Link to podcast | 30 August, 2023

If you are a GP or an aspiring GP (or even just a venture nerd) you will enjoy this podcast episode. There was so much I learnt from this one; a lot of it being very tactical advice around fundraising from LPs, such as on how to segment the LP market, how to construct your top of funnel, and ensuring that your discussions with LPs don’t fall through midfunnel (fundraising from LPs is effectively enterprise sales!), and the ideal LP pitch. The inputs from Mark Suster on how to construct a mid-funnel strategy and campaign that you can sustain yourselves for 6-12m with an LP was practical and useful, as was the discussion around why SPVs (along with low reserves) is not a wise strategy. Find below a transcript that I organised (the podcast publisher doesn’t publish a transcript).


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

Mark, it’s so good seeing you and thanks for being on the show for the special episode about fundraising.

Mark: Of course, I’m always happy to talk to you.

Why 2023 is like 2011 per Mark

Samir: Let’s talk about what’s going on. I was actually just looking at the numbers right before this call about VC fund fundraising, $150 billion plus in 2020-21 dropped off a cliff in 22, early part of 23, about 33 billion raised during the first six months, and it does seem to be affecting everybody, big funds, small funds. Since you spent so much time both with LPs and GPs, maybe provide a summary of what you’re seeing and hearing at a high level.

Mark: If I’m talking for a minute to fellow GPs, let me tell you that the market that you exist in is no different than the market you’re serving, where you’re looking to invest. So, everything that you can see psychologically going on for your own fund and how you’re deploying capital of course is the same of LPs and let me say it clearly, which is there was way too much supply of capital for the last 7, 8, 9 years, maybe even 10 years. As a result, every startup you funded got funded at a higher price after you, everything you funded seemed to be working. Loss ratios were at an all-time low. Loss ratios on deals worth less than one X were south of 40% by 2021, it had gone south of 20% that were any amount of loss and we all got used to this period of time where fundraising into startups was easy.

So, the same was true of managers. LPs have always been hard to raise from, they have always been very selective with where they put their dollars, but so much money entered the ecosystem in the last 5, 7, 8 years that we have all fooled ourselves into thinking this is easy. Turns out it’s not easy and I would say today reminds me a lot of 2011 because 2011 we were just fresh off the global financial crisis. People were questioning whether or not venture capital was a real asset class. There was a report that had come out from Kauffman saying ‘Don’t invest in venture capital’. And of course if you had followed that advice, you’d have missed the best decade of venture capital maybe ever. I think it’s just a return to normal is like I think how I would call it.

Samir:  You mentioned 2011 and I remember the Kauffman report, I think it was called The Enemy Is Us, right? And it talked about the big funds versus small funds. The difference is back in 2011, rates were really low. Rates are much higher, at least from what we’ve seen historically over the last 25 years. What are you hearing, I guess from the institutional LPs because a lot of the institutional LPs had the denominator effect affect them in 2022, at least when public markets went down, the actual markdowns of the private markets didn’t happen and so they were over allocated. It seems like some of that has been not necessarily fully resolved, but to a certain degree. We’ve seen the public markets go up, private markdowns are happening, but what are you hearing I guess from the institutional investors as they approach venture today?

The Denominator Effect, and how it is impacting LP allocation to venture

Mark: So, we can’t put everyone into one bucket. You have endowments, US endowments, you have big pension funds, you have foundations, you have corporate investors, and then you have family offices. And of course they’re all in different situations. I would say the people who seem to be most over their skis have the biggest problem with the denominator problem, which just as a reminder for everybody, If I have a fixed allocation for venture, let’s say that’s 8% of my total investment book and then suddenly the stock market percentage because the stock market declines by 30%, if I was at my target at 8%, I might find myself at nine and a half, 10% because one of the other categories went down and venture doesn’t mark down as quickly. So, on a relative basis, I have too much assigned to venture capital. So, to rebalance my books, I have to slow down my pace to venture, that’s the denominator problem.

