E8: How Roger Ehrenberg Nets 10x Fund Returns

0:09Welcome back to Turpentine VC, a podcast where we discuss the art and science of building successful venture firms, VC to VC. In episode seven and episode eight of Turpentine VC, Chad Byers of Sousa and Mike Maples Jr. of Floodgate both mentioned Roger Ehrenberg of IA Ventures. As the VC, they both highly respect and look to as the gold standard for seed investing. So I'm really excited to have Roger as our guest for today's episode. We dive into his contrarian and opinionated view of how seed funds should operate and how that's allowed him to generate 10x fund returns. If you like what you hear, please do subscribe and leave us a review.

0:48And check out our companion newsletter, where we share the top three takeaways from each interview. Now, on to my conversation with Roger. Welcome to Turpentine VC. Thanks so much for joining. Thank you, Eric. Great to be here. So I just had Mike Maples on before you, and he unwittingly said that you're the investor he perhaps most admires because you said what you were going to do. You were very specific about what you were doing, what you were not doing, what you stood for, what you didn't stand for, and you didn't waver. And you've had phenomenal results to show for it, I believe, 10X funds.

1:22Why don't you talk about what that firm strategy was exactly? Sure. So I had this deeply held view that running a concentrated portfolio at Seed And being ownership sensitive was ultimately the way to give yourself the best chance at outside success. And my goal was never to try and stamp out 3x funds. It was to try and create discontinuity, kind of maximum convexity in the portfolio. And rather than having a series of smaller option bets, it was really much more a function of both acknowledging that the most valuable resource that myself and my partners, Brad and Jesse, had was time, really not money.

2:16and that we specifically focused on companies that sat at the intersection of what we perceived to be not well understood. And yet, if their hypotheses were correct, that there was a massive market opportunity that was there for them. But at the same time where we felt our greatest value was in helping those founders design the experiments to determine product market fit. So we always would invest pre-product market fit. We're not providing scaling capital. We're providing, can this actually be a real business capital? and can just then warrant additional money to peel back the layers of the onion to see can you actually create a category-defining company?

3:09And so in 2023, do you think that strategy would still take hold? We've seen seed change a lot, right? Multi-stage firms have gotten into seed. There's a lot more capital. Sam Lesson recently wrote that he thinks it's the end of seed, but he particularly thinks end of seed in terms of club deals. He thinks you can only do seed in the way you did it, which is contrarian and right. How do you think about seed today with the rise of super angels, et cetera? Do you think that strategy holds up? I do. And I think very few firms do it. And why? Because it's hard. And it's putting your eggs in a relatively narrow basket.

3:53And I think that makes most managers, especially first-time fund managers, very uncomfortable. That what feels safe when one gets in a business is to tag along with demonstrably successful investors or perhaps even more truthfully, investors with bigger names and brands forgetting about success in the way that high quality LPs measure success, notably DTI. And I think it feels comfortable to be with the crowd because if you're wrong, everyone's wrong. And if everyone's right, you're right. So it's kind of a seemingly less risky strategy when one is trying to get in business and not screw up too big so you don't get a chance to even have a second fund.

4:49But the reality is to me, the risk is almost the exact inverse. The real risk, especially if you have LPs with any sophistication, is that if you're not taking true pre-seed and seed stage risk, which means not just the companies, it means the ownership, the check size, and the conviction where you're going to actually allocate your scarce time. And the way that we talked about it at IA was really bending the curve. That if we didn't feel that we could bend the curve for a company in that pre-seed to seed stage as they're going through this kind of experimentation process and sprinting towards product market fit, then unclear whether or not we were really the right investors for that company.

5:35And I would say today in my own investing, I still follow a similar strategy. So, which is all to say, I think that the data bears this out. One of the features of our favorite LPs was their willingness to share data with us on their historical experience with managers across decades. And there is something about concentrated seed that occupies this unusual place in the two by two, because you are taking the biggest risk, but you are generally getting compensated for it. Whereas at the series A, and often at the series B, you're paying much higher prices without a similar amount of de-risking.

