Brad Gerstner talks AI, Tech Super cycles vs. Market cycles, and the start of Altimeter as a $3MM fund

0:00Welcome back to another episode of Venture Unlocked, the podcast that takes you behind the scenes of the world of venture capital. I'm your host, Samir Akachi, and on today's episode, we're thrilled to bring on Brad Gerstner, founder and CEO of Altimeter Capital. Altimeter was first founded in 2008 during the global financial crisis with an initial fund of only$3 million, which Brad raised from friends and family. The firm takes an incredibly focused and high-conviction approach to investing and has backed companies such as Snowflake, Unity, Gusto, and Modern Treasury. Before Altimeter, Brad worked as a multiple-time entrepreneur, was a founding principal of General Catalyst and worked at Park Capital.

0:34He's also an active thought leader in all aspects of the innovation economy, including numerous media appearances and a recurring role on the popular All In podcast. He is also active in areas that seek to improve the future of the country through efforts such as Invest America. We had a wide ranging conversation that covered a lot of ground, including technology, super cycles, AI, and the state of the market today. This was a fun conversation for me, and I think you'll really enjoy it. So let's get right into the episode now. Samir Kaji is the CEO and co-founder of Allocate. Allocate and Venture Unlocked are independent of each other.

1:08Any statements or references made by Samir or his guests regarding third parties, investments, or securities are solely their views and opinions and are not intended as investment advice or an endorsement of such parties or securities by Samir, his guests, or Allocate. Allocate or its clients may maintain relationships with, or investment positions in, guests, third parties, or securities mentioned in this podcast. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Brad, it's so great to see you. Thanks for being on. Well, it's great to be here and no lack of things to talk about in the world.

1:43I think there's a lot to talk about. But before we go into current events and what we're all seeing, I actually want to go back. I mean, you were, you know, you were raised in Indiana and then ultimately made your way to the tech. I think you had a few journeys in being an entrepreneur before starting Altimeter. Give us the snapshot of what got you into tech and then ultimately some of the things that really inspired and guided starting Altimeter, I think, in 2008. Well, I mean, we could go in the Wayback Machine. You're right. I grew up in a small town in Indiana. My dad was first-generation college, first-generation founder, started a company in 1978 in the auto parts manufacturing business.

2:24Unfortunately, interest rates were 18%. Inflation was roughly the same. There was no such thing as venture capital. He borrowed money from the local bank. And, you know, like I was in fourth, fifth grade at the time, you know, this valiant effort as a entrepreneur, which in my mind was a quite a heroic thing he was trying to do, but ultimately wouldn't work. You know, so much of your adult life is trying to make sense out of your childhood. And here I saw this guy who was my hero, who was clearly going through a lot of personal trauma associated with this failure. And that really sent me down a path to trying to understand the world of business because the world of business could help me better understand why this could happen.

3:09My grandfather, and I've told the story, his father basically said to all the grandchildren, there are four of us, you're not allowed to become entrepreneurs. You have to become professionals. So I go to law school to honor his wish. But in classic romantic literature fashion, I had to come back and ultimately be an entrepreneur to slay the dragon. So I left law school while I was in law school, and I'd always been fascinated with technology. But 1996, the Netscape browser was introduced in 1994, end of 94, 96. I think Mark's on the cover of pretty much every magazine. I gathered my classmates in law school, got around the single computer in the library.

3:53I showed them the Netscape browser. I told him how this was going to change everything. Kind of fit of haste, I decided to buy a one-way ticket to Silicon Valley because I had really not traveled much. I had never been to California. And I wanted to see what this place was all about. I landed at SFO. I got in a taxi. This was pre-mobile phones, really pre-internet. And I said, take me to Silicon Valley. And he said, well, where? There are a lot of places in Silicon Valley. And I said, I don't know, a hotel. And he dropped me off at the Rosewood Hotel. I ended up walking around and went into the Venture Law Group, which was a law firm at the time that was taking equity stakes to help companies get started.

4:34But what it did is it planted its seed and demystified this place. It looked a lot like the place I was from. It was very rural. I'd go back to business school in 99. While I was there, everybody was trying to start a company. As the resident lawyer, they all asked me for my help and incorporating their business and getting their business going. And two, they were going around Boston pitching people to raise money for their ideas. And there were a bunch of really excellent firms in Boston, Charles River or Matrix or Greylock or just go through the list. But there's this scrappy start, a couple of guys who were doing some angel investing, David Fialco and Joel Cutler.

