Tag: correlation ventures

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The Science of Selling – Early DPI Benchmarks

The snapshot

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.

  1. 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.
  2. 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.
  3. 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 5-15
Net 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:

How much of selling is art? How much is science?

Between USV selling 30% of their Twitter stake, Menlo selling half of their Uber, Benchmark only selling 15% of their Uber pre-IPO shares, and Blackbird recently selling 20% of its Canva stake, it feels more like the former than the latter. Then when Howard Marks says selling is all about relative selection and the opportunity cost of not doing so, it seems to reinforce the artistic form of getting “moolah in da coolah” to borrow a Chris Douvos trademark.

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.”

Source: Fred Wilson’s Taking Money “Off The Table”

In aggregate, we’ve seen venture fund distributions follow very much of the power law – whether you’re looking at Correlation’s recent findings…

Source: Correlation Ventures

Or what James Heath has found across 1000+ firms’ data on Pitchbook.

Source: James Heath

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 5-15
Net 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%.

Source: Jake Kupperman’s The Time Has Come to Modernize the Venture Capital Fund of Funds

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.

Cover Photo by Renate Vanaga on Unsplash

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.

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Spilling the Tea on Deep Tech

teapot

It’s not every day one gets to sit down and experience a Chinese tea ceremony under a late afternoon Los Altos sun. Sitting across from me was a gentleman in a white tee who moonlighted as a tea connoisseur. As such, he was in the middle of passionately describing to me what was some of the best tea I’ve had to date.

“David, smell this blend three times. You’ll realize that each breath you take will smell completely different from the last.”

To my bewilderment, he was right.

As I handed the teapot back to him, he continued, “Now the first pour you always pour out. Here, we are just washing the tea leaves. But we use this opportunity to also coat the insides of your teacup with the flavors of this next tea.”

True to his word, he awakened the inner mold of my cup with the smoky liquid infused by leaves that had been aged longer than I’ve been alive. Then poured the first pour back onto the teapot with the lid on, creating a wet seal around the teapot. As a result, the leaves were washed. The aromas are concentrated in the pot. And the cup has been given time to get to know the tea.

When, finally, the teacup landed back in my hands, I could taste the unfiltered, rich, smoky, yet mellow aroma of a Wu Yi Shui Xian tea.

If I didn’t know any better, I’d never have guessed his “day” job was being an investor. Specifically, a pre-seed and seed deep tech investor.

Of course, you’re smart. Given the title of this blogpost, you didn’t come here to read about the intricacies of drinking tea. But about the intricacies of deep tech, which in the process of editing this piece, I realize deep tech happens to have the same initials as drinking tea. But that’s not only stretching it, but I digress.

The fine gentleman who sat across from me in a white tee, his name is Arkady Kulik, Co-Founding Partner of rpv, a fund dedicated to backing early-stage scientifically intensive teams. In other words, deep tech. Currently, the industry itself is highly fragmented. In Arkady’s words, “it’s like investing in IT in the 80s. But they’re all ventures that can completely reshape the landscape.”

As Arkady continued, he shared something else quite fascinating. “In software, you’re looking at a high market risk and low technological risk. In deep tech, it’s the exact opposite. We have a low market risk and high technological risk. The problem is not whether they can sell this to people, but rather whether they can build it.”

Naturally, as someone who spends little time looking into the deep tech world week to week, I had to double click on that. What followed was a conversation where I found myself wishing I could take notes faster.

Smelling the tea leaves

As a non-technical person, the biggest question for me has always been: How do you evaluate a deep tech deal?

To Arkady, it’s the entry point in price as a function of Technology Readiness Level. TRL, for short.

rpv focus, deep tech, technology readiness level, nasa
Source: rpv’s Investor Deck (and yes, Arkady gave me permission to share this)

“TRL is actually something that the team at NASA came up with. NASA has always had a lot of internal projects, and they needed some internal tool to evaluate the readiness of those projects.

“It was developed in the 1970s, but was formalized in the decade after. One through three on the TRL scale is all theory. They’re largely funded by the government through grants and such. Seven through nine on the scale is commercial, and covered by generalist VCs. Everything in between is in some form of a product development process. That’s where we come in.

Source: rpv’s Deck, citing NASA TRL levels

“To get the graph above, we take TRL levels on the X-axis and the historical round size data on the Y-axis. Then we looked at every single company, took the lowest and highest round in each vertical within deep tech, and mapped it out.”

