Chris Douvos founded Ahoy Capital in 2018 to build an intentionally right-sized firm that could pursue investment excellence while prizing a spirit of partnership with all of its constituencies. A pioneering investor in the micro-VC movement, Chris has been a fixture in venture capital for nearly two decades. In addition to successfully identifying and catalyzing nascent funds, he bridges a gap between the providers of capital and the consumers of capital by creating platforms for transparent dialogue. Chris authors the blog SuperLP in which he chronicles his adventures investing in venture capital and private equity; and his brick oven pizza parties, small gatherings of LPs, GPs, and entrepreneurs, are well-known in the Valley. He is sought after not only for investment capital, but also for his advice, and serves on numerous managers’ advisory boards.
Prior to Ahoy Capital, Chris spearheaded investment efforts at Venture Investment Associates, and The Investment Fund for Foundations. He learned the craft of illiquid investing at Princeton University’s endowment. He started his business career as a strategy consultant at Monitor Company. Chris regularly speaks at industry conferences and business schools and is a frequent resource for tech and business media. He earned his B.A. with Distinction in history from Yale College in 1994 and an M.B.A. from Yale School of Management in 2001. He was awarded the CFA Charter in 2004.
[00:00] Intro [03:01] What Chris learned from the founder of Greylock and the Chief Investment Officer at Yale’s Endowment. [06:25] How a timber pitch and losing the nose game earned a Chris a front-row seat to venture capital. [10:35] How 2001 is similar to 2023. [12:44] What legislation makes California special? [13:11] Do firms need to have geographical presence? [16:44] How did Chris first start to build his deal flow? [23:17] What needs to go in a good cold email [24:53] Breaking down how Chris constructed his first opinion on great venture capital firms [30:04] How did Josh Kopelman build ‘ecosystem as a service’ in 2004 [33:28] How did Chris end up backing Data Collective [37:52] What are the 4 leading indicators of fund manager outperformance? [48:46] Which firm of Chris’ recent portfolio is willing to be wrong and alone? [51:32] Chris’ Peter Dolan impression [56:09] Thank you to Alchemist Accelerator for sponsoring [58:45] Legal disclaimer
“Entrepreneurship is like a gas. It’s hottest when it’s compressed.”
“Have an opinion. Have a viewpoint. There are so many investors who are just caught up in these tides. They’re heat-seeking missiles, looking for the new, new thing. The reality is that by the time, the new, new thing is new to them, it’s already a little bit longer in the tooth in the ecosystem — all the great deals have been done.”
“I’m looking for well-rounded holes that are made up of jagged pieces that fit together nicely.”
I’ve always been a fan of easter eggs. Cup of Zhou also happens to be one of them. Superclusters is another. But this time, rather than leaving it for surprise, I’d love to spell out why and with that, the purpose of this podcast.
In the startup world, we always say startups are the stars of our universe. They shine the brightest and they light up the night sky. We also have tons of aphorisms in the startup world. For instance, “Aim for the stars, land on the moon”. Startups are often called moonshots. They need to achieve escape velocity. And so on.
So if startups are the stars of the universe, galaxies would be VC firms that have a portfolio of stars.
And if galaxies were VC firms, superclusters would be LPs. Superclusters are collections of multiple galaxies. For example, the supercluster that the Milky Way is in is called Laniakea (Hawaiian for “immense heavens,” for the curious).
So why a podcast on the LP world?
The LP industry in ten years will be much bigger than it is today. We are not even close to the TAM of it.
The LP industry will be a lot more transparent than it is today. FYI, as many of you know already, the industry is very opaque. Many want and still like to keep their knowledge proprietary. But what’s proprietary today will be common place tomorrow. I’m not here to share anyone’s deepest, darkest secrets, or anyone’s social security number. That’s none of my business. But the tactics that make the greatest LPs great are already being shared over intimate happy hours and dinners between a select few. And it’s only a matter of time before the rest of the world catches up. We saw the same happen with the VC industry, and now people are moving even more upstream.
I think of content on a cartesian X-Y graph. On the X-axis, there’s intellectual stimulation. In other words, interesting. On the Y-axis, there’s emotional stimulation, or otherwise known as fun. Most financial services (for instance, hedge fund, private equity, venture capital, options trading) content tends to highly index on intellectual stimulation and not emotional. And for the purpose of this pod, I want to focus on making investing in VC funds fun AND interesting.
You can find my podcast on YouTube, Spotify, and Apple Podcasts for now. In full transparency, waiting on RSS feed approval for the other platforms, but soon to be shared on other platforms near you.
You can expect episodes to come out weekly with ten episodes per season, and a month break in between each to ensure that I can bring you the best quality content. 🙂
You can find my first episode with the amazing Chris Douvos here:
I am no doubt flawed, clearly evidenced by my verbal “ummmm’s” and “likes” in the podcast. But nevertheless pumped to begin this journey as a podcast host. I expect to grow in this journey tackling the emerging LP space and running a podcast, and I hope you can grow with me. So, any and all feedback is deeply appreciated. Recommendations of who to get on. What questions would you like answered. Formats that you find interesting. I’m all ears.
That said, I’m grateful to everyone who made this possible. My mighty editors, Tyler and JP. Without the two of you, I’d still be struggling telling head from tail on how to do J-cuts and L-cuts. The sole sponsor for the pod, Ravi and Alchemist. And while the pod itself is separate from Alchemist altogether, Ravi pushed me to make it happen. And for that and more, I am where I am now. Every single LP who took a bet on me for Season 1 when all I had for them was an idea and a goal. Chris. Beezer. Eric. Jamie. Courtney. Ben. Howard. Amit. Samir. Jeff and Martin.
And to everyone, who’s offered feedback, advice, introductions and pure energy to fuel all of this. Thank you!
And to you, my readers, I appreciate you taking time out of your busy day when there are so many things that fight for your attention, that you spend time with me every week! If I could just be a bit more self-serving, if you have the chance to tune in, I’d be extremely grateful if you could share it with one LP or one GP who could take something away from it.
