The art of raising from LPs in an economic downturn with Mark Suster, Upfront Ventures

0:00Welcome back to another episode of Venture Unlocked, the podcast that takes you behind the scenes of the business of venture capital. I'm your host, Samir Kaji. Today, we're excited to bring Mark Zuster back on the pod. Mark is the managing partner of Upfront Ventures and also an active contributor of great content for the venture ecosystem through his blog, Both Sides of the Table, which I'd highly recommend you subscribe to. Mark and I were recently chatting about venture funds raising this market, and given some of the macro challenges, we thought it would be timely to record a session on what we're both seeing and how venture fund managers should think about navigating in this market.

0:32I really hope you'll enjoy my conversation with Mark. So let's get into the episode now. Samir Kaji is the CEO and co-founder of Allocate. Allocate and Venture Unlocked are independent of each other. Any 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.

1:06This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Mark, it's so good seeing you and thanks for being on the show for the special episode about fundraising. Of course, I'm always happy to talk to you. Let's talk about what's going on. I was actually just looking at the numbers right before this call about VC fund fundraising,$150 billion plus 2020-21, dropped off a cliff in 22, early part of 23, about$33 billion raised during the first six months. And it does seem to be affecting everybody, big funds, small funds. Since you spent so much time both with LPs and GPs, maybe provide a summary of what you're seeing and hearing at a high level.

1:50If I'm talking for a minute to fellow GPs, let me tell you that the market that you exist in is no different than the market you're serving where you're looking to invest. So everything that you can see psychologically going on for your own fund and how you're deploying capital, of course, is the same of LPs. And let me say it clearly, which is there was way too much supply of capital for the last seven, eight, nine years, maybe even 10 years. As a result, every startup you funded got funded at a higher price after you. Everything you funded seemed to be working. Loss ratios were at an all time low.

2:35Loss ratios, deals worth less than 1x were south of 40%. By 2021, it had gone south of 20 % that were any amount of loss. And we all got used to this period of time where fundraising into startups was easy. So the same was true of managers. LPs have always been hard to raise from. They have always been very selective with where they put their dollars. But so much money entered the ecosystem in the last five, seven, eight years that we have all fooled ourselves into thinking this is easy. Turns out it's not easy. And I would say today reminds me a lot of 2011. Because 2011, we were just fresh off the global financial crisis.

3:23People were questioning whether or not venture capital was a real asset class. There was a report that had come out from Kauffman saying, like, don't invest in venture capital. and of course if you'd followed that advice you'd have missed the best decade of venture capital maybe ever i think it's just a return to normal is like i think how i would call it you mentioned 2011 and i remember the coffin report i think it was called the enemy is us right and it talked about the big funds versus small funds the difference is back in 2011 rates were really low rates are much higher at least from what we've seen historically over the last 25 years What are you hearing, I guess, from the institutional LPs?

4:06Because a lot of the institutional LPs had the denominator effect affect them in 2022, at least, when public markets went down, the actual markdowns of the private markets didn't happen, and so they were over allocated. It seems like some of that has been not necessarily fully resolved, but to a certain degree, we've seen the public markets go up. Private markdowns are happening. But what are you hearing, I guess, from the institutional investors as they approach venture today? So we can't put everyone into one bucket. You have endowments, U.S. endowments. You have big pension funds. You have foundations.

4:45you have corporate investors and then you have family offices and of course they're all in different situations i would say the people who seem to be most over their skis have the biggest problem with the denominator problem which just as a reminder for everybody if i have a fixed allocation for venture let's say that's eight percent of my total investment book and then suddenly the stock market percentage, because the stock market declines by 30 percent, if I was at my target at 8 percent, I might find myself at nine and a half, 10 percent because one of the other categories went down and venture doesn't mark down as quickly.

5:26So on a relative basis, I have too much assigned to venture capital. So to rebalance my books, I have to slow down my pace to venture. That's the denominator problem. There also was the numerator problem. The numerator problem is because venture got marked up so much in 2020, 21, and 22. Because venture got marked up so much, my percentage, my relative percentage also went up. So you had a compounding problem on both sides. I would say there are really three pools of capital that are not overtapped that the smartest, most savvy investors are focused on. Number one is pension funds that historically didn't have big allocations to venture.