While every firm’s “blue box” is different — and after learning about this, I do encourage every deep tech firm to go through such an exercise, rpv’s sweet spot is companies leveraging technologies TRL 3-6 whose round is shy of $1.5 million.

The first pour: Tea meets cup

After passing through the smell test, the first question Arkady tries to answer is always: Is it BS? “I look at every deck myself. No analyst. No associate.”

After Arkady looks at the deck, he then sends it to his team. “They give me one of three scores: green, yellow, or red. If it’s positive — meaning either green or yellow, I take the first meeting. We have 12 deal breakers, ranging everything from lack of ability to protect IP (it’s why we don’t do software deals) to tech, finance, or team conflicts of interest. If any of us in diligence raise a flag, we don’t continue. If not, we ask specific questions to the team.”

When meeting with the team, the question of founder resilience always comes up. Of course, every investor measures grit differently. I ask about excellence and scar tissue, but I was deeply curious as to what Arkady asks for.

“I try to gauge it from learning about founders’ past experiences (not necessarily professional ones),” he goes on, “I dig deeper on tough situations a founder has faced. Also proposing hypothetical scenarios about their fundraising or team dynamics help a lot in understanding that facet.”

Without a beat, I follow up, “For that, do you have any go-to questions?”

“Nothing formal. I try to find an experience in someone’s past that could be good grounds for showing resilience: competitive sports, PhD, previous startups, complicated and long-term projects in the corporation or something like that.

“For the hypothetical scenarios, I ask things like ‘What if you won’t gather the round?’ Or ‘What if your co-founder absolutely had to resign, what’s your action plan in the bus factor case?’

“It’s an area where you look at how they react, not just what they say. How does their body language change when they’re answering the question. It’s about the non-verbal signals. ‘Tell us an experience in the past and things didn’t go your way, and things were dragging.’ Was it when you applied to college? Or went for your PhD? Or when you were trying to go on a date with someone you liked?’

“Resilient people usually have some kind of Plan B. People who don’t have another plan and still try the same thing again and again are stubborn. We don’t seek stubbornness in entrepreneurs. We look for their ability to be honest with themselves and other people.”

The second pour: Tasting the depth

“If there are no red flags after meeting the founders, then we move into scientific due diligence. We ask everything from deep scientific questions (on isotopes or wavelengths) to the feasibility of the product — essentially a peer review on a paper by our internal, but also external scientists and advisors. The latter to get a truly unbiased opinion.

“Then we do a deeper diligence process with a scorecard of 35 items from team composition to their stage of development to their ability to protect IP to the availability of competition, each rated twice. Once by myself, and another by our advisors and venture partners. Then we average the points out for each of the 35 items and compare against our thresholds. If it’s a green light, we make an investment decision. If yellow, we follow up with the target venture’s team to see if they have a good answer to our concerns. And if not, then we say no. If red, well, we also say no. Though we have yet to give a red final score after using the scorecard since they’ve all died during the extensive due diligence process.”

In our conversation, which eventually migrated to Zoom (with some people, you just never run out of things to ask), I postulated about the variability in venture firms using scorecards. There are strong reasons why you should or shouldn’t from both sides of the aisle. Both of which have generated great returns for their LPs.

Today, many of the top tier venture firms make outlier decisions based on gut. It’s the same reason why generational or succession planning at these top firms are so hard. Once the GP leaves or retires, the next generation have a hard time making the same investment decisions as the previous generations.

On the scorecard end of the spectrum, hedge funds are, by definition, firms who employ algorithmic discipline to generate alpha. On the venture side, you have Correlation Ventures, SignalFire, just to name a few. Seven years back, Social Capital’s Capital-as-a-Service, just to name a few. The last of which seemed to have been deprecated due to the inability to scale support for a portfolio of 500 startups, rather than the inefficacy of their “scorecard.” As you might suspect, a topic I’m quite fascinated about.

“We make our decisions based on scorecards,” Arkady reaffirmed, “And if you were to look at each one we’ve done, you’ll see that it’s rare that our team sees eye to eye. We disagree a lot. It’s an individual decision and we take it. And we never try to convince the other to change their score. We trust each other to give a score we believe in. For advisors, since we have many, we take the average of all their opinions. We also ask different advisors for each item on the scorecard. Some advisors are excellent in one area, but might not be fluent in another.