Cheers,
David
P.S. Don’t worry. I’ll still continue to write on this blog weekly about everything else in between. That’s a habit I’m not willing to give up any time soon.
P.P.S. I’m already working on and recording for Season 2 of the pod, and I can tell you now that things will only get spicier.
P.P.P.S. Due to a million bugs and a half, I’m still working on launching a dedicated website for the podcast (superclusters.co), but until then, I’ll be sharing the show notes of each episode here.
Stay up to date with the weekly cup of cognitive adventures inside venture capital and startups, as well as cataloging the history of tomorrow through the bookmarks of yesterday!
The views expressed on this blogpost are for informational purposes only. None of the views expressed herein constitute legal, investment, business, or tax advice. Any allusions or references to funds or companies are for illustrative purposes only, and should not be relied upon as investment recommendations. Consult a professional investment advisor prior to making any investment decisions.
One of my recent favorite soundbites is Rich Paul‘s. For the uninitiated, he’s the agent behind LeBron James and Draymond Green. And in his recent Tim Ferriss episode, he said: “Some people define the business card and some people are defined by their business card, and so I don’t carry a business card.”
Some of the most exciting conversations I’ve been having as of late have been in the world of family offices. There’s this shift in generational wealth transfer, but often times without sufficient knowledge transfer. At the same time, there are many next gens leaning more into risk and philanthropy. Many want to increase their exposure to venture and private equity as an asset class, but are still learning how to underwrite such risk.
My conversations echo a lot of what Citi’s been seeing as well. Two in five family offices wanted to increase their exposure to illiquid asset classes, namely the PE and VC asset classes. And while many bucket VC and PE in the same asset class, the truth is the assets operate very differently. Even within venture, underwriting the risk and performance of a sub-$40M fund versus a $40-100M fund versus a $100-500M fund versus a $500M+ VC fund are completely different. Some LPs may disagree on the exact benchmarks (for instance, sub-$100M funds and everything else), but the reality of assessing an emerging manager and an established manager are different. But I digress.
The rest are either rebalancing or figuring out their re-up strategy. Yet, as I’m sure GPs are seeing today, that shift in strategy, requires time, research, and confidence before family offices can pull the trigger. Many are waiting to Q1 next year, but engaging in conversation today.
I’ve also written before about one of my favorite lines from Engineering Capital’s Ashmeet Sidana, “A company’s success makes a VC’s reputation; a VC’s success does not make a company’s reputation. In other words to take a concrete example, Google is a great company. Google is not a great company because Sequoia invested in them. Sequoia is a great venture firm because they invested in Google.”
And I’m seeing a similar vein with family offices. The next gen don’t want to be defined by their predecessor’s goals and records. They want to define their own legacy.
There’s also the saying: If you know one family office, you only know one family office. So any broad-stroke generalizations are loosely correlated at best. That said, anecdotally, having talked with about a hundred or so family offices, here’s what I’ve come to notice.
My crudely drawn 1D scale of whether venture capital is an asset class or an access class
Smaller and/or emerging LPs see VC as an access class. Larger and more sophisticated and established LPs see VC as an asset class.
The Mendoza line — the line that separates the emerging LPs from the established ones —seems to be around 20-30 managers or over 6-7 years of venture data. For the latter, that means, you’ve seen Fund I’s and II’s graduate to Fund III’s and IV’s.
So the question for many of the next generation leading family offices has flipped from: Are you defined by your surname? To: Do you define your surname?
For those that pursue the latter, they’re a lot more proactive than previous generations. They participate in communities. Go to events. Seek education on the matter. Network with their existing managers to discover new ones. Some have also built covenants to co-invest in their manager’s breakout winners. Quite a few are building emerging manager programs or would like to. They’re hungry. Hungry to learn.
The problem I’m seeing with many managers is that they’re seeking transactional relationships. The urgency to get to their first or final close leads them to optimize for LPs who can close fast. And I get it, that’s been the game historically. But it’s leaving a massive opportunity in the market for those who have the time and are willing to educate their and prospective LPs. Who are willing to spend time building a relationship through giving first.
Stay up to date with the weekly cup of cognitive adventures inside venture capital and startups, as well as cataloging the history of tomorrow through the bookmarks of yesterday!
The views expressed on this blogpost are for informational purposes only. None of the views expressed herein constitute legal, investment, business, or tax advice. Any allusions or references to funds or companies are for illustrative purposes only, and should not be relied upon as investment recommendations. Consult a professional investment advisor prior to making any investment decisions.
The other day, I had a super insightful conversation with one of my awesome teammates here at Alchemist Accelerator about access and exposure. The difference between accelerators and emerging early-stage managers.
I’ll preface that for investors, particularly emerging managers, the three things you need to win are sourcing, picking, winning. And to be a GP, you need at least two of the above three. But for the purpose of this blogpost, I’m only focusing on sourcing.
I’ll also preface with the fact that I may be biased. I started in venture at SkyDeck, an accelerator. Additionally, I advise at a bunch of studios, incubators and accelerators. Moreover, I worked at On Deck when we launched our accelerator. And now, I’m here at Alchemist Accelerator.
I truly love early-stage programs. The earlier the better.
Instacart’s recent IPO is a clear example of venture returns compared to the public market equivalent as a function of stage. The earlier you invest, the more alpha you generate to your most liquid comparable.
It’s the difference between a market maker and a market taker. A price maker and a price taker.
Though admittedly, one day, this too may become saturated, just like how venture capital went from 50-60 funds in ’07 and ’08 to now over 4000 in 2023. Do fact check me on exact numbers, but I believe I’m directionally accurate.
Let me give a more concrete example. Harvard is a phenomenal institution. And there’s a Wikipedia page full of breakout Harvard alums. But as an LP, if 50% of your managers, despite having different theses, all have half their portfolio as Harvard alums, then you as the LP are overexposed to the same underlying asset. The same is true for Stanford. Or seed or Series A funds investing in YC founders. All great institutions, but you’re not getting your buck’s worth of diversification.
The only caveat here is if you’re not looking for diversification. After all, the best performing fund would be the fund that invested a 100% of their fund in Google at the seed round. AND holding it till today. Realistically, they will have had to distribute on IPO.