5:13They were talking about starting a venture firm, but hadn't really started it. All my friends found their way to them. And at one point in one of those meetings, David Fialco pulled me aside. He's like, we're not investing in any of these guys, but you got to come work with us. And so I started working with them during business school, helped them put together their launch deal, early online travel business. I would end up becoming the co-CEO of that business. We grew it to over a billion dollars in gross bookings over the course of two years and sold it to Barry Diller in May of 2000, announced the deal in May of 2001.

5:46It was quite a formative thing being around them at the start of this venture capital firm, around them as part of this launch deal. And then I thought, well, okay, I'm going to go back and work at this new venture firm. But I had been bitten by the founder bug, being CEO of a business with 1 ,200 employees, selling it successfully. And I had a friend, a classmate named Bejal Samaya, who now is one of the leaders at Lightspeed. And Bejal said, hey, Brad, I have an idea for a new business. It was a local search business. Think maybe Yelp before Yelp. So he and I decided to start that business instead of going back to venture capital.

6:22And we get some term sheets from venture capitalists, but we had made a little bit of money. We decide we want to own more of it. So we bootstrap it. We own it ourselves. We end up recruiting somebody at a price line to run it day to day and sold that business to a public company in Seattle called Marchex. And that was a lesson. The first one was we had a bigger outcome, but I owned a little. The second one I owned a lot. It was a needle mover for a poor kid from Indiana, just getting out of debt from business school, etc. And then, you know, I decided I wanted to go back to investing. But I had learned during that period of time that I really was fascinated by this intersection between public and private.

7:00I was convinced that companies were going to stay private longer. They were going to raise more capital in the private markets. and that those companies would scale on the back of the internet to a much larger scale before they went public. And that if you wanted to capture what had previously been IPO returns, you really needed to be a participant in the venture market. I had deep networks there. I had founder credibility there. And so I thought that was a competitive advantage for me. On the public side, I got my series seven and 63 during law school, day traded stocks to put myself through law school and business school.

7:35I was really fascinated with the public markets, but I had no real professional hedge fund experience. I'd gotten to know Seth Klarman, who ran Baopost, Paul Reeder, who ran Par in Boston at the time I was running that first startup. And I went to Paul Reeder and I said, hey, I'll work for you for free. You just have to have lunch with me every day for the next two years and teach me the hedge fund business. You know, little did I know it would turn into a lifelong friendship, a lifelong mentorship, lunch every day. We still talk every week. And I went to work for Paul and I built his technology practice, both the public market technology practice, where I managed a pool of capital, investing in things early like Google and Priceline.

8:20And then I ran a venture pool of capital where I led the series B and in Zillow, in ITA software and Faircast and Sidestep. And so we built in no time a really successful technology fund that today we'd call a crossover fund. We didn't use that nomenclature at that point in time. But Paul knew. I said at the time I started, I'm an entrepreneur. I'm a founder. If I love the business, I'm going to start my own. So hire me accordingly. And sure enough, at the end of 2007, I said to Paul that I was going to launch my own fund. I didn't know the world was going to melt down in 2008 the way that it did, you know, and I just got married had my first child There was a lot of pressure not to launch my fund by the fall of 2008 I mean this was really the end of times But because I had started two things really from scratch I thought that if you studied some of the great firms Including park capital the firm I was at that was started in the middle of the snl crisis with less than$5 million, or you studied Baupost that was started in 1981, really in the aftermath of those double-digit interest rates and inflation, or even Tiger, which was started in the aftermath of the Tiger shutdown and the dot-com blowup.

9:38Those distress-era funds did quite well. I lived a pretty simple life. I knew I didn't need a lot of money. I started with very little money in the fall of 2008. It took me a few years to get back to Silicon Valley and to launch our first formal VC fund. But by 2011, 2012, I was living out here. It was off to the races. That happened to be early in the super cycle of mobile and cloud. And so it turned out to be a pretty good time to deploy those first few funds. Yeah. And I want to come back to super cycles in a second. But going back, of course, raising that first fund during one of the toughest economic dislocations we've seen up until maybe today.