6:08And that's a game for scaled venture, because those are people writing$7 ,500 million minimum. So not your fund one, fund two, fund three that Samir, you are normally advising and talking to. So that's kind of not available. You shouldn't be talking to them if you're raising a$200,$300 million fund and you're fund one, two, or three, they're not going to invest. The second big pool of capital is sovereign wealth funds. So there are a ton of investors that are spending time in the Middle East right now. And there's a lot of capital. And in Singapore, there's a lot of capital in those two places.

6:46They historically have not been in venture or had access to venture. They know that they are suddenly the pretty girl or pretty boy at the ball right now. And they know that everyone's trying to get access to their money. They rightly are a little bit skeptical and they want to see how committed are you to you? You know, is this like a one night stand or are you really committed? Right. That also is not really a game for early managers. So the most important third pool of capital is RIAs. And this is people who are managing usually high net worth individuals, people who don't have scale, who would like some exposure to private investments, who know that historically endowments and foundations have done really well by investing in privates who haven't had the availability to do so.

7:36And those pools of capital are increasing their exposure to venture. Now we can talk about some of the problems of the last 12 months, but generally speaking, want more access. And I think that is the best place for emerging managers to look. And let's maybe double click on something there and maybe add a fourth, which is direct family offices that are domestic, not just the folks in Singapore, Abu Dhabi, Dubai, the Middle East regions. And RAs, of course, do work with a lot of those families too. So it's either working directly with the family or going to the RA that's managing, putting something on the platform, and effectively allowing their high net worth individuals to invest in an asset class that historically has been unavailable.

8:22So you're right that the emerging manager category, I think I looked at the numbers last year. I think it was at the midpoint of this year. Something like 62 % of the capital was raised by 6 % of the firms out there. That does lead to what you just said is the bigger funds are able to raise from these big pools of capital. But if you're an emerging manager, that's a fund one, a fund two. Let's even say a fund two. You might've had a fund one that's two years old. You have some performance, but everyone rightfully is going to be skeptical about the markups, the resiliency of that portfolio. So what are you seeing as maybe the path for somebody that's raising a fund to that does have a long-term view and wants to build a long-term franchise?

9:12How do they navigate in this environment? And what is that pool of capital? You mentioned RAs. How do they go after them? First of all, of course, you're right. There are family offices that act independently and invest on their own. So I think that is another good source. I think when they're working with managers, when they're pooling their money together with OCIOs, outsourced CIOs or RIAs or other people, they just end up with the degree more sophistication of understanding the asset class, which is why that's appealing. Or if they're working with people like yourselves, where they really understand what venture is, then you're entering a conversation with a sophisticated buyer.

9:55And I think that's a good thing for emerging managers to be in that position. Look, fundraising isn't easy. It's not meant to be easy. And venture capitalists historically have not allocated that much time to it. Like we at Upfront, we think very long-term about relationships. I remember so many people that I went to see in 2011 said no to me. And VCs don't like to be told no. And I think I found it a little bit easier, Samir, both because I had been an entrepreneur before, so I was used to no, and because it was 2011 where the norm was no. So I didn't feel like anything was wrong with me. And I said to every LP who passed, listen, I totally get it.

10:42Like I'm first time managing partner. The fund isn't new, but I had just taken over as managing partner. I'm going to tell you the five things that I'm going to achieve as managing partner. And I want you to be in line first for my fifth fund. I was raising fund four at the time. And overwhelmingly people told me no. There was really one guy who turned up, who said, I believe in you. I believe in what you're doing. I'm going to be the guy who takes the risk on you. I call people like this egg breakers because they're people willing to break the rules. You know, the old saying, like you can't make an omelet unless you're willing to break some eggs.

11:19Right. And the guy was Jamie Sparrens. He worked at Morgan Stanley at the time. He's no longer there. I took seven trips to West Conshohocken, seven. And I remember because he called me on a Saturday and he said, I think we're making progress. Could you be here on Monday? And I was with my family camping in the mountains. It's the first time we've ever camped in a tent together. And I said to my wife, I need to leave you here. I've got to jump on a red eye and go to Philadelphia. And luckily I have a very patient wife, a very understanding wife. And I did that and I flew out there because he said, come.