The question is are you a fisher? Or are you a digger? One requires a fishing rod; the other a shovel. The latter requires more work, but you’re more likely to be the first to gold. Like Eniac was for mobile. Or Lux to deep tech.
So how do you know you’re fishing in someone else’s pond?
Easy. Your deal flow includes someone’s else’s brand. Whether that’s Sequoia or YC or SBIR. It’s not your own. You don’t own that pipeline. A lot of people have access to it. It’s no longer about proprietary deal flow, but about proprietary access to deals to borrow a framing from the amazing Beezer.
If your deal flow pipeline looks something like the graph below, you probably don’t have a sourcing advantage.
Now that’s not to say there aren’t a lot of nonobvious companies coming out of YC or these startup accelerators. Airbnb, Sendbird, Twitch (the last of which Ravi who I work with here at Alchemist happened to be one of the first institutional investor for, so have heard some of these stories), and more were all non-obvious coming out of YC. And have also seen the same for companies coming out of Techstars, 500, and Alchemist, where I call home now. But that’s a picking advantage, not a sourcing one.
The flip side is, how do you know you’re excavating your own pond?
I’ll preface by saying having your own Slack or Discord “community” is not enough. Or having your own podcast.
I put community in quotes simply because having XXX members in a large group chat isn’t indicative that their presence is really there. Is their seat warm or cold?
I love using a stadium analogy. Imagine you sold a couple thousand season tickets to a team. You can name whatever sport it is. Football (yes, the rough American kind). Soccer. Basketball. Baseball. You name it. But despite all the tickets you sell, a solid percentage of your seats each game is empty. Can you really say that your team has fans? All you did was sell a couple of cold seats.
You can make the same analogy with likes or comments on Instagram. Which seems to be a problem these days, when an influencer with a couple thousand likes per post starts hosting their fan meetups, only to realize they rented out an empty hall. In case, you’re wondering for the IG example, it’s due to bots.
All that said, I like to think about excavation in the lens of competition for attention. Everyone only has 24 hours in a day. 7 days in a week. 365 days in a year. And as someone who is expecting any level of engagement from others, you are fighting for attention with every other product, person, and habit out there.
Perks of being a consumer investor, I think about this a lot. But in the same way, having an unfair sourcing advantage is the same.
Is the greatest source of your deals tuning into you at least four of the seven calendar days in a week? Or if you have a professional audience (i.e. only product people, or only execs), are they engaging at least 3 workdays per week or 8 workdays per month? Are they spending more time reading/listening/engaging with you than with their best friend?
If you have a community, do you have solid product-market fit? Is your daily active to monthly active over 50%? You don’t need a massive audience, but for the people who are primary sources of your deal flow, are you top of mind? As Andrew Chensays, at that point, “it’s part of a daily habit.”
Is it easy for them to share your content, what you’re doing, who you are with others? Does sharing you or your content generate dopamine and social capital for them? Do you embody something aspirational? Is your viral coefficient greater than 0.5? Even better if it’s 1, then you’re ready to go viral.
And do people stick around? Do the seats stay warm? Is your community self-propagating? Is your content evergreen? Or do you produce content at a voracious pace that it doesn’t have to be? Do you live rent free in people’s brain?
And once you do invest, are you the weapon in the arsenal of choice? For instance, 65% of Signalfire’s portfolio use their platform weekly to learn and get advice. But more on the winning side in a future essay.
In closing
To truly have a sourcing advantage, you need to be building your own platform that is impressionable and regularly take mind space from the founder audience. But if you don’t, that’s okay. You just need to be really good at picking and winning.
Stay up to date with the weekly cup of cognitive adventures inside venture capital and startups, as well as cataloging the history of tomorrow through the bookmarks of yesterday!
The views expressed on this blogpost are for informational purposes only. None of the views expressed herein constitute legal, investment, business, or tax advice. Any allusions or references to funds or companies are for illustrative purposes only, and should not be relied upon as investment recommendations. Consult a professional investment advisor prior to making any investment decisions.
In one of the recent All-In podcast episodes, Bill Gurley shared that both VCs and LPs aren’t marking down their portfolios. For GPs, inflated numbers helps you raise the next fund. For LPs, they’re given their “bonus on paper marks. So, they don’t have an incentive to dial around to their GPs and say, ‘Get their marks right.’ ‘Cause it’s actually going to reflect poorly on them if they were to roll those up.”
The last few years, enterprise value has been largely based on multiple expansion. The truth is we’re not going to see much of it in the incoming years. Even AI that’s exploding right now will see a contraction of their multiples in due time.
Companies that should not be in business today will see their ultimatum too in the next few years. Hunter Walk recently wrote “they’re 2017-2021’s normal failures clustered into current times.”
So, while some GPs do pre-emptively mark down their portfolio by 25-30% — we’re seeing this behavior more so in pre-seed and seed funds — the only people in this whole dance that are incented to mark down portfolios are new LPs trying to figure out if they want to commit to a new fund.
And while the advice applies to newer VCs, the same is true for experienced investors. Of course, most investors aim to be in the upper right-hand corner, but that’s really, really hard. In truth, most notable investors fall in two cohorts: marketers and tastemakers.
Marketers:
Share a high volume of deal flow,
Lower quality opportunities,
Have relatively low conviction on each deal compared to their counterparts, the tastemakers,
Have comparatively diversified portfolios,
And could have adverse effects on branding and positioning in the market.
Tastemakers, on the other hand:
Share a lower volume of deals,
Usually higher quality opportunities,
Higher conviction per deal,
Have comparatively more concentrated portfolios.
And the downside may simply be the fact that their volume may not warrant raising a fund around, and might be better off as an opportunistic investor.
And speaking of concentrated versus diversified, the interesting thing, as Samir Kaji shared on his recent podcast episode, is that “at 85 companies [in the portfolio], you had over 90% chance of getting a 2X. But a very low chance at getting anything above a 3X. And with smaller portfolio sizes [between 15-25 companies], there was much higher variance — both on the top and bottom. Higher chance that you perform worse than the median. But a much higher chance of being in the top quartile and even beyond that, in the top decile.”