“The final thing I’ll say is that when something feels off, we say no. Even if the data shows green, but we’re unsure about the validity of the data, we still pass. One of the best pieces of advice I got around hiring is if you’re not sure about a hire, pass. It’s the same with investing.”

For Arkady, that is the weapon of their choice.

In closing

Between three calls and a tea ceremony, even then, we only touched the tip of the iceberg. One I’m likely to have many more questions for Arkady and my other friends who live and breathe in this space. It’s an exciting space. To be fair, even calling it all just one space is an understatement. It’s a permutation of many that’ll be segmented when the broader investment community starts to understand them all better. Myself included.

Looking forward to it all, and appreciate you, Arkady, for all the back and forth edits, lessons, and the tea!

Photo by Content Pixie on Unsplash

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.

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No One Talks About Selling

Seemingly, everyone these days – from Twitter to podcasts to blogposts (including mine) – talk about buying and investing in startups. What are best practices for investment theses? How do I pick the best companies to invest in? Conversely, how do I get picked or get allocation into hot startups? But people rarely seem to be talking about selling positions. So, if you know me, I hit up two of the smartest people I know – one early-stage, the other growth-stage. Both of whom might be familiar faces on this blog. So I asked them:

How do you think about selling a position? How much does DPI matter for your investors?

The below insights include minor edits for clarity.

The notice that you’ve all seen a million times

None of this is investment advice. This content is for informational purposes only, and should not be relied upon as legal, business, investment, or tax advice. Please consult your own adviser before making any investments.

Shawn Merani (Parade Ventures)

Shawn was instrumental in my early career growth in venture. When I met him years ago, he was still running Flight Ventures, where he wrote early checks into Dollar Shave Club and Cruise Automation and was one of the first syndicates on AngelList. There he led a network-based model of syndicate leads, which I’ve heard been described by others as a “venture partner program on steroids.” Now he’s the solo GP at Parade Ventures, a seed stage venture fund investing in enterprise-themed companies.

“I would preface all of this with the fact we have never fully exited a position before a traditional liquidity event, but more so, have managed our position given the duration of our ownership and to generate returns for our LPs and manage risk. 

“We talk to founders all the time, and foster a relationship that grows. When I was writing check sizes for 1-5% of ownership, my engagement then is very different from my engagement with founders now, where we take more concentrated bets.

“When it comes to selling, it’s about influence and information. The larger our ownership, the more information we have access to. And if a company is doing well, we don’t think about selling. In fact, it’s the exact opposite; we buy more. If things are working, we take our pro rata. In some cases, we take more than my ownership target. And founders are willing since we’ve been helping them from the beginning. We know when there’s going to be a 3-4x uptick every 12-18 months. Compounding is powerful.

“Our investors back the fund because they trust us. They don’t talk to the founders as often as we do. They trust our decision when we say we should buy more or keep our shares. There are two ways to talk about DPI:

1. Making money for your current investors, and
2. Telling the story.

“Selling is really a case-by-case scenario, and it really depends on my relationship with the founder. All the equity in which I sold so far has been before Parade. But if we know the company is doing well, we buy more. There are also holding periods to consider under QSBS, which has huge tax benefits.”

For those that are unfamiliar with the terminology, DPI means distributions to paid-in capital. Effectively, how much money you actually return to your investors versus “paper returns”. QSBS, or qualified small business stock, tax exemption allows investors in qualified businesses to avoid 100% of the capital gains tax incurred if they hold their stock for more than 5 years.

Ratan Singh (Fort Ross Ventures)

I posed the same question to someone I’ve been a huge fan of the day I met him – Ratan Singh, Partner at Fort Ross Ventures. He’s an investor in some of the most recognizable businesses today, including the likes of Rescale and Clearcover, as well as holds board seats at Blueshift and Ridecell. You may remember Ratan from a previous essay about speed as a competitive advantage for investors. And you’ll likely see him a lot more on this blog. He summed it up best in our chat when he said, “There are two reasons why an investor needs to care about DPI: time horizon and fund strategy.” Both of which are variables, not constants, between early- and growth-stage investments.

“The true metric at the end of the day is DPI. DPI is turning in money to your investors. And there are two reasons why an investor needs to care about DPI: time horizon and fund strategy.

“Let’s start with time horizon. For a seed stage fund, as you get close to the end of your fund cycle, that’s when DPI matters. What type of vintage is the fund in? In 2021, it’s going to be the 2010 and 2011 funds.

