A capital allocator is someone who balances the humility that they are not the world’s best at something (or might never be) with the deep belief in the long-term potential of an asset class (even if that means they will play a less active role in the future of that asset class).
As always, the last holiday period was a time for introspection and reflection. Many of the conversations I had were around request for startups (RFS) with VCs and request for funds (RFF) with LPs. Many of the latter focused on spaces and problems that individuals and family offices personally care a lot about.
In the essence of putting my vote for all the below, I’m going to phrase them as questions and pontifications rather than statements. Since I don’t have the capital to invest in such organizations, but also it is highly likely that these organizations need no external sources of capital. In fact, a number of the family offices I’ve conversed with have enough capital where they no longer use external bank providers for lending, but borrow and invest only within the families.
Is there a world where the LP is the sourcing engine for the GPs in their portfolio?
Like Deep Checks, but catalyzed by a single institution with large brand appeal. The problem is two-fold:
- Most LPs are not good at identifying great deals at the pre-seed and seed stage.
- Many LPs love co-investment opportunities. They’ve historically invested in brand-name funds expecting such opportunities, but largely evidenced in the 2020 to early 2022 hype cycle, most got no calls from their VCs at all. So, they’ve moved towards emerging managers who don’t have reserves to cash in on their top deal flow.
If an LP is willing to be a sourcing engine which complements their portfolio funds’ deal flow, that LP will have a chance to build (a) conviction earlier, and (b) build relationships with founders earlier. And in the sourcing/picking/winning framework, outsource the picking element to people who have more refined tastes built upon years of being boots on the ground.
Of course, said LP cannot enforce that GP invests in a certain type of company in which its sourcing engine brings in. That’ll defeat the purpose of investing in GPs in the first place, as well as diversifying risk.
Is there a world where a deeply networked LP leverages their network to support the underlying startup portfolio?
There are a number of fund-of-funds in the world who offer their geographical connections to help a portfolio fund’s startup grow in their respective market, but I’ve seen comparatively few, if any, LPs who offer their deep networks as advisors/mentors to portfolio founders.
For the most part, a VC is likely to better connected to tech talent, executives and founders. But quite a few family offices and endowments have their own deeply entrenched networks. Endowments have alumni networks. Family offices, depending on their source of wealth, are well-connected in the industry that created their wealth. Luxury brands. Oil and gas, as well as renewable energy. Infrastructure. CPG. Pharmaceutical drugs. Transportation. And the list goes on.
In other words, the LP would help a VC win deals based on their expansive combined networks. And sometimes the best advice a founder can get is not from another founder or VC, but someone tangential to the ecosystem who has seen the world from a birds eye view.
I’ve written before that there are three kinds of mentors: peer, tactical, and strategic. And you need all three.
- Peer: Someone with similar level of experience as you do
- Tactical: Someone who’s 2-5 years out and who can check your blind side
- Strategic: Someone who’s attained success in a particular field and is often 10+ years out from where you are. They offer the macro and big-picture perspective, and help you define long-term goals.
Founders often have their peers already. And if not that, there are a number of communities, forums, and groups out there where founders can exchange notes with each other. Many VCs often bring their founders together to co-mingle as well in annual or quarterly get-togethers.
VCs themselves often act as tactical mentors, and given how their portfolios grow also have access to a plethora of tactical mentors for any given company.
LPs with their large networks of people who run multi-billion dollar enterprises (often not tech), many of whom achieved financial success independently, have access to people who could be strategic mentors for founders in their fund-of-fund’s underlying portfolio.
Request for Funds of Funds?
This isn’t a particularly traditional fund model or fund-of-funds model, but nevertheless would be an interesting product for asset owners. Namely large institutions who are looking for product diversification and who have little to no short-term and medium-term liquidity needs. Large single family offices, pensions, and potentially some endowments and foundations.
Is there a smaller product that focuses on vintage diversification from both an entry and exit perspective?
Most investors focus on entry vintage diversification, not as much for exits. Some LPs do, to make sure they have liquidity in every vintage. While I’ve seen only a small, small number of funds and fund-of-funds do this, I wonder if this is something that is more interesting to a broader customer base of LPs.
Of those I’ve seen so far:
- Crypto funds that hold both token-based assets and equity-based assets. The token-based ones are expected to deliver DPI within years 4-8. The equity-based assets are expected to deliver DPI within years 8-12.
- Funds-of-funds that hold multiple asset classes within a single LP entity. Secondaries for 3-6-year time horizons. Buyouts for 5-8-year time horizons. And venture capital for 8-12 year time horizons. Some also hold venture debt assets and cryptocurrency themselves.
- Large multi-stage billion-dollar plus VC funds that have a suite of product offerings for LPs.
There are many emerging LPs and LPs who see VC as an access class who can’t write massive checks, but need to hedge their bets when writing into a speculative asset class.
While I’m still working to collect more data on this, I do wonder. In modern history, market cycles happen every 8-12 years. Venture funds exist on 10-12 year time horizons. Theoretically, that means if you’re investing in the least expensive entry windows, you’re also existing in the lowest revenue multiple windows. And if you’re investing in the most expensive vintages, you’re also existing in the great markets. Which effectively means, the delta between “buying low” and “selling high” are roughly the same no matter which markets your entry point is.
The data seems to suggest that so far, but the publicly available datasets (i.e. Pitchbook) have heavy survivorship bias. There’s no incentive for funds that fizzle out midway or near the end to report their metrics. Carta is really interesting, but their datasets aren’t robust till after 2017.
As an allocator, it just means you just need to be in every vintage. It makes me wonder if it really matters to be investing in down or up markets. Probably not. As the sages who have invested through multiple cycles tell me. Though I wonder if underwriting venture funds to 15 years changes anything on the DPI front across multiple vintages.
Photo by Felicia Buitenwerf on Unsplash