It’s also so hard to tell what high quality companies look like before the liquidation event. Naturally, high quality funds are even harder to tell before the fund term. It’s ’cause of that that a few LPs and I wrote the post last week on early DPI. But I digress. At the end of the day, many, for better or worse, use valuation and markups as a proxy for quality.
But really, the last week’s valuation in this week’s market environment. Rather than chasing an arbitrary number, a lot more LPs when evaluating net new fund investments, and GPs making net new startup investments, care about the quality of the businesses they invest in. It’s not about the unicorns; it’s about the centaurs. The $100M annualized revenue businesses.
Samir Kaji’s words in 2022 ring true then as they do today. “Mark-downs of prior vintages are starting to occur but will take some time given valuation and reporting lags.” We’re still seeing many who have yet to go back to market. As many say, the flat round is the new up round. But until folks go back to market, there are many who won’t jump the gun in writing down their portfolio. But they are cautioning themselves, so that hopefully they won’t make the same mistakes again. The goalposts have changed.
I’m reminded of Henry McCance’s words channeled through Chris Douvos. “When an asset class works well, capital is expensive and time is cheap. What we saw in the bubble was that capital got cheap and time got expensive.”
We’re now back at a time when capital is expensive and time is cheap.
Stay up to date with the weekly cup of cognitive adventures inside venture capital and startups, as well as cataloging the history of tomorrow through the bookmarks of yesterday!
The views expressed on this blogpost are for informational purposes only. None of the views expressed herein constitute legal, investment, business, or tax advice. Any allusions or references to funds or companies are for illustrative purposes only, and should not be relied upon as investment recommendations. Consult a professional investment advisor prior to making any investment decisions.
Some of you reading here are busy, so we’ll keep this top part brief, as an abstract sharing our top three observations of leading fund managers.
Generally speaking, don’t sell your fast growing winners early.
Except when…
Selling on your way up may not be a crazy idea.
You might sell when you want to lock in DPI. Don’t sell more than 20% of your fund’s positions unless you are locking in meaningful DPI for your fund. For instance, at each point in time, something that’s greater than 0.5X, 1X, 2X, or 3X of your fund size.
You might consider selling when you’ve lost conviction. Consider selling a position when you feel the market has over-priced the actual value, or even up to 100% if you’ve lost conviction.
You might consider selling when one is growing slower than your target IRR. If companies are growing slower and even only as fast as your target IRR, consider selling if not at too much of a discount (Note: there may be some political and/or signaling issues to consider here as well. But will save the topic of signaling for another blog post).
Do note that the above are not hard and fast rules. Every decision should be made in context to other moving variables. And that the numbers below are tailored to early-stage funds.
Net TVPI Benchmarks from Years 5-15Net DPI Benchmarks from Years 5-15
Let’s go deeper…
On a cloudless Friday morning, basking in the morning glory of Los Altos, between lattes and croissants, between two nerds (or one of whom might identify as a geek more than a nerd), we pondered one question:
Everyone seems to have a financial model for when and how to invest, but part of being a fiduciary of capital is also knowing when to distribute – when to sell. When RVPI turns into DPI. And we haven’t seen many models for selling yet. At least none have surfaced publicly or privately for us. The best thought piece we’ve seen in the space has been Fred Wilson’s Taking Money “Off the Table”. At USV, they “typically seek to liquidate somewhere between 10% and 30% of our position in these pre-IPO liquidity transactions. Doing so allows us to hold onto the balance while de-risking the entire investment.”
As such, it gave birth to a thought… What if selling was more of a science?
What would that look like?
Between two Daves, it was not the Dave with sneakers and a baseball cap and with the profound disregard to healthy diets, given the fat slab of bacon in his croissan’wich, who had the answer there.
“To start off, in a concentrated portfolio of 30 investments, a fund returner is a 30x investment. For a 50-investment fund, it’s 50x. And while hitting the 0.5x DPI milestone by years 5-8, and a 2x DPI milestone by years 8-12, is the sign of a great fund, you shouldn’t think about selling much of your TVPI for DPI unless or until your TVPI is starting to exceed 2-3x.” Which seems to corroborate quite well with Chamath Palihapitiya’s findings that funds between 2010 and 2020 convert have, on average, converted about 25% of their TVPI to DPI.
“Moreover, usually you shouldn’t be selling more than 20% of the portfolio at one time (unless you’re locking in / have already locked in 3X or more DPI). You should be dollar-cost averaging – ensuring time diversity – on the way out as well. AND usually only if a company that’s UNDER-growing or OVER-valued compared to the rest of your portfolio. Say your portfolio is growing at 30% year-over-year, but an individual asset is growing slower at only 10-20% OR you believe it is overvalued, that’s when you think about taking cash off the table. Sell part (or even all) of your stake, if selling returns a meaningful DPI for the fund, and if you’re not capping too upside in exchange for locking in a floor.”
Meaningful DPI, admittedly, does mean different benchmarks for different kinds of LPs. For some, that may mean 0.25X. For others that may mean north of 0.5X or 1X.
“On the other hand, if a company is outperforming / outgrowing the rest of the portfolio, generally hold on to it and don’t sell more than 10-20% (again, unless you’re locking in meaningful DPI, or perhaps if it’s so large that it has become a concentration risk).”
I will caveat that there is great merit in its counterpart as well. Selling early is by definition capping your upside. If you believe an asset is reaching its terminal value, that’s fine, but do be aware of signaling risk as well. The latter may end up being an unintended, but self-fulfilling prophecy.
So, it begged the question: Under the assumption that funds are 15-year funds, what is meaningful DPI? TVPI? At the 5-year mark? 7.5 years in? 10 years? And 12.5 years?
The truth is the only opportunities to sell come from the best companies in your portfolio. And probably the companies, if anything, you should be holding on to. By selling early, you are capping your downside, but at the same time capping your upside on the entire portfolio. When the opportunity arises to lock in some DPI, it’s worth considering the top 3-5 positions in your fund. For instance, if your #2 company is growing quickly, you may not be capping the upside as much.