There also was the numerator problem. The numerator problem is because venture got marked up so much in 2020, 21 and 22 because venture got marked up so much, my percentage, my relative percentage also went up. So, you had a compounding problem on both sides.

The three, or four pools of capital that the smart investors are tapping

Mark: I would say there are really three pools of capital that are not overtapped, that the smartest, most savvy investors are focused on. Number one is pension funds that historically didn’t have big allocations to venture, and that’s a game for scaled venture because those are people writing $75 hundred million minimum. So, not your fund one, fund two, fund three that Samir you are normally advising and talking to. So, that’s kind of not available. You shouldn’t be talking to them. If you’re raising a $200-300 million fund and you are fund one, two or three, they’re not going to invest.

The second big pool of capital is sovereign wealth funds. So, there are a tonne of investors that are spending time in the Middle East right now and there’s a lot of capital and in Singapore, there’s a lot of capital in those two places. They historically have not been in venture, had access to venture, they know that they are suddenly the pretty girl or pretty boy at the ball right now and they know that everyone’s trying to get access to their money. They rightly are a little bit sceptical and they want to see how committed are you? Is this like a one night stand or are you really committed? Right? That also is not really a game for early managers.

So, the most important third pool of capital is RIAs (Registered Investment Advisors), and this is people who are managing usually high net worth individuals, people who don’t have scale, who would like some exposure to private investments, who know that historically endowments and foundations have done really well by investing in privates who haven’t had the availability to do so. And those pools of capital are increasing their exposure to venture. Now, we can talk about some of the problems of the last 12 months, but generally speaking they want more access and I think that is the best place for emerging managers to look.

Samir: And let’s maybe double click on something there and maybe add a fourth, which is direct family offices that are domestic, not just the folks in Singapore, Abu Dhabi, Dubai, the Middle East regions, and RIAs of course do work with a lot of those families too. So, it’s either working directly with the family or going to the RIA that’s managing, putting something on the platform and effectively allowing their high-net-worth individuals to invest in an asset class that historically has been unavailable. So, you’re right that the emerging manager category, and I think I looked at the numbers last year, I think it was at the midpoint of this year, it was something like 62% of the capital was raised by 6% of the firms out there. And that does lead to what you just said is the bigger funds are able to raise from these big pools of capital.

But if you’re an emerging manager, that’s a fund one let’s even say a fund two. You might’ve had a fund one that’s two years old, you have some performance, but everyone rightfully is going to be sceptical about the markups, the resiliency of that portfolio. So, what are you seeing as maybe the path for somebody that’s raising a fund to that does have a long-term view and wants to build a long-term franchise, how do they navigate in this environment and what is that pool of capital? You mentioned RIAs, how do they go after them?

The emerging venture manager’s game plan

Mark: First of all, of course, you’re right, there are family offices that act independently and invest on their own. So, I think that is another good source. I think when they’re working with managers, when they’re pooling their money together with OCIOs, outsourced CIOs or RIAs or other people, they just end up with a degree more sophistication of understanding the asset class, which is why that’s appealing. Or if they’re working with people like yourselves where they really understand what venture is, then you’re entering a conversation with a sophisticated buyer. And I think that’s a good thing for emerging managers to be in that position. Look, fundraising isn’t easy. It’s not meant to be easy, and venture capitalists historically have not allocated that much time to it. We at Upfront, we think very long-term about relationships. I remember so many people that I went to see in 2011 said no to me and VCs don’t like to be told no.

And I think I found it a little bit easier, Samir, both because I had been an entrepreneur before, so I was used to no. And because it was 2011 where the norm was no. So, I didn’t feel like anything was wrong with me. And I said to every LP who passed, listen, I totally get it. I’m a first time Managing Partner, the fund isn’t new, but I had just taken over as Managing Partner. I’m going to tell you the five things that I’m going to achieve as Managing Partner and I want you to be in line first for my fifth fund. I was raising fund four at the time, and overwhelmingly people told me no. There was really one guy who turned up who said, I believe in you. I believe in what you’re doing. I’m going to be the guy who takes the risk on you.