11:58And that's really what it takes. It was the seventh visit. And for whatever reason, that was the time. And he called me a week later and he committed 22 and a half million dollars. And that will be the best performing fund that upfront's ever done. So I feel grateful for the risk. And I told them, you're a lifetime friend, anything you ever ask of me, the answer is yes, because you took the risk when no one else would. But the truth, Samir, is that by fund five, all of those people that I was nice to when they said no, that I kept the relationship going through the fundraising process, the next fundraise was so easy.

12:35And that was a 2015 fund. I had, I want to say like$95 million of new capital, even before I started asking people for money. So you really need to manage through one cycle and understand that if you're raising fund two, you might not meet all of your goals. You might not meet all of your ambitions. You might have to get used to hearing no's and manage through that and get to your next fund. And I think you'll see more yeses as long as you consistently keep relationships built and deliver against what you said you would do. There's another thing that I do want to juxtapose in a minute in terms of the differences maybe in 2011 and where we are in 2023.

13:16Before we go there, though, one thing that I'm curious about is as you thought about raising fund four, talking to a lot of LPs, that speaks to almost like building a sales funnel. You're picking the right target. You mentioned as an emerging manager, there's no way I should go to a pension or sovereign wealth fund and these folks. So it's figuring out who your target segment is and then building a pipeline around it. Tell me a little bit about how you built that pipeline and how do you move people through the sales funnel? I'm a big believer in referrals. It's no different than selling enterprise software in that regard, which is if I cold call a senior vice president at a customer, they might take a meeting.

14:01But when they meet you, they're leaning out like their arms are crossed and they're leaning out and like, tell me why you're wasting my time. When a customer says, man, we got a lot of positive benefit out of using this tool. You really ought to meet this person and see what they can do for you. They come leaning in. And the same is true for venture capitalists raising money. So if I ping a bunch of LPs and I say, I'm going to be in New Orleans, would you meet me? I'm going to be in Chicago, would you meet me? Most of the time they'll say, sure, stop by, right? Because it's their job to meet people.

14:38But having a referral that said, hey, I've sat on a board with Mark. He was valuable. Would you meet him? And it's someone that they trust. That matters a lot. So the top end of your funnel is just knowing who's out there, segmenting it by are these people who invest in my stage. Let's say I'm raising$150 million. If it's people who are writing 100 million plus checks, you're wasting your time. If it's people who have never really invested in venture, you're probably wasting your time. So making sure there are a few managers that are at the right stage size. You know, because we've talked before, I told you, for me, that's why buy anything?

15:21And why buy anything is like, are you really in the market for this kind of venture capital? And then the second rule of sales is why buy me? Do you buy my differentiation, what I do that's differently than other people? And so that's just a segmentation game. So we research who's in the market. We're constantly talking to VCs and LPs, asking who's active, put it in a funnel. and then we look for buying signals okay so it i usually have my rt ir team like try to get a initial call to just feel out whether it's worth our time so if you say i have too many managers and we're trying to pare back but yeah we do occasionally take new people you just have to beat someone who's on my existing roster maybe i could beat them but like that's not a very efficient use of my time.

16:13If they say we're over allocated to venture, our target is 12 % and we're at 22%, I'm probably wasting my time. Now, what makes our ears perk up is if they say we're building a program. We're at eight managers, we'd like to be at 18. We're at 4%, we'd like to be at 9%. And we just ask, what is your current outlook on venture? If it's highly referred, if we feel like they are interested in our stage of venture, if we feel like they're in a phase of their deployment of capital that we would be a good fit, we put a lot of energy into Top of Funnel. Now, Top of Funnel, Samir, is incredibly easy. It's easy because everyone's nice in the first meeting.

17:00They want to learn. They want to get to know you. They smile. They ask good questions. So you walk away thinking, man, this is easy. And then nothing closes, right? And so the problem is top of funnel. Like if you're smart and good at segmentation and you do a little bit of desk-based work and you ask your friends for referrals, top of funnel is easy. Mid-funnel is where everything dies. Mid-funnel. So tell us about mid-funnel because I think you're right. You know, you have that first meeting. You walk away energized. They're asking good questions. And a lot of times the manager will think, oh, I got them.