Do keep in mind that sometimes it’s hard to fully conceptualize the value of compounding. As one of my favorite LPs reminded me, if an asset is growing 35% year-over-year, the last 20% of the time produces 56% of the return. Or if an asset is growing 25% YoY, if you sell 20% earlier (assuming 12 year time horizons), you’re missing out on 45% of the upside.
As a GP, you need to figure out if you’re IRR or multiple focused. Locking in early DPI means your IRR will look great, but your overall fund multiple may suffer.
As an LP, that also means if the gains are taxable (meaning they don’t qualify for QSBS or are sold before QSBS kick in), you need to pay taxes AND find another asset that’s compounding at a similar or better rate. As Howard Marks puts it, you need to find another investment with “superior risk-adjusted prospective returns.”
And so began the search for not just moolah in da coolah, but how much moolah in da coolah is good moolah in da coolah? And how much is great?
Net TVPI Benchmarks from Years 5-15Net DPI Benchmarks from Years 5-15
Some caveats
Of course, if you’ve been around the block for a minute, you know that no numbers can be held in isolation to others. No facts, no data points alienated from the rest.
Some reasons why early DPI may not hold as much weight:
Early acqui-hires. Usually not a meaningful DPI and a small, small fraction of the fund.
There’s a possibility this may be the case for some 2020-2021 vintages, as a meaningful proportion of their portfolio companies exit small but early.
In other words, DPI is constructed of small, but many exits, rather than a meaningful few exits.
TVPI is less than 2-3x of DPI, only a few years into the fund. In other words, their overall portfolio may not be doing too hot. Obviously, the later the fund is to its term, the more TVPI and DPI are alike.
As a believer in the power law, if on average it takes an outlier 8 years to emerge AND the small percentage of winners in the portfolio drive your return, your DPI will look dramatically different in year 5 versus 10. For pre-seed and seed funds, it’s fair to assume half (or more) companies go to zero within the first 3-5 years. And in 10 years, more than 80% of your portfolio value comes from less than 20% of your companies. Hell, it might even be 90% of your portfolio value comes from 10% of your companies. In other words, the power law.
GPs invested in good quality businesses. Some businesses may not receive markups, but may be profitable already, or growing consistently year-over-year that they don’t need to raise another round any time soon.
Additionally, if you haven’t been in the investing game for long, persistence of track record, duration, and TVPI may matter more in your pitch. If you’ve been around the block, IRR and DPI will matter more.
As the great Charlie Munger once said, “selling for market-timing purposes actually gives an investor two ways to be wrong: the decline may or may not occur, and if it does, you’ll have to figure out when the time is right to go back in.” For private market investors, unless you can buy secondaries, you’ll never have a time to go back in until the public offering. As such, it is a one-way door decision.
Some LPs are going to boast better portfolios, and we do admit there will be a few with portfolios better than the above “benchmarks.” And if so, that’s a reason to be proud. In terms of weighting, as a proponent of the power law, there is a high likelihood that we’ve underestimated the percent of crap and meh investments, and overestimated the percent of great investments in an LP’s portfolio. That said, that does leave room for epic fund investments that are outliers by definition.
We do admit that, really, any attempt to create a reference point for fund data before results speak for themselves is going to be met with disagreement. But we also understand that it is in the discourse, will we find ourselves inching closer to something that will help us sleep better at night.
One more caveat for angels… The truth is as an angel, none of the above really matter all that much. You’re not a fiduciary of anyone else’s capital. And your time horizons most likely look different than a fund’s. It’s all yours. So it’s not about capping your downside, but more so about capping your regret. In other words, a regret minimization framework (aka, “spouse regret/yelling minimization insurance”).
That will be so unique to you that there is no amount of cajoling that we could do here to tell you otherwise. And that your liquidity timelines are only really constrained by your own liquidity demands.. For instance, buying a new home, sending kids to college, or taking care of your parents (or YOU!) in their old age.
But I do think the above is a useful exercise to think through selling if you had a fund. You would probably break it down more from a bottoms up perspective. What is your average check size? Do you plan to have a concentrated portfolio of sub-30 investments? Or more? Do you plan to follow on? How much if so? And that is your fund size.
In closing
Returning above a 3x DPI is tough. Don’t take our words for it. Even looking at the data, only 12.5% of funds return over a 3x DPI. And only 2.5% return three times their capital back on more than 2 separate funds.
In the power law game we play, as Michael Mauboussin once said, “A lesson inherent in any probabilistic exercise: the frequency of correctness does not matter; it is the magnitude of correctness that matters.” Most will return zero, or as Jake Kupperman points out: More than 50%.
But it’s in the outliers that return meaningful DPI, not the rest. Not the acqui-hire nor really that liquidation preference on that small acquisition.
At the end of the day, the goal isn’t for any of the above to be anyone’s Bible, but that it’d start a conversation about how people look at early returns. If there is any new data points that are brought up as a result of this blogpost, I’ll do my best to update this thread post-publication.
Big thank you to Dave McClure for inspiring and collaborating on this piece, and to Eric Woo and all our LP friends who’ve helped with the many revisions, sharing data, edits, language and more. Note: Many of our LP friends chose to stay anonymous but have been super helpful in putting this together.
Footnotes
For the purpose of this piece, we know that “good” and “great”, in fact all of the superlative adjectives, are amorphous goalposts. And those words may mean different things to different people. This blogpost isn’t meant to establish a universal truth, but rather serve as a useful reference point for both LPs, looking for “benchmarking” data, and GPs to know where they stand. For the latter, if your metrics do fall in the “good” to “great” range, they’re definitely worth bragging about.
And so with that long preamble, in the piece above, we defined “good” as top quartile, and “great” as top decile. “Good” as a number on its own, enough for an LP to engage in a conversation with you. And “great” as a number that’ll make LPs running to your doorstep. Or at least to the best of our portfolios, leveraging both publicly reported and polled numbers as well as our own.
Our numbers above are also our best attempt in predicting steady state returns, divorcing ourselves from the bull rush of the last 3-5 vintage years. As such, we understand there are some LPs that prefer to do vintage benchmarking, as opposed to steady state benchmarking. And this blogpost, while it has touched on it, did not focus on the former’s numbers.