10:19But at the time, that was a$3 million fund. So mainly friends and family, you're describing sort of this new way of thinking about this, which is crossover. We call it, of course, now we've seen the D1s and the Tigers. But back then, there was very few investors that were doing both public and private investing. I think famously, I think Legg Mason invested in the Series C of Zillow since he brought Zillow up. I the company, which of course it wasn't turned out not to be a great sort of outcome for them. But when you were starting, was there some type of true north that you saw? Like, you know, forgetting about the fact that you really felt like you wanted to start something, you were an entrepreneur.

11:00But I've heard you talk about this notion of essentialism in how you run a business. Was that apparent to you then in terms of creating the cast of which Altimeter was founded on? I'll come back to essentialism in a second because that's always, it's kind of a life philosophy and a business philosophy of me. But the really driving motivation, listen, I had started two businesses. I knew, I looked at lots of businesses with General Catalyst, with Par Capital. Every business needs a competitive moat and a competitive reason to exist. Like the question was, why does the world need Altimeter? Like what do I bring that these other firms like Tiger and Co2 didn't bring, right?

11:42What do I bring that these great venture capital firms in Silicon Valley didn't bring? And my observation was this. I was a founder. I was a byproduct of Silicon Valley. I had raised money in Silicon Valley. Like I understood Silicon Valley. I understood the journey of founders. So I was of Silicon Valley. Like that was my DNA. And I happen to be pretty good at public market investing. When I looked at the guys in New York who I admired, like Philippe or Chase-a-Tiger or Dan Sundheim, they were public market investors. They were stock pickers in New York who had not started companies, tech companies like I did, but they happened to do venture capital.

12:25So I thought there was a real opportunity to be venture first and public market second, as opposed to the other way around. And that was a big differentiator. To live here, to wear the black t-shirt, to have stood in their shoes, to have hired, to have fired, to have built technology. And to this day, what Altimeter means more than anything else in the mind of the founder, in the mind of early stage GPs, is just that. We have public market sensibilities. We can help you scale your capital. But unlike a lot of those late stage investors. We live here. We stand in your shoes. We do what you do. We're going to help you build this business.

13:02And I think that's a big difference in the mind of founders and a big difference in the mind of the earliest GPs who are looking for somebody to partner with. So when we look back at the prior decade, and most of it, if not all, was marked by this zero interest rate policy that created these incredible tailwinds for both companies and funds. And you've said something that is around the notion that the best founders strategically pick their investors. And during that ZERP period, perhaps that wasn't always true because it was often who was willing to write the biggest check at the highest valuation.

13:39Now, as things have shifted back, where it does seem like founders care about strategic capital, I'm curious from your standpoint, what about a fund makes the best founders pick them? And how does that then create the model of altimeter? The most experienced founders understand that in the journey to build this giant outcome that they hope to build, they're choosing partners that provide capital and intellectual resources to increase the probability of their success. If you're a founder and what you're trying to do is minimize dilution in that round of financing, and that's your only lens, then you're probably not the right partner to us.

14:27Because that lens will ultimately undermine your ability to find ultimate success. Your lens should be, is this partner going to provide the type of capital and the type of intellectual expertise, whether it's marketing, whether it's customer introductions, whether it's recruiting, whether it's, are they going to provide those things in a way that increases our probability of success? And I just happen to think we do that better than most of these other folks, okay? Particularly the ones who are not here. Every day we get up, we have to earn the right to be the founder's choice of preference in those moments because they do have choice.

15:09What happened when the world lost its mind and we went to the zero interest rate band really in March of 2020, right? You got to take yourself back. We didn't know whether COVID was Ebola. We didn't know. We knew the virality was exceptionally high. We didn't know the lethality of COVID. But imagine COVID had been as lethal as Ebola and as viral as COVID. The Fed and Congress did what I think was the right and appropriate response. Unfortunately, I think we stayed in that posture too long. By the spring of 2021, we knew that supply chains were breaking, that inflation was rampant, the cost of a cargo container from China had gone up 10x, and we already had vaccines.