6:23And I think that's really the key. is that many larger multi-stage funds will invest in A's and B's without really pricing the risk reduction from seed as you think about that valuation versus the seed valuation. So we always lived in that very early, very risky, miasma, teams forming, ideas gelling, plans codifying. But boy, if you hit it, then you can really hit it. Right. And yeah, it's interesting because there was a ton of capital that flooded in over the past few years. One of the things that we did at our firm was we were seeing that follow on rounds were happening increasingly earlier ahead of any de-risking for these companies.

7:18And so it actually made more sense to allocate the follow on dollars to new companies so we can get more shots on goal. And just because these follow on prices didn't make sense. I'm curious if you would have advised against that or how you think about that for you if you were starting IA today, given sort of how much capital is flooded into the ecosystem. I think your adaptation makes sense. I think it depends on how horizontal your portfolio is. I think what IA did was severely cut velocity to almost zero and then would just be wildly selective about even that first check in a market where even those first checks are getting priced at largely irrational levels.

8:03And I think the current market is kind of bearing that out now that we're in the midst of this correction, or one might say rationalization. What I think an adaptive strategy in this environment is for a manager that runs a concentrated portfolio and has skill in helping to assist leadership teams with hard, hard questions of resource allocation. Do you narrow your scope in an environment of scarcity and go deeper? Or do you try and go more horizontal and to build brand that way and to kind of believe in your best position for the next phase of abundance because you've created a broader footprint?

8:55Those are really hard questions, but I think the best opportunities in this current phase aren't necessarily net new companies, but investing dollars in existing companies at depressed prices when the businesses themselves are simply taking longer to gestate because they might be platform-type businesses, which, as you know, if you're actually building a platform business, I mean, it could take five years to actually create the critical mass. Or if you're building something that is around open source or developer tools, and you need that community evangelism, and you need a large enough user base to get that flywheel going, these things just take time.

9:44But in a market like this, it's very painful to give companies like that the appropriate resources and the time necessary to achieve their potential. So that's when tremendous opportunities exist when it's almost like dislocation in the opposite direction where the potential of these companies relative to the price is massively skewed in your favor instead of the converse when you're reaching to invest companies when valuation is moving away from it. I see you as a true craftsman investor. You have an idea of what it means to be a good investor, an idea of what it means on how to win, and you've won.

10:23And so that has only been confirmed. And it works in rational markets better than crazy markets, but it works in all markets. Whereas there are other, I'll give YC and Andreessen as other examples, where it's almost like they're playing a different sport. YC in particular is obviously playing a hugely horizontal or, you know, high volume game. They have special economics. They don't invest in the way that you invest, but they really focus on sort of the product to entrepreneurs and this heavy services approach and Andreessen at the later stage, and they're playing this massive AUM game. And is your analysis, hey, different, like it's a different sport, but they, you know, you can have multiple kinds of winners.

11:04I've wondered if the future venture is going to look more like the craftsman approach that has won for so long, or more like the sort of product or platform approach that is a bit newer, but is, you know, creating a getting a lot of dollars and has some, you know, flashy wins. What do you think about that? Eric, that is a fantastic question. And this is one of the times when my being old, and having been through so many cycles and been in so many corners, the financial markets, I think I've actually got pretty reasonable perspective on this. The answer is there is no one prevailing regime. It's going, it's cyclical.

11:42It's based upon interest rates, investment alternatives, PR, and a host of other factors. But certainly the most notable is kind of interest rates and macroeconomic environment that drives interest in these, you know, long duration, less liquid asset classes. So I would posit that the venture world is no different than the public equities world when it comes to its shape and how things move up and down and firm types and preferences shift. But if you look at some truly great generational firms that have literally done the same thing from inception, like take Baupost Group in deep value long short.

12:34Okay, so Baupost has been doing their thing for I think 40 years now, let's say. and their relatives' returns would go up and down cycles and go down and up cycles. But net, net, if you look at the rate at which capital compounds, and again, I'm not an LP. I just know from being in the hedge fund business, like Baupost was always just unwavering in their strategy. I view us in the way, in venture, in the way that I view Baupost in the hedge fund arena, which is they stayed relatively small. They've generated tremendous returns over long periods of time. They've obviously built a culture of success where they could continue to elevate young talent and to continue to be great stock pickers in all markets.