“For the majority of the time, you want to ride your winners. At the end of your time horizon, ask for a one- to two-year extension. Usually LPs want more money or their shares distributed. They’ve already waited 10 years. Two more won’t make a difference, especially if you have some big fund returners in the making.

“For fund strategy, did you meet the objectives for your LPs already? If you have, and you want to sell some of your winnable deals in your portfolio to help raise your Fund II because those are the same LPs that would re-up in your next fund, then you might consider selling.

“The worst reason to sell is that you want to take the wins you currently have since you think the market is overvalued. ‘I’m at the peak.’ Or ‘I want to take chips off the table because there’s something bad that will happen, but that is very hard to predict.’

“There were a bunch of funds at the beginning of this year that sold their entire positions. They were desperate to lock in a win. They sold because they thought the market was at the top. And, they were wrong. I’m against it. Selling early doesn’t fully realize the strategy you have put forth. For us, at the growth stage, we shoot for 48 months to an exit. If it takes longer, did we underwrite it wrong? But even if it does, the case may be that the company is growing a little slower than expected.

“At the early stage, all funds will say 2 to 3x cash-on-cash in the LP presentation. Most funds return 1 to 1.5x, on average, with most funds total DPI at 1.2 to 1.5x, which barely returns the fund. Before your time horizon, everyone likes to cite unrealized gains and mark ups because TVPI’s all they have.

“DPI matters most for funds in the top quartile – the top returners, funds with more than $500 million, or nowadays, $1 billion mega-funds. For the bottom majority of funds, early DPI won’t matter. They would be limiting their upside.

venture returns
Author’s Note: Notice that 65% of financings lost money for their investors.
Source: Correlation Ventures

“The new interesting commentary is that – where the job is getting harder – a lot of crossover funds are making binary bets. Finding the one deal that’s the next Salesforce – the next industry-defining company. And putting a lot of capital to find that one or two companies. Tiger and Coatue, still maintain that 10-12% IRR, but spend a lot to find the company that’ll be the next Databricks. Every generation has their industry-defining companies. And, they’re willing to lose it all to find that one.

“You usually don’t see this at the growth stage. It’s bad for innovation. Everyone is trying to find investments that are scaling. 1000 investments in the past year became unicorns. And there are 3000+ unicorns. Yet, the top five to seven companies are still undercapitalized.”

In closing

As we closed the selling part of our conversation, Ratan shared a great quote from an Economist article:

“Flush with cash amid a deal frenzy, what is the industry to do? One option would be to liquidate portfolios, that is, to sell more assets than it buys, in effect trying to cash in some chips when prices are high. As yet, however, this does not seem to be happening. Take the figures for three big managers, Blackstone, Carlyle and KKR. So far this year for every $1 of assets, in aggregate, that they have sold, they have bought $1.30. Although Carlyle is being more cautious than the other two firms, these figures indicate that the industry overall thinks the good times will roll on.”

In fairness, as the saying goes, the high risk, high reward. Data does show that the funds with the greatest track records have more deals that lose money than those make them more money than they invested.

Interestingly enough, there’s also a huge differential between the world’s most valuable and most funded startups. According to Founder Collective, “the most valuable companies raised half as much capital and produced nearly 4X the value!” All of which echo Ratan’s words. “The top five to seven companies are still undercapitalized.”

Source: Founder Collective

The public often looks towards invested capital as a proxy of startup performance. But the data suggests that isn’t the case. In the words of the team at Founder Collective, “capital has no insights.” One of my favorite lines from Ashmeet Sidana of Engineering Capital frames it is still: “A company’s success makes a VC’s reputation; a VC’s success does not make a company’s reputation.”

But when DPI boils down to selling on multiples at the end of the day, I often reference Samir Kaji‘s tweet on the return hurdles expected of different stages of investors. As you might guess, the return expectations of each type of fund varies based on fund strategy.

As all things in the world, exiting is just as nuanced and complicated as entering. Hopefully, the above insights will be another set of tools for your toolkit.

If this essay has inspired more questions, here are some further reading materials, courtesy of Ratan:

Photo by Visual Stories || Micheile on Unsplash

Thank you Shawn and Ratan for reading over early drafts.

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The Investor I Am Working To Be

I wrote an essay exactly a week ago about welcoming tough founder narratives. In it, the prerequisite to play in VC is to be open-minded – to “stay positive” and to “test negative”. I’m reminded of something Tim Ferriss shared in his recent interview with Jim Collins, “It is not that beauty is hard to find, it’s that it is easy to overlook.”