16:03So staying another nine months at zero made no sense to me. And I think that what we started saying to founders is be careful. You're acting as though we're going to have zero rates forever. You're making short-term decisions based upon the highest price. But if you get too high of price that you can't grow into before you burn this capital, then you're going to be faced with this really nasty choice, which is to do a down round, which is very dispiriting to your company. It will distract you. It will distract your team because that team that had gotten options priced at a billion now is underwater by 50 % or 70%.

16:46They're demoralized. But not surprisingly, nobody wanted to hear that in the spring or the summer of 2021. I went on CNBC in October of 21. I said a normalization process post-COVID would have rates go back to their January 2020 levels and would cause a 30 % correction in the NASDAQ and an even steeper correction in venture because the multiples were even higher. And that, in fact, occurred. And I would say it took until really Q2 of 2022 until the rest of the world came around and Silicon Valley sobered up and came around to that view that things had fundamentally changed. So what do you do during those times?

17:36Because I had this very same conversation with people during the course of 2021 when everything was up to the right. I think the number of unicorns that were minted during that 21 period It exceeded all the unicorns minted up to that point. And there was incentives built into the system to be able to raise bigger funds, put more money into companies for those founders to optimize on things that fundamentally the market was giving them. So you're now in a situation where you have capital to deploy both on the public and private side, knowing what you think is going to happen, which is this dislocation that is where gravity comes back into the world.

18:19But at the same time, you don't know for sure where rates are going to go. And so in some ways, you have to continue to participate with whatever the market clearing prices for these companies. How did you handle it internally? And what was that? What were those internal discussions? Well, I'll tell you, and let me be absolutely clear. I would like to say that we did everything perfectly. We certainly didn't. I said on many occasions during 2021, We're all gaslighting ourselves. When you're playing a sport, you can wish that the rules were different, but you kind of have to play the game on the field.

18:55And we're on the field. And I didn't want interest rates to be zero. I didn't want prices to be where they were, but that is the game we were forced to play. So at Altimeter, we talk about the future as a distribution of unknown and unknowable probabilities. Okay, so what we spend our time as a research institute doing is trying to discern how those probabilities for a set of future unknown events are going to play out. And what we knew by the summer of 2021 is that the probability that multiples would reset lower was much higher than what was being priced into the market. So on the public side, we started putting on hedges.

19:43Now, of course, we had committed to a lot of deals in Q1 and Q2, many of which closed in Q3 of that year. And by October 21, we were basically out of the market. We never say it's all or none because we don't know the future with that degree of certainty. But what we should be able to figure out is less or more. And in the venture world, you want to find that magic quadrant where we're early in a super cycle, but we're in the bottom half of pricing. And what was clear in the summer of 2021 is we were in the top third of pricing and we were later in a super cycle. And, you know, that tends to be a tough period in which to really run up the score.

20:30And as Bill Gurley reminds us all, he's a great friend. And his number one lesson is the venture business is a cyclical business. It is not suspended from the economic laws of gravity. Some people say, well, I'm just going to invest in great companies and they'll be worth more in 10 years. But as Warren Buffett says, every investment is determined by the price of entry. You've got to find that intersection. And now I happen to think as we sit here in Q3 of 2023, we're now in the bottom third of the pricing cycle. And we are very early in the next and very big super cycle, which is AI. So it reminds me more of the period from 2002 to 2005 or 2010 to 2013, 2014.

21:22I think this is a really interesting moment. But I would say late 20 and the first three quarters of 21 were particularly pernicious from a pricing perspective. And looking back, I mean, one of the things that is also this truism is you can't really time market. So it's hard to know exactly where you are. But you can have these probability based points of view where you can dial back or dial forward. And it sounds like in 2021, the decision was made primarily at the end that we were at this really difficult place where it wasn't just the clearing price of these companies, but the risk that was imbued by taking the level of capital that they were at the valuations in terms of if the market resets, where do these companies end up?

22:12And I think the tough thing for a lot of people to reconcile is this nature of looking at technology as this exponential curve. And we've seen this before, whether it's personal computing to the Internet, mobile cloud, now AI, versus the overlay of venture investing, which is highly cyclical. And it's really hard to make those decisions without really understanding exactly what ultimately is the right decision to make in that very moment. And we've seen people, really smart people that you and I both know, that were investing heavily through 2021 and were essentially gaslighting themselves into thinking that we were in a new paradigm where gravity wouldn't come into play.