EDIT (Aug 18, 2023): Have gotten a few questions about where’s the data coming from. The above numbers in the Net DPI and Net TVPI charts are benchmarks the LPs and I agreed on after looking into our own anecdotal portfolios (some spanning 20+ years of data), as well as referencing Cambridge data. These numbers are not the end-all-be-all, and your mileage as an LP may very much vary depending on your portfolio construction. But rather than be the Bible of DPI/TVPI metrics, the purpose of the above is give rough reference points (in reference to our own portfolios + public data) for those who don’t have any reference points.
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The views expressed on this blogpost are for informational purposes only. None of the views expressed herein constitute legal, investment, business, or tax advice. Any allusions or references to funds or companies are for illustrative purposes only, and should not be relied upon as investment recommendations. Consult a professional investment advisor prior to making any investment decisions.
Somehow do a better job of massaging the current data, which is challenging; or you have to
Be better at making qualitative judgments; or you have to
Be better at figuring out what the future holds.”
And while I go in length why the above are true in a former piece… today, I want to postulate a fourth.
Be better at listening to the silence.
Let me elaborate.
Facts and opinions
If I were to ask you, what day’s your birthday? I bet you could answer pretty quickly.
And the same would be true, if I asked you the color of the sky. Or what you ate for breakfast in the morning. Questions on facts have factual answers. There is either one immediate answer, or an answer you know exactly how to find, and at the very end, still a definitive answer. An example of the latter would be, What is the temperature right now?
On the other hand, if I were to ask you, what do you think about your life partner? The answer varies. You might say she or he is reliable. Or caring. And kind. And if I follow up with silence, you might spend some time thinking and filling the void with more words. Those words… are powerful. They simmer all of your life experiences and your stories — all your trials and tribulations, years, months, weeks, days, hours and minutes — onto a neatly organized platter for the other person. Those words that summarize it all are powerful. But what’s even more interesting to investor is the time it takes to come up with those words. That precious time, as your life is playing out like a flipbook, spends its precious milliseconds hugging silence.
No matter how miniscule those gaps are, they exist. And our goal as investors, and even more so for startup investors or emerging fund investors, with very little data to go on, is to create new datasets. In essence, to ask questions where the answers don’t just fill the air with vibrations, but to find answers that are dotted with tranquil stillness.
Great investors read between the lines. Listen to the pauses — the spaces between words. They look for the quiet thing out loud.
That silence is often more telling than anything you could put on a pitch deck or in a templated answer of “Tell me about your company.”
In closing
I know in this side of the world, we talk a lot about 10-year overnight successes. But let’s focus on the first two words of that phrase first. Ten-year. Startup journeys are long. They’re arduous. More things will go wrong than right. In the words of a serial founder with a few 9-figure exits under his belt, he once told me, “This shit sucks.” It’s tough. And if anyone discounts that — be it founder, operator, investor, friend or family — they don’t get it.
But that’s the very reason why investors look for grit, passion, and for me, obsession. But it’s also not a question we can really ask without getting a gift-wrapped, carefully-prepared answer. And so pushing the boundaries of questions is our job as investors. Why? Because even if for a moment, it sheds light into who we’re truly talking to.
And if there’s evidence of grit, passion, or obsession there, there might be something special.
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The views expressed on this blogpost are for informational purposes only. None of the views expressed herein constitute legal, investment, business, or tax advice. Any allusions or references to funds or companies are for illustrative purposes only, and should not be relied upon as investment recommendations. Consult a professional investment advisor prior to making any investment decisions.
VCs win upon liquidity event. And that happens either via M&A or via going public. After that, the shares are transferred to the hands of the LPs and they choose how they’d like to liquidate or keep. To date, we have neither seen a trillion dollar acquisition nor a trillion dollar IPO. I’m not saying it’ll never happen. I’m sure it will, at some point. A combination of inflation and companies finding more liquidity when private markets are bullish.
As Charles Hudson suggests in his one of his latest posts, the venture world has been changing. What was once a cottage industry gave way to multi billion dollar funds. While there are still many small sub-$100M funds, LPs have started evaluating venture capital not as just one big industry, but segmenting it by size of fund. Small funds, sub-$100M. Medium-sized funds, $100-500M. And big funds, funds north of $500M assets under management (AUM for short). And as the Mike Maples dictum goes, your fund size is your strategy.
Returning a billion-dollar fund requires different kinds of investments and math for it to work compared to returning a $50M fund. And one day, as large funds continue to expand into multiple stages, check size, but also eventually into public markets, we might see them start to bet on trillion-dollar outcomes. Because to return a 11- or 12-figure fund, you need to do just that. But given the market we’re in now, I imagine that won’t be in the near future.
The 10,000-foot view
So the thing you have to gain conviction around, as a macroeconomist, is not how big a venture fund should be. Nor the debate on how many VC funds is too many. The number nor the size truly matter in the grand scheme of things.
For an illiquid asset class like venture, where you’re betting on the size of the home runs, not one’s batting average, what you have to gain conviction around is:
How many truly great companies are there every year
How much capital is needed to get these companies to billion dollar outcomes
For the latter, there are two main ways to get to billion dollar exits: going public or getting acquired. And while there are outliers, the best way is for these businesses to get to $100M of recurring revenue.
And everything else is downstream of that.
As an LP once told me, “In the 1990s, it took $7 million to get to first revenue. In the 2000s and into the early 2010s, it took $700K. Now it takes $70K.” With each era and each wave of technological development, founders become more capital efficient. There are less barriers to get to market. Now with AI, it might just be $7K to get to first revenue, if not sooner.
The question is how much capital is needed to get to $1M ARR. If we take a decent burn multiple of 1.5x, then we underwrite an assumption that it’ll take $1.5M to get to $1M ARR. And possibly $4.5M to get to $3M ARR. And somewhere in there, that founder will find product-market fit and turn on the growth engine. CAC (customer acquisition cost) falls. And lifetime value increases. Payback periods shorten. And if all goes well, founders may find themselves with a sub-one burn multiple. And after they hit $1M ARR, and they triple the first two years, double the next three, they’re at $100M ARR. Of course, I’m illustrating the above all in broad strokes. The best case scenario. But most things don’t go according to plan.