In a world where it is my job to evaluate people who stretch the margins – to stretch “common sense”, it’s easy to be cynical. On the same token, it’s also easy to be incredibly optimistic. As Blake Robbins of Ludlow Ventures puts it, “the best venture capitalists [are] able to perfectly toe the line of optimist vs. pessimist.”

Since then, partly due to the semi-recent influx of investment talks I’ve seen and been a part of – the holiday mad dash, if you will, I’ve had some time to myself to re-center my purpose in the venture world.

The role of an investor

As someone on the investing side of the table, it is our job to check founders’ blind sides. To consider things they may not be aware to even consider. Drawing parallels between seemingly orthogonal parts of the business that we know because we’ve seen hundreds, if not thousands of businesses. For example, if you’re creating a plug-and-play solution – a product whose main selling point is its ease of use, the more you have to spend on your customer success team, the less effective your product is.

Of course, we merely provide insight and context to a situation, but it is the founders who have the final say.

The brand of an investor

Craig Thomas, an LP, wrote on his Substack last month: “Brand is arguably the only thing that resembles a moat in traditional venture capital.” To summarize Nikhil Basu Trivedi words briefly, brand here is constructed by how strong the synergy between the various forms of acquisition channels (i.e. content, performance marketing/ads, virality/word-of-mouth) and the players in the ecosystem (i.e. founders, investors, LPs, operators, talent, etc.) are. In simpler terms, brand is about who knows and how well they know what you stand for.

Increasingly, in the world of venture, while “picking” the right investments via conviction and a thesis still matters, it’s becoming a world of VCs “getting picked“, as Fred Destin of Stride.VC tweets. This is especially true for the deals that investors expected outsized returns on – effectively, uncapped upside.

Craig provides a great graphic for why brand matters. The blue-dotted line, which he calls the Mendoza Line for VC firms, represents y = x + b. And the best VC firms have b’s where b > 1.

Craig Thomas’ chart plotting the relationship between brand and AUM (assets under management)

He points out that the fallacy here is when firms prematurely scale. Increasing their AUM (assets under management) before establishing and growing their brand. And it’s something I’m not keen on falling for.

Seen in another light, Correlation Ventures did a study that found almost 65% of venture-backed deals fail to return on investment. And only 4% make outsized “magical returns”. Proving that b > 1 is truly easier said than done.

returns on venture backed startups is very low in most cases based on data from Correlation Ventures

There’s a saying in venture: Luck only gets better with success. It’s largely described in the context that it only takes one epic investment to get you on the radar. And I believe building a successful brand is a leading indicator of success. Of course, having a strong brand and having outsized returns are not mutually exclusive either. In a 2015 Medium post, Blake quotes Brett deMarrais of Ludlow Ventures, which I think acutely sums up what it means to be a great investor. “There is no greater compliment, as a VC, than when a founder you passed on — still sends you deal-flow and introductions.”

As you might have guessed, I’m on the brand-building phase. Craig wrote: “Brand is reputation and access.” A great brand leads to better deal flow, which leads strong signals for downstream investors. Which leads to a stronger brand. Analogized, it’s what Reid Hoffman has said all these years: “a good product with great distribution will almost always beat a great product with poor distribution.” As an investor, a VC is their own product.

In closing

To quote Ruben Harris’ first boss in Ruben’s recent interview with Garry Tan, “To become a billionaire, help a billion people.” Through a mutual friend, I first met Ruben, Artur, and Timur back in ’18 around the inception of Career Karma and when they were hosting office hours at their apartment for folks who wanted to break into tech. At the inflection point in my career, I went to one of these to meet the individuals I had only been communicating over emails with. And within 5 minutes, Ruben said: “Here’s who you’ve got to talk to…”. And gave me 2 names I hadn’t even considered reaching out to beforehand. Both ended up being great influences on my growth.

True to their mission, even prior to the founding of Career Karma, they’ve been playing the connective tissue between talent, education and occupation. From their podcast to their company, the triple threat have created an impressive brand and community of givers and hustlers. And I highly recommend checking out their podcast to hear some of their community’s stories. Here’s one of my favorites. Congratulations on your A led by Initialized, Ruben, Artur, and Timur!

Similarly, that’s the investor I’m working to be. While I still have miles more to go in building a brand, I believe I’m taking steps in the right direction.

Photo by Daan Stevens on Unsplash

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