a network-based fund, especially with those top three names, is you have to be everywhere now and venture to capture the outliers. The report also says most had a personal story of feeling unfairly treated or feeling limited in their native environment.

33:30And this study observed these traits in communities left behind for generations. And so I think from a diversity angle, you know, that backing GPs that have diverse perspectives or have had differentiated journeys to get to venture, because I still think there's a level set basic requirement to be a venture capitalist, but they can provide access to those communities that have been left behind. behind. And it also creates a huge opportunity to find founders that can, you know, create companies that meet the needs of those types of communities. And it wasn't long ago, David, that, you know, we would be sitting here in Silicon Valley.

34:07I remember when I came into the industry 25 years ago as a journalist covering Silicon Alley here in New York, and, you know, Asian and Indian entrepreneurs, or just even rank and file workers at startups, you know, were not considered leadership quality uh they were you know great developers they were kind of put in a box over here and you had to be a white dude from stanford to run the company and then these were great people to have on your team and then you look across silicon valley uh and i've watched it happen in my career you know the age of you have to be a white guy to be ceo is like long over microsoft google like go down the list like find a straight white male running a tech company at scale, there might actually be, you know, the minority of numbers, I haven't actually run those numbers of the top 10 market cap companies, but it's certainly very different than it was in the 80s and 90s.

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