Then an investor has to figure out if one should only make net new investments or re-capitalize a select few of their existing investments.
Then as LPs, what is the minimum ownership percentages that can return funds at each differentiated stage and fund sizes? And due for possibly another blogpost altogether, how does a 7-8x multiple on forward-looking ARR impact round sizes and valuations across bull and bear markets?
All this admittedly is both art and science. But I will admit that larger fund sizes and playing the AUM game may not be the answer.
In closing
My friend recently sent me this letter that Sam Hinkie wrote when he retired as GM of the 76ers. In it, he quoted the great Sage of Omaha when he closed down Buffett Partnership. “I am not attuned to this environment, and I don’t want to spoil a decent record by trying to play a game I don’t understand just so I can go out a hero.” And it’s for that same reason, Sam stepped down. The same reason Jerry Seinfield turned down $110 million to do another season of Seinfeld. Even though the sequel business does quite well.
There is no shame in knowing when to hang up the cleats. And there is great power in being disciplined. In fact, it’s one of the most sought-after traits in fund managers. If not, the most sought-after.
In VC, it comes in all sizes, ranging from:
Fund size discipline. There a lot of GPs out there who have gone on to raise 9- to 10-figure early stage funds. A mathematical equation that becomes increasingly harder to prove true, given outputs need to reflect inputs. In other words, larger funds are harder to return. There are a lot of VCs who would rather play the AUM (assets under management) game than stay disciplined on returns. Not just paper returns, but real cold hard cash. In the words of my friend Chris Douvos, “moolah in da coolah.” To quote another line from Chris, “OPM (other people’s money) is like opium. It’s addicting.” Something one too many investors have gotten addicted to.
Thesis discipline. As a friend who’s been a VC across multiple economic cycles once told me, it’s much better to turn down an off-thesis hot deal led by a top tier firm than to take it.
Career discipline. To echo the words of Sam Hinkie above.
And of course, knowing that we underwrite billion dollar outcomes, rather than trillion dollar ones. Then again, that’s just a subset of fund size and portfolio construction.
Stay up to date with the weekly cup of cognitive adventures inside venture capital and startups, as well as cataloging the history of tomorrow through the bookmarks of yesterday!
The views expressed on this blogpost are for informational purposes only. None of the views expressed herein constitute legal, investment, business, or tax advice. Any allusions or references to funds or companies are for illustrative purposes only, and should not be relied upon as investment recommendations. Consult a professional investment advisor prior to making any investment decisions.
Surprisingly, last week was the first week I’ve gone to multiple events for a given conference. Also I’m using the word “conference” very loosely here since I’m counting a tech week as one. What started off as ‘I’m going to support just one friend,’ ended up being a slippery slope, and supporting many friends, and catching up with friends in town. I mean, c’mon, how do you not at least say hi to a friend who’s flown from NYC or Miami? Perks of being bad at saying no.
That said, for the founder focused on getting to product-market fit, or actively fundraising, or the GP fundraising, your time is better spent elsewhere. But if you’re exploring and trying to increase the surface area for luck to stick, these events are great. So many fun, interesting ideas floating around.
Eight quick takeaways, before I go back and I let you go back to the rest of your week:
For VC/founder events, most attendees are founders. Smaller VCs went to the GP events. Bigger VCs just host their own.
For LP/GP events, most attendees are GPs. Went to an event of this type, and I kid you not, only met 2 LPs out of 15 people I chatted with. The rest were GPs. The folks you would like to show up at VC/founder events would rather pitch than to be pitched.
Interestingly enough, for the events that have a good proportion of LPs, most don’t seem to be investing in emerging managers. Anecdotally, have heard three of my friends who are individual LPs get turned down from LP events during SF Tech Week.
Smaller funds seem harder to raise than larger funds.
US large family office and institutional LP market is drying up. Most have overextended to buyouts and still need therapy for being burned in 2020 and 2021. For those that haven’t, they’re resorting to intros from friendlies.
Hosting your own events gives you better bang for your time than attending events.
And as one would suspect, AI dominates 70-80% of conversation.
Investing in unsexy industries is sexy. New moniker is to invest in industries where either 1/ people have scruffy beards or unkempt hair or 2/ meetings that require suit and tie.
Stay awesome, friends!
#unfiltered is a series where I share my raw thoughts and unfiltered commentary about anything and everything. It’s not designed to go down smoothly like the best cup of cappuccino you’ve ever had (although here‘s where I found mine), more like the lonely coffee bean still struggling to find its identity (which also may one day find its way into a more thesis-driven blogpost). Who knows? The possibilities are endless.
Stay up to date with the weekly cup of cognitive adventures inside venture capital and startups, as well as cataloging the history of tomorrow through the bookmarks of yesterday!
The views expressed on this blogpost are for informational purposes only. None of the views expressed herein constitute legal, investment, business, or tax advice. Any allusions or references to funds or companies are for illustrative purposes only, and should not be relied upon as investment recommendations. Consult a professional investment advisor prior to making any investment decisions.
In 2016, I jumped into the VC world, knowing no better than what my forefathers and foremothers taught me. Outside of a handful few, many of the people I looked up to and sought for advice had been in the business for less than a decade. In effect, they started their investing career after the GFC (Global Financial Crisis) in 2008. While they still bore more scar tissue than I did, I learned quickly that the one question to ask founders early on was “What is your last round’s valuation?” or “What valuation are you seeking?” For the latter question, the implicit answer we sought out for was their 12-month revenue. And subsequently, their valuation multiple. In Mark Suster‘s words, we were “praying to the God of Valuation.” But really, their exit multiples matter more than the entry or current multiple.
For fund managers and partners, the question was “What is your IRR or TVPI?” or “What’s your AUM?”. Rather, the answer we should be seeking isn’t some function of their portfolio’s valuations, but the quality of the businesses they invest in.