13:33That is what I set out to have IAB. I think Brad and Jesse are carrying that along brilliantly. But I think there will always be the YC types in the world. You could argue Vanguard kicked off that incredibly horizontal approach to investment management. And then you've got these very narrow specialty managers. So I think it's all part and parcel of the same thing, which is there can be these multiple strategies that are also servicing different types of investors. Like, let's face it, if you're a certain scale of LP, you can't really invest in IA because we're just too small and the check size that you would want to write, we simply won't accept.

14:25So then Andreessen, with their infrastructure and their – I mean, they're a corporation, right? It's like – but they are institutionally investable with enormous dollars. And if they can put up good returns, they don't even need to be great returns. Good returns in this multi-product array that they now have, then that's great. for what many institutions want. YC is much more geared towards not the investor, but the founder, and they've created this ecosystem. And if I look at what I would consider their unfair advantage to be at this point is cohort after cohort that have extraordinary individuals that have built some really tremendous companies that then feed back into the ecosystem.

15:27And they've done a brilliant job. I mean, different people think different things. That's something I respect very highly, is that they really have built an ecosystem that is unrivaled in gunship. Hey, we'll continue our interview in a moment after a word from our sponsors. Now, most venture capitalists are not macro thinkers or don't have the type of experience that you do, but you are a macro thinker. And so when you think about the next few years, and obviously no one's a predictor, but you're a student, how do you expect what's going to happen in macro is going to, what kind of ripples is it going to send through the venture ecosystem in terms of what kinds of players it's going to favor, maybe what kinds is going to hurt, or what mental model of macro should VCs have as they look at the next few years of venture capital?

16:19Definitely a defensive posture. I think that, again, so much is driven by rates and global sentiment, long-dated rates, not that policy. And look, I mean, if SOFR was six and the 30-year was three, I would feel very differently. Um, but with SOFR at five and change in the 30 year, well above four and mortgage rates over seven for the first time in 40 years, like that's, that's a tough environment, right? Because we are, as a general matter, in a more risk-off culture when it comes to illiquid assets. In liquids, we've seen the equity markets, the large mega cap techs had a bid for a while. It's softening now.

17:20But in general, it's been pretty good. But long-duration assets have generally looked like crap. And that's the intersection of poor liquidity. and uncertain prospects. So not really knowing how macro is going to affect growth rate, which of course, the two biggest things with a long duration equity like a venture-backed company is growth rate and interest rates. Those are really the two salient financial factors. So what I had alluded to earlier about the best place to deploy dollars right now is probably in your best companies and to be extremely careful with met new companies to the extent that they're capital intensive.

18:11If you back teams that are unbelievably scrappy and can really build a lot for very little, and you feel like you've got very strict parameters around which you're willing to write an additional check to continue to fund that development, again, in an environment of scarcity, then I think probably the best risk reward is fortifying your high potential companies that you've already gotten to know over years and years and years. Fascinating. And give my audience a little bit of a mini macro lesson in terms of close the loop or flesh out more about how higher interest rates or lower growth rates, like how that affects the venture ecosystem exactly.

19:03Kind of tie that thread together. Sure. So they both ultimately get to the same concept with, which is terminal value. And what is the multiple that an investor is willing to put on future cash flows? And when you have attractive, low risk investment alternatives that are yielding a high rate, and in our case, the highest rate that we've seen again in decades, then cash feels pretty good in a scary world. And that's going to mean that the risk premium that you're going to charge on long duration equities is going to be much, much higher. So then we get to growth rate. Well, so that means that you need extraordinary growth rate, like the 10 % month on month, not from C to A or A to B, but from B to N.

20:03So something that really has tremendous nonlinear growth, which again, is very, very hard to find. I mean, there have been companies like Snowflake or something like that that have exhibited these unbelievable, or even for a period, a data dog, right? That just crazy, crazy growth, even at scale for an extended period of time. Those are companies that they will not trade anywhere near what they would have in a lower rate environment, but they will still trade at premium multiples. But unless you're one of those companies, then growth rate and interest rates are going to drag down that terminal multiple, which is going to drag down the present value to future cash flows.