17:33They're going to definitely come in. I could feel it. A month goes by. You send an update. Maybe they respond. Maybe they don't. And at some point during that mid-funnel, because these things do take a long time, you lose momentum. And then you realize that what you thought was real is actually not real. And you realize maybe you hadn't built enough of big of a top of the funnel and moved the high value prospects through the mid-funnel. What does it actually mean to move people through mid-funnel? So I wrote a blog post about this once. I think you know I keep a blog both sides of the table. And I have Y-axis is love and X-axis is time.

18:13Okay? Love and time. And when you're in the room and it felt magical and they engaged and asked you good questions and you built rapport, it was probably real. You know, I'm not saying that they weren't like – in that moment, they're like, hey, we could write a check here, right? But 60 days later, 90 days later, they've met 38 other funds and they sort of kind of forget you. Like Mark, he was that, was he that guy? He's from California. He's a gray hair dude, right? You want to think that you're so memorable that they know everything about you and they just don't. And it's no different than when we see an entrepreneur.

18:55If we see an entrepreneur in the meeting, they might have wowed us. And then six weeks later, we've seen 48 other companies and we're like, yeah, they did AI for voice recognition, you know. So you need to mid funnel is about having a campaign that sustains itself over six to 12 months. So you've got to have a plan for what are all the documents I'm going to release over the next year? What is all the materials I'm going to share over the next year? if you have more than a solo GP, I always tell people don't go together. Because if you have two GPs or three GPs, and you all go together and you go to St.

19:37Louis and you meet a high profile prospect for you. Now there's no reason for them to meet you again, because they met you all. So you call them six weeks later and say, can we meet you? And they're like, they don't want to meet you because they know that's a that you know, they have to now do work or decide to tell you no or decide to buy. But if you see them and then six weeks later, another partner happens to be in town and six weeks after that, you invite them to an event in Chicago that you're doing, that you're hosting with a bunch of LPs. It's just a way of continuing to keep engagement, which is no different than any sales marketing campaign that exists in any market.

20:17You need to produce materials. You need to send them emails. You need to stay top of list. I also tell people like, it's really good to get people out of their office. Like if you sit in an office with a PowerPoint or keynote slides and you're flipping a deck, you're doing what everyone's doing. And you probably know this from our prior conversations. We did something we called city tours. We decided to travel all across the United States. We went so far, we've been to seven separate cities. We host 12 to 14 LPs in a dinner discussion, no obligation to them. We're not pitching people. I invite other GPs to attend.

20:54So it's not just an upfront event. And we host a dinner and have a dialogue with people. It's the kind of stuff we do with entrepreneurs as VCs all the time. We do dinners, we do breakfast. We just don't do it with LPs. And that makes no sense to me. So we started hosting these with LPs. And lo and behold, I learn a lot about what's going on in their industry. I learn a lot about what their challenges are because we talk about them as a group. And they get to know me in a context that's different than the conference room. And then we're a little bit more memorable. When you think about those type of events, it makes not only a ton of sense, but it seems like a great return on investment because you're also learning.

21:36You're getting a bunch of people in a room in a less high-stress situation because they're not looking to buy, they're just talking. And actually, LPs do like talking to each other. What are some of the other non-obvious things that you've learned in terms of great ROIs, in terms of getting people through that mid-funnel? Well, first of all, LPs love to meet entrepreneurs. They don't get invited to meet entrepreneurs a lot. And that's something most VCs have access to. I remember in the early days of Tinder, Sean Radd, I had backed Sean's previous company. It was called Adly. And then suddenly Tinder was the hottest thing in the world.

22:14So I called in a favor and said, Sean, I'd like to host a bunch of LPs. If I did, would you come to a dinner with me? And, you know, he was super gracious and said yes. And, you know, so I was writing to LPs saying, would you like to come to meet the CEO of Tinder? And this is, again, when Tinder was on the ascendancy, right? So So what does every LP want to know right now? They all want to know what's going on with AI. Like they read about in the paper, they hear about it from every VC. They don't want to hear about it from VCs. They want to hear about it directly from the CEOs who are running that.