To be fair, I failed to fully appreciate the latter answer until this year.
The odds aren’t bad, but that doesn’t mean they’re great
Jared Heyman wrote a great piece last year on the probability of success for YC startups. After parsing through the data, he found that after a couple years of survival, a startup is just as likely to go through an exit (i.e. acquisition or go public) as it is to fail (i.e. inactive). Additionally, ~88% of startups reach resolution (exit or inactive) around the 12-year mark.
It’s also interesting to note that the average time it takes for a YC company to exit (if they exit) is seven years. In fact, the time horizon has shortened in the past few years from an average timeline of nine years to five. Of course that’s pre-2022, so the time to exit is likely to increase once again to the mean or longer as:
Markets are less liquid. Valuations drop. Rounds are smaller. Buyers are less eager to buy. Founders have less access to liquidity and exit opportunities. As such, the markets will demand more proof from founders of market traction.
Investor sentiment is guarded, echoing Howard Marks. I haven’t seen the newest numbers but at best, I imagine we’ll see more capital go towards existing investments, maintaining overall investment volume. At worst, a decline of capital deployment, outside of ephemerally “hot” industries, like generative AI.
Investors’ key worry is investment losses. Investors up and downstream become more risk averse.
Interest rates are rising to curb inflation, leading to a debt investor’s market rather than an equity investor’s. Founders are likely to turn to expensive debt instruments (and many already have). Higher interest rates also mean greater return expectations from investors.
Jared does note in another piece that “while YC startups may cost 2-3 times as much as their non-YC peers to investors, they’re worth 6-7 times as much in terms of expected investor returns.” It’s great to be an LP in YC, but tough to be choosing YC startups. Of course, at the very end there’s a gentle reminder that VCs (and angels) are defined by the magnitude of their successes rather than the number of their failures (and successes). Just because a portco gets to an exit doesn’t mean it’ll be a fund returner. With shifting markets, this will be as true for YC under Garry’s leadership as for any other fund.
Of course, I don’t mean to pick on YC. They do a tremendous job of picking founders. And it’s true that they have set the golden standard for startup accelerators. It’s just that the above data was easily accessible.
Portfolio consistency
Interestingly enough, Oliver Jung, Airbnb’s former VP International, wrote half a month later that Adinvest’s Fund II made him $200 on every dollar he invested in the fund, largely because of a 1000x Adinvest II made into Adyen.
That’s a phenomenal outcome! To make investors back $200 on every dollar invested is definitely one for the books. The question becomes (and I have no inside scoop on this): How did the rest of the portfolio do? Was Adinvest’s Fund II purely based on luck or is there a consistent model that can be replicated in future funds?
For that question, it begs another. If we took out Adinvest’s investment in Adyen, what is the DPI (distributions to paid-in capital) of the rest of the fund? That will dictate Adinvest’s ability to raise a subsequent fund, at least from the larger, more sophisticated LPs. A great and consistent portfolio may look something a little like this.
Given that the average fund’s returns (with a large enough portfolio i.e. 100 portcos) normalizes to a 3x gross return — venture’s Mendoza line, 3-5x would put you in the ball park of good. High single digits would put you in the great category. And double digits would put you in epic.
And if Adyen really was the sole outlier success, did the GPs have the conviction to double down in subsequent rounds? If so, how did they earn their pro rata?
Sometimes all you need is one investment to push you from a nobody to a somebody, but if you’re intent on building a multi-decade-long career in the space, your founders should see you in the same or better light than those equipped with asymmetric information (i.e. those who read about you in the media).
While many Fund I’s and II’s may not have a reserve ratio, were the GPs and LPs able to continue to invest via SPVs? By doubling down, it’s the difference between a strategy to win and a strategy not to lose. How much of Adinvest’s AUM does their investment in Adyen account for? And being a fund manager means balancing oneself on the tightrope between the two strategies. In doubling down, that investment becomes a larger percent of the capital you manage (AUM). If you lose, you lose much more. If you win, you win a lot more.
Of course, this is true for any fund. I ended up overly picking on the case study of Adinvest to illustrate the point, but I have nothing against the great success Oliver, the other LPs and the team at Adinvest did have. On a broader spectrum, the purpose of having many shots on goal is theoretically so that you will have a few outliers. So your fund can grow based on a consistent strategy.
There are many times when all you have is that one outlier (often still in paper returns, not distributions yet). It happens. I’ve seen it happen. But if that one doesn’t work out, how forthcoming are you with your “disappearing TVPI?” I imagine a lot of investors who are planning to raise in 2023 will come face to face with these questions, having made big bets on hot startups in the last two years. Will you shrug it off? Or will you candidly share the lessons in which you learned?
The above is just something I’ve thought about a lot more as I see more emerging GP fundraising decks, as they boast about their angel portfolio (if they did have one).
In closing
There’s a proverb that goes: A broken clock is still right twice a day. You can be the worst investor out there, but with enough swings at bat, you’ll still be able to hit some outliers.
In the world of investing, you’re guaranteed to be wrong more often than you’re right. But I’ve seen many that do a lot of stuff ‘wrong’ and still have a winning fund. The big question… and the question, sophisticated and institutional LPs are asking is: Is it repeatable?
So, even if you did hit some home runs, is your success repeatable?
One last footnote. In talking with a number of investors who’ve been in the business for more than a decade, I’m starting to realize that selling (i.e. knowing when to sell and how much to sell) is just as important. An art and a science. I’ve written about it before (here and here), but I imagine I’ll revisit the topic again in long form soon. Especially as I see more discourse on the topic and funds close and liquidate in the near future. From great ones like Union Square Ventures to those who need to return some DPI to raise their next fund.
Stay up to date with the weekly cup of cognitive adventures inside venture capital and startups, as well as cataloging the history of tomorrow through the bookmarks of yesterday!
Any views expressed on this blog are mine and mine alone. They are not a representation of values held by On Deck, DECODE, or any other entity I am or have been associated with. They are for informational and entertainment purposes only. None of this is legal, investment, business, or tax advice. Please do your own diligence before investing in startups and consult your own adviser before making any investments.