I call people like this egg breakers because there are people willing to break the rules. The old saying, you can’t make an omelette unless you’re willing to break some eggs, right? And the guy was Jamie Sparence (?), he worked at Morgan Stanley at the time, he is no longer there. I took seven trips to West Conshohocken, and I remember because he called me on a saturday and he said, I think we’re making progress. Could you be here on Monday? And I was with my family camping in the mountains. It’s the first time we’ve ever camped in a tent together. And I said to my wife, I need to leave you here. I’ve got to jump on a red eye and go to Philadelphia. And luckily I had a very patient wife, very understanding wife, and I did that and I flew out there because he said, come and that’s really what it takes.

It was the seventh visit and for whatever reason that was the time and he called me a week later and he committed $22.5 million and that will be the best-performing fund that Upfront’s ever done. So, I feel grateful for the risk and I told them, you’re a lifetime friend. Anything you ever ask of me, the answer is yes, because you took the risk when no one else would. But the truth Samir, is that by fund five, all of those people that I was nice to when they said no, that I kept the relationship going through the fundraising process, the next fundraise was so easy and that was a 2015 fund. I want to say $95 million of new capital even before I started asking people for money. So, you really need to manage through one cycle and understand that if you’re raising fund two, you might not meet all of your goals, you might not meet all of your ambitions, you might have to get used to hearing no’s and manage through that and get to your next fund. And I think you’ll see more yeses as long as you consistently keep relationships built and deliver against what you said you would do.

Building an LP pipeline

Samir: There’s another thing that I do want to juxtapose in a minute in terms of the differences maybe in 2011 and where we are in 2023. Before we go there though, one thing that I’m curious about is as you thought about raising fund four, talking to a lot of LPs that speaks to almost like building a sales funnel. You’re picking the right target. You mentioned as an emerging manager, there’s no way I should go to a pension or a sovereign wealth fund and these folks. So, it’s figuring out who your target segment is and then building a pipeline around it. Tell me a little bit about how you built that pipeline and how do you move people through the sales funnel?

Mark: I’m a big believer in referrals. It’s no different than selling enterprise software in that regard, which is if I cold call a Senior Vice President at a customer, they might take a meeting, but when they meet you, they’re leaning out, their arms are crossed and they’re leaning out and asking, tell me why you’re wasting my time. When a customer says, man, we got a lot of positive benefit out of using this tool, you really ought to meet this person and see what they can do for you. They come leaning in. And the same is true for venture capitalists raising money. So, if I ping a bunch of LPs and I say, I’m going to be in New Orleans, would you meet me? I’m going to be in Chicago, would you meet me? Most of the time they’ll say, sure, stop by. Right? Because it’s their job to meet people.

But having a referral that said, Hey, I’ve sat on a board with Mark, he was valuable, would you meet him? And it’s someone that they trust that matters a lot. So, the top end of your funnel is just knowing who’s out there, segmenting it by, are these people who invest in my stage? Let’s say I’m raising $150 million. If it’s people who are writing a hundred million plus checks, you’re wasting your time. If it’s people who have never really invested in venture, you’re probably wasting your time. So, making sure they’re in a few managers that are at the right stage size. We’ve talked before, I told you, for me, that’s ‘why buy anything’ and why buy anything is like are you really in the market for this kind of venture capital? And then the second rule of sales is why buy me? Do you buy my differentiation, what I do that’s differently than other people?

And so that’s just a segmentation game. So, we research who’s in the market. We’re constantly talking to VCs and LPs asking who’s active, put it in a funnel, and then we look for buying signals. So, I usually have my IR team try to get an initial call to just feel out whether it’s worth our time. So, if you say, I have too many managers and we’re trying to pare back. But yeah, we do occasionally take new people. You just have to beat someone who’s on my existing roster. Maybe I could beat ’em, but that’s not a very efficient use of my time. If they say we’re over allocated to venture, our target is 12% and we’re at 22%, I’m probably wasting my time. Now what makes our ears perk up is if they say we’re building a programme, we’re at eight managers, we’d like to be at 18, we’re at 4%, we’d like to be at 9%.