20:46That's a helpful overview. And do you think that interest rates have been artificially low these past few decades? My economist friend, Scott Sumner, thinks that maybe perhaps they weren't low, maybe perhaps thanks to demographics or productivity or other factors, maybe we just have lower rates from now on. I would say yes and no. Now, look, your friend is a trained economist. I'm not a trained economist, but I would say it can't be either or. Certainly, the global growth rate is slowing down. So global GDP is slowing down as the population explosion slows down. And now we're even saying in the company that had the greatest growth in history, China, their growth is waning and they're in deep trouble because they've had this massive demographic shift against a wave of overinvestment that's going to have ripples across the globe, as we're already seeing today.

21:51So that's certainly part of it, but it can't be disputed that in just talking about US policy, that the US very intentionally and Western Europe very intentionally ran loose money policies in order to keep interest rates towards zero, especially coming out of the global financial crisis. They had been low before then, but they were not crazy low. But we had more than a decade of that bubble inflating of literally zero interest rates that made investing in long-duration equities and other risk assets so compelling. So you get exactly what you have today, which is the bubble coming out of the balloon.

22:45Incredible pain. I mean, I remember I was sitting on a panel with Fred Wilson. I think this is probably in 2010 coming out of the GFC and what is venture investment going to normalize at on an annual basis? And we were like, maybe like 10 billion, 10 billion. I mean, I was 10 X off that one. I mean, and by the way, if, if, if I had known what Fed policy would be, I would not have said 10 billion. Maybe I would have said 30 or 40 billion. I would not have said 10. I would not have thought it could be a hundred. so i was like orders of magnitude off because i could not have foreseen that the fed would keep rates at zero for almost 15 years if you let's say you have to make a prediction now about where they will where they will normalize knowing what you would you know now about you know how the fed has acted and and what played out what prediction would you make i mean so i don't again i just haven't looked at the statistics lately so i mean obviously i mean i know that venture investment in 22 and 23 has fallen tremendously.

24:01I don't know what it is now. If you tell me what it is now and what it was at its peak, I could tell you. I think it's going to be significantly lower. I just do not think that there's going to be a ton of net new investors coming into venture right now, I think. And you can see it. You know, where is some of the biggest money going right now? It's going into real assets. It's going into things like sports or it's going into intellectual property like media rights. And I think there are other megatrends. Now, clearly, AI occupies this unusual place in the universe right now where it has largely been immune to the cyclicality and volatility of venture investment.

24:56But there aren't too many sectors like that. And there's always one, right? Whether it was clean tech, machine learning, data, whatever, and now it's AI. um so i do i do think that the biggest biggest pockets of capital right now are not really focused on venture right because even with ai it's unclear how many you know amazing startup opportunities there will be as opposed to just going to the incumbents i agree with you i like i right now you know the i don't know how much true white space is left in the venn diagram with you know 200 new circles having been created over the last 18 months and so if the if your prediction is correct what does that mean for these the a16z's the yc these massive kind of aum platforms do they do they struggle or do they have to reset their strategy a bit so i think with with folks like that that already have an embedded lt base and they're just cranking out new fund products i think they'll be fine because again they are institutionally investable.

26:02My hypothesis is that these LPs are underwriting these firms for a generation. They are not tourist VC investors. And as such, those are not the firms that are going to be hurt. I think net new fund creation is going to be hurt. And if I'm totally honest, Eric, and I actually, I said this five years ago, there are too many firms. And when you have taxi drivers and Uber drivers talking about their venture investing in the same way that, you know, when they talked about, you know, crypto with Bitcoin at 60 ,000, again, this is not a new movie. We've seen this movie a thousand times before. You don't, in the same way that you don't need as many banks in the country as we have, you don't need as many seed stage venture funds.

26:55You just don't need them. Totally. It's, it's, you know, I'm going to make a joke of an analogy only because you said you're old. I remember this video around this kind of veteran or very old man who, who looks at the state of America today. And he, he's very sad. He says, you know, we didn't go to Vietnam for this. It's kind of this, this, and meant to be this moving video. And I, I, I'm sort of imagining you look in the last five years of venture or you know or maybe about a decade saying oh yeah i can't believe it it went like this it wasn't supposed to be like this you make me sound like one of those old guys in that i can't believe the industry has unfolded this way yeah okay well you're right that is exactly what i would say yeah all these players who've made all this money maybe in the wrong way or I don't know.