22:56Now, things have changed, and I agree with you. But when you think about super cycles, I mean, you've been through these super cycles before. You mentioned coming to Silicon Valley, the internet was new, mobile and cloud and AI. What are the markers of a superciple from a technology standpoint where you can point to something as a material platform that companies and entire industries are going to be reshaped on? It's a great question. I want to come back to the other one in a minute about institutionally why people did too much. It's a really important conversation. Let's come back to that. But let's talk about the super cycle question.

23:33Ultimately, technology only has value if it improves lives and outcomes. Why was the internet going to be something that was as disruptive as it was? Because it held the promise to make all of our lives as consumers way better. We could discover information we previously couldn't discover it. We could discover it in a fraction of the time. We could have better life experiences, whether it was places we were going to travel or things we were going to do with our children or restaurants we were going to eat at a Friday night or knowledge that we were going to be able to share with our kids on how to do their algebra homework.

24:12Everything in our world improved because of this new thing. On the enterprise side, it allowed every enterprise in the world to connect. It allowed enterprises to communicate with customers in radically different and more efficient ways. and it allowed enterprises to radically reduce the cost of doing certain activities. Those two things, like when you touch all of enterprise and all of consumer in a way that is a step function different than the way the world operated before, that is, I think, prone to having extraordinary unlock of value. Let me juxtapose that against crypto as an example. People have said that I'm anti-crypto, which is not a fair characterization.

24:55I've been following crypto for 15 years or 13 years. If I think about, you know, some of the people I first heard about crypto from, the likes of Mickey Malka, you know, folks who sold their startups in South America, who had their profits inflated away by governments because they had currency controls. It would have radically improved the lives of those people had they been able to put their life savings in crypto and move that seamlessly out of the country. That is a real benefit to those citizens and those consumers living in those places. But when I saw a lot of the stuff that was being purported to be benefits of crypto in 2019, 2020, etc., I really didn't get it.

25:41I didn't see the benefits to the consumer beyond those original benefits that had been true for a decade, right, and that were really captured by Bitcoin. Like if you wanted to take advantage of that benefit for those citizens, then you could just buy Bitcoin. You didn't need to invest in all these other things. And so I said at the time, the total market cap of crypto, I think at its peak, was$3 trillion. And I looked around. I said, is it making companies' lives easier, better, cheaper, faster? No, I couldn't find a single enterprise that I talked to that said, we're using crypto and it's helping us better connect with our customers.

26:20or it's making running a call center cheaper. I couldn't find consumers, you know, outside of a few who had apes on their Twitter handles or whatever who said like, this is radically changed. And by the way, I was looking hard because if you're gonna be a venture capitalist, you better not be dogmatic. You better be open-minded to the possibility you're wrong and these things that you don't understand will become understandable. So I said 3 trillion represents a successful super cycle. That's what the entire cap of internet was in 2005. And I said, it's a super cycle in terms of valuation, but I don't see the delivery in making consumers' lives better.

27:02It's not helping me travel better. It's not helping me find a better restaurant. It's not helping educate my kids better. And so it was really those things when I say, is it real or is it a pretender in terms of a super cycle? Mobile devices, that made every consumer's life better. made every business's business better. The cloud computing didn't directly have a radical, you know, impact on consumers, though Google Docs and a lot of other things that consumers use were taking advantage of the cloud. But derivatively, it had a lot of benefit to consumers because the things that they, whether it was like they didn't know were going on in the background to lead to better targeting of ads or better targeting of content is because we're capturing all this data in the cloud.

27:48And so again, if you looked at it for the enterprise, part of the reason we were early to the cloud with Mongo and HubSpot and Twilio and Okta and Snowflake, et cetera, is because we had a belief when the rest of the world didn't, that the cloud was going to be cheaper, faster, and more performant and more secure. And those things would ultimately cause the replatforming of all of our compute into the cloud. And we knew because we're excited about this burgeoning thing around deep learning and augmented intelligence, that the only way we could ultimately build supercomputers to take advantage of all the world's data is if all the world's data was actually captured, frictionless, and in the cloud.