And we just ask, what is your current outlook on venture? If it’s highly referred, if we feel like they are interested in our stage of venture, if we feel like they’re in a phase of their deployment of capital that we would be a good fit. We put a lot of energy into top of funnel. Now top of funnel, Samir is incredibly easy. It’s easy because everyone’s nice in the first meeting. They want to learn, they want to get to know you, they smile, they ask good questions. So, you walk away thinking, man, this is easy. And then nothing closes. And so the problem is top of funnel. If you’re smart and good at segmentation and you do a little bit of desk-based work and you ask your friends for referrals, top of funnel is easy. Mid funnel is where everything dies.

Mid-funnel needs a campaign that sustains itself for 6-12 months

Samir: So, tell us about mid-funnel because I think you’re right, you have that first meeting, you’re walk away energised, they’re asking good questions and a lot of times the manager will think, oh, I got them. They’re going to definitely come in. I could feel it. A month goes by, you send an update, maybe they respond, maybe they don’t. And at some point during that mid-funnel, because these things do take a long time, you lose momentum and then you realise that what you thought was real is actually not real and you realise maybe you hadn’t built enough a big of a top of the funnel and moved the high value prospects through the mid funnel. What does it actually mean to move people through mid-funnel?

Mark: So, I wrote a blog post about this once. I think you know I keep a blog, Both Sides of the Table and I have Y axis is love and X axis is time. Okay, love and time. And when you’re in the room and it felt magical and they engaged and asked you good questions and you built rapport, it was probably real. I’m not saying that they weren’t like in that moment they’re like, Hey, we could write a check here. But 60 days later, 90 days later, they’ve met 38 other funds and they sort of forget you. Like Mark, he was that, was he that guy? He is from California, a grey hair dude, right? You want to think that you’re so memorable that they know everything about you and they just don’t. And it’s no different than when we see an entrepreneur. If we see an entrepreneur in the meeting, they might’ve wowed us and then six weeks later we’ve seen 48 other companies and we’re like, yeah, they did AI for voice recognition.

So, mid-funnel is about having a campaign that sustains itself over six to 12 months. So, you’ve got to have a plan for what are all the documents I’m going to release over the next year? What is all the materials I’m going to share over the next year? If you have more than a solo GP, I always tell people, don’t go together because if you have two GPs or three GPs and you all go together and you go to St. Louis and you meet a high profile prospect for you, now there’s no reason for them to meet you again. They met you all. So, you call ’em six weeks later and say, can we meet you? And they’re like, they don’t want to meet you because they know they have to now do work or decide to tell you no or decide to buy. But if you see them and then six weeks later another partner happens to be in town and six weeks after that you invite ’em to an event in Chicago that you’re doing that you’re hosting with a bunch of LPs. It’s just a way of continuing to keep engagement, which is no different than any sales marketing campaign that exists in any market. You need to produce materials, you need to send them emails, you need to stay top of list.

I also tell people it’s really good to get people out of their office. If you sit in an office with PowerPoint or keynote slides and you’re flipping a deck, you’re doing what everyone’s doing. And you probably know this from our prior conversations, we did something, we called City Tours. We decided to travel all across the United States. We went so far, we’ve been to seven separate cities. We host 12 to 14 LPs in a dinner discussion. No obligation to them. We’re not pitching people. I invite other GPs to attend. So it’s not just an Upfront event and we host a dinner and have a dialogue with people. It’s the kind of stuff we do with entrepreneurs as VCs all the time. We do dinners, we do breakfast, we just don’t do it with LPs. And that makes no sense to me. So, we started hosting these with LPs and lo and behold, I learn a lot about what’s going on in their industry. I learn a lot about what their challenges are. We talk about them as a group and they get to know me in a context that’s different than the conference room and then we’re a little bit more memorable.