22:48So much better if you could host eight CEOs talking about how their businesses are responding to AI and invite four LPs to attend. There's so much low hanging fruit for what you can do. and you know i always goes back to me this thing about sales uh i don't know have you ever heard of zig ziglar now yeah so zig ziglar i'm sure no one on the no one who's watching or listening uh will have heard of him he's old school but it was all about sales and he's a genius and what he said that always sat with me samara is he said um people don't care how much you know until they know how much you care. And I'd love people to reflect on that.

23:34People don't care how much you know until they know how much you care. So the care how much you know, we all like to feel like we're super smart and we all went to good schools and we want to tell everything we know to people. And we also think that's what they expect of us. So like, it's almost like this imposter syndrome thing. Like I have to know everything about technology and everything about the market and tell people how smart I am to win. But in reality, they also want to know that you actually care about them, that you are interested in them, that you're going to be a real partner for them.

24:09It's kind of like I was saying to you about the Middle East. You turn up once and think people are going to suddenly throw$20 million at you. They're like, you're here for my money. You turn up three times or you do them favors or you host them at an event in New York or London, they'll see. So for me, we host LPs all the time. We don't ask for a lot all the time. We're trying to tee up opportunities for them. And they see you just as, he's kind of a nice-ish, normal guy who's got a point of view and an opinion and surrounds himself with smart people. And I like the way that guy thinks. Not everyone will think that.

24:45But if you're having 12 people turn up at dinners seven times in six months, that's 42 people. When you think about those dinners, and of course, you're in a position where you have institutional LPs, maybe some family offices as well. And many people are raising from both camps and maybe it's$150 million fund. You know, I may not be able to raise from the pensions, but certainly fund of funds, endowments, foundations. And then I also have my family office, which are two very different segments in terms of the way they behave, characteristics. what have you noticed as the tangible differences when talking to these groups and ultimately how does that shape how you work with them well as a starting point if it's a family office is it run by the family or is it run by an outsider by a professional manager usually when you're talking to big institutions well not usually always they're run by professional managers i think when it's your own money, people have a harder time making commitments.

25:49They have a harder time just thinking in aggregate numbers and I'm just making 12 manager bets. I find it easier when you're mostly dealing with professional management, managing other people's money. There's a sort of more of a dispassionate, I'm just going to look at, do I think you have the right skill sets, the right access, some competitive edge? Do you have a history of performing well? And that's suited me better. Maybe other people have a different model. Other things, Samir, that I test for, you know, we're an atypical investor up front, and I'll say it this way, which is in a really booming market, we never perform as well.

26:34And the reason is we're not rushing to get into the hot category. So if you wanted to perform incredibly well in the last 18 months. And you're not worrying about cash returns. It's just TVPI. You should have put as many quick dollars into small dollar increments into AI because rest assured someone else was going to market up to an astounding high price and it will be valued at, let's say, a billion dollars. That doesn't mean it's worth a billion dollars. That's the value. whereas we tend to shy away from momentum and try to focus on where we think the market's going to be in three four five years and so you don't get as quick of markups but in a correcting market like this we show much better because we have like i always say to people look look at unicorns in 2012 there was one unicorn one in 2013 there were three in fact aileen lee wrote the article in 2013 when she wrote it there were four they were unicorns that's why she called them unicorns by 2015 there was like 45 net new ones created that year by 2018 it was 125 in 2021 there were 725 ish new unicorns created 2021 compare that with the public market samir There are about 175 internet companies worth a billion dollars public in the US.

28:08There's about 175 software companies worth a billion dollars. So approximately 350 total, total, that's it. Public companies worth a billion. So why do we think you could create 725 net new ones in one year? It's fantasy. Everybody's TVPI who were in those deals are fantasy. So I tell LPs, if you're going to look, go through someone's portfolio, say how many were funded by SoftBank? How many by Tiger? How many by Coachu? And I'm not picking on those people. They're good investment funds and they make money. But you can rest assured that if they have a bunch of those funded in 2021, they're just significantly overvalued.