27:44Is that kind of your experience? Like AUM. I mean, that's the thing, man. It's just, I have such a hard time with it. Now, look, again, Andreessen is very particular. They are a multi-strategy, multi-product, institutional investment management firm. They are not a venture firm, as far as I'm concerned. So forget about them. But then if you look at the rest of the industry and you look at what I believe is the lack of LP discipline in just signing up for fund 3, 4, 5, 6, 7, 12, 15 of name your venerable venture firm. And you look at the returns with a few notable exceptions, they're not good. And to me, I never understood that.

28:35I've never been an institutional LP marshalling dollars of that magnitude, but somehow the GPs were able to create this illusion that, and it can't be true that all of these funds are so special and all of this capacity was so valuable that, well, if you don't jump, if you, if you don't re up, well, then we're going to give it to X and you'll never get to invest with us ever again. The GPs were masterful at that. You're talking about hundreds of billions of dollars over the last 20 years in these kinds of funds, you know, which again, I like, I feel so grateful for the LP relationships that we established and cultivated at IA because we were extremely focused on getting a set of partners, firstly, who we viewed as true partners, where we wanted them so they could mentor us in ways that we needed help and support.

29:43And believe me, we needed a lot and we still learn a ton from our LPs, but where they, even as large institutions, viewed a 20, 30, 40, 50 million dollar allocation to IA as being incredibly valuable. And yes, it's not a 200 million dollar allocation to a billion dollar fund, but that was huge to us. And look, if we can generate what we've generated so far, then that's a lot of absolute returns for these causes that we believe very passionately in. So I just think the whole market was so distorted on both the GP and the LP side. And now that reckoning is happening. And even though it's painful, I think it's ultimately a really healthy thing.

30:37Yeah. And others like Bill Gurley have been talking about it for needing to happen for a while. And yeah, and so you're encouraged by sort of this, this, you know, forced discipline that is going to have to come back. For sure. You mentioned crypto, I believe that you guys, you know, got into crypto as well. You know, you mentioned sports, you guys are focused in sports now. And obviously, it's both to make money, but also a passion project with you and your family. Any reflections on getting involved in crypto a bit or what you learned about it from a meta perspective and also then let's talk about sports i view it in kind of three buckets there's crypto nfts and web3 so crypto just bitcoin ethereum whatever i traded some of that pretty well cool but like that was purely a short window in time where i felt like I had a deeply held view about the way things would go, took my gains and stopped.

31:44For me, it's not a religion. It was an asset that had an observable value. It had a trend in the sentiment and I traded against that and made some decent money and then said, okay i'm at so that's that's crypto then there's nfts and projects my sons um andreith and i spent some time looking at different projects and and invested in some and i would say that we did a relatively shitty job um pricing those projects rationally i think we got caught up in some of the hype and the shifts in sentiment and it was a great learning experience that was that for it and then web three more like um core infrastructure we've got some investments there that are good and that's more like venture uh but it's something that you know was this this sphere was kind of the initial engagement with my sons and working together now transitioning to sports I had kind of put a stake in the ground as I was transitioning out of IA.

33:18I had the opportunity to invest in the Miami Marlins.

33:24The now chief commercial officer is my wife's first cousin, somebody I've known since he was seven years old. And so they were really just looking to raise friends and family money from around the table because I didn't want to do a capital call during COVID. And it just ended up being a really good opportunity and we're a huge baseball family. So it was kind of the culmination of one of those fantasies that you think will never in a million years happen. And it happened. And so continue to be very involved with the team and ownership today. since then i really codified this thesis around this uh what i call the entertainmentification of sports live sports sports betting sports media sports data all working together in this kind of network effect almost you know not not like a yc but in the sense that like we do we We have built this almost like a little Koretsu of our companies having these strategic overlaps where they're actually working together, not because they're Eberg companies or not because I tell them to, because it's actually great to work with a friendly who is synergistic with what you're doing and you share Eberg in common.

34:42And so, you know, around the biggest sports betting conference in the tri-state area, we held an event that 75 people come, a bunch of our companies, some franchise owners, other big investors, sports media. And like, it was amazing. And to see the energy, like, to me, that business feels a lot like going to tech meetups in 2008. Yeah. And so, you know, we've now built this portfolio where, you know, we have baseball team, investor in an MLS team, investor in an F1 racing team. Wow. And, and then having these, um, these sports betting investments, sports media, sports data, that's really where the boys and I are spending our time.