A non-obvious hack for mid-funnel – do events where LPs meet founders

Samir: When you think about those type of events, it makes not only a tonne of sense, but it seems like a great return on investment because you’re also learning, you’re getting a bunch of people in a room in a less high stress situation because you, they’re not looking to buy, they’re just talking and actually LPs do like talking to each other. What are some of the other non-obvious things that you’ve learned in terms of great ROIs in terms of getting people through that mid funnel?

Mark: Well first of all, LPs love to meet entrepreneurs. They don’t get invited to meet entrepreneurs a lot. And that’s something most VCs have access to. I remember in the early days of Tinder, Sean Rad, I had backed Sean’s previous company it was called Adly. And then suddenly Tinder was the hottest thing in the world. So, I called in a favour and said, Sean, I’d like to host a bunch of LPs. If I did, would you come to a dinner with me? And he was super gracious and said yes. And so I was writing to LPs saying, would you like to come to meet the CEO of Tinder? And this is again when Tinder was on the ascendancy, right?

So, what does every LP want to know right now? They all want to know what’s going on with AI. They read about it in the paper, they hear about it from every VC. They don’t want to hear about it from VCs. They want to hear about it directly from the CEOs who are running that. So, much better if you could host eight CEOs talking about how their businesses are responding to AI and invite four LPs to attend. There’s so much low hanging fruit for what you can do. And it always goes back to me, this thing about sales. I don’t know. Have you ever heard of Zig Ziglar? Yeah. So, Zig Ziglar, I’m sure no one who’s watching or listening will have heard of him is old school, but it was all about sales and he’s a genius. And what he said that always sat with me, Samir, is he said, people don’t care how much you know until they know how much you care. And I’d love people to reflect on that. People don’t care how much you know until they know how much you care.

So, they care how much we all like to feel like we’re super smart and we all went to good schools and we want to tell everything we know to people, and we also think that’s what they expect of us. So, it’s almost like this imposter syndrome thing. I have to know everything about technology and everything about the market and tell people how smart I am to win, but in reality, they also want to know that you actually care about them, that you are interested in them, that you’re going to be a real partner for them. It’s kind of like I was saying to you about the Middle East, you turn up once and think people are going to suddenly throw $20 million at you. They’re like, you’re here for my money. You turn up three times or you do them favours or you host them at an event in New York or London, they’ll see. So for me, we host LPs all the time. We don’t ask for a lot all the time. We’re trying to tee up opportunities for them and they see you just as he’s kind of a niceish, normal guy who’s got a point of view and an opinion and surrounds himself with smart people. And I like the way that guy thinks. Not everyone will think that, but if you’re having 12 people turn up at dinners seven times in six months, that’s 42 people.

Be upfront about your ‘why buy me’ or differentiation

Samir: When you think about those dinners, and of course you’re in a position where you have institutional LPs, maybe some family offices as well, and many people are raising from both camps and maybe it’s $150 million fund, I may not be able to raise from the pensions, but certainly fund of funds, endowments, foundations and then I also have my family office, which are two very different segments in terms of the way they behave, characteristics. What have you noticed as the tangible differences when talking to these groups and ultimately how does that shape how you work with them?

Mark: Well, as a starting point, if it’s a family office, is it run by the family or is it run by an outsider, by a professional manager? Usually when you’re talking to big institutions, well not usually always, they’re run by professional managers. I think when it’s your own money, people have a harder time making commitments. They have a harder time just thinking in aggregate numbers, and I’m just making 12 manager bets. I find it easier when you’re mostly dealing with professional management, managing other people’s money. There’s a sort of more of a dispassionate, I’m just going to look at, do I think you have the right skill sets, the right access, some competitive edge? Do you have a history of performing well? And that’s suited me better. Maybe other people have a different model. Other things, Samir that I test for, we’re an atypical investor at Upfront, and I’ll say it this way, which is in a really booming market, we never perform as well.

And the reason is we’re not rushing to get into the hot category. So, if you wanted to perform incredibly well in the last 18 months, you’re not worrying about cash returns, it’s just TVPI (total value of a fund, relative to paid-in capital). You should have put as many quick dollars into small dollar increments into AI because rest assured someone else was going to mark it up to an astounding high price and it will be valued at let’s say a billion dollars. That doesn’t mean it’s worth a billion dollars that’s the value. Whereas we tend to shy away from momentum and try to focus on where we think the market’s going to be in 3, 4, 5 years. And so you don’t get as quick a markups. But in a correcting market like this, we show much better because we have, I always say to people, look at unicorns in 2012, there was one unicorn, one in 2013, there were three.

In fact, Aileen Lee wrote the article in 2013. When she wrote it there were four, they were unicorns. That’s why she called them unicorns. By 2015, there was like 45 net new ones created that year. By 2018, it was 125. In 2021, there were 725 ish new unicorns created. Compare that with the public market Samir, there are about 175 internet companies worth a billion dollars public in the us, there’s about 175 software companies worth a billion dollars. So, approximately 350 total public companies worth a billion. So, why do we think you could create 725 net new ones in one year? It’s fantasy. Everybody’s TVPI who were in those deals are fantasy. So, I tell LPs, if you’re going to look, go through someone’s portfolio, say how many were funded by SoftBank? How many by Tiger, how many by Coatue?

And I’m not picking on those people. They’re good investment funds and they make money, but you can rest assured that if they have a bunch of those funded in 2021, they’re just significantly overvalued. I mentioned all this Samir, like the why buy me is you need to align yourself with someone who thinks the way you do. If you come into me and you’re saying, I want to know how many unicorns you have, or why isn’t your TVPI 12X? Well, I can say, historically, TVPI for the best performing top quartile funds consistently 2.5X. So, if you expect me to be 12X in every fund, you don’t understand the market very well and we’re not likely going to be a good match for you.

Samir: And I think a lot of people forget that. So, I posted this the other day in terms of what returns are looking at from ‘96 to 2021 and the top quartile was about 2.38X median, much lower of course, and even top decile according PitchBook, but 3x, and I think a lot of people did get a little bit spoiled, and it was a red herring that, oh, you can get a 10 X. And a lot of those funds were really small funds where people were writing a lot of checks and they were getting marked up really quickly. And so, people were able to raise going from a fund one to a fund two based on marks that were essentially two years into a fund. You had 77% IRR, you had a 2.6X and it was able to be raised and of course now that isn’t the case.

And a lot of those past portfolios are going to show less resiliency because not only are those markdowns happening, but they’re also behind several rounds of preferences. So, when you look at somebody that’s raising today I think we counted 2,600 new firms that were formed post your fund four back in 2012, how would you advise somebody that’s going out knowing that you can’t really rely on the numbers? The benchmarks really don’t mean as much today. How do you actually differentiate in a pool of managers that are all trying to raise at the same time, often from the very same people?

Trust is the key

Mark: As VCs, we need to think how do we fund companies? And the kinds of decisions at the seed round that we are looking at is similar to how you should expect people to think about you even if they don’t verbalise it. Here’s what I mean. I always tell people the thing you’re fundamentally buying is trust. Now what does that mean, Trust? If I’m going to hand a 28 year old, $4 million on zero revenue, I want to trust that you’re going to be a good steward of my capital. I want to trust that you’re going to be all in on this and not other things. I want to trust that you’re going to be able to attract and retain really good talent. I want to trust that you’re going to produce intellectual property that’s differentiated, and I want to trust that if things are starting to succeed at your company, you’re not going to sell quickly for 3X, but you really truly want to build something long-term, and I might dress it up as an evaluation of your IP, or I might dress it up as we’ve done a TAM analysis or a SAM amount, whatever, blah, blah, blah.

But fundamentally, those are checklists used to create to justify, instinctively, do I trust this individual and are they going to be a good partner to me? And the same is true for LPs, and I don’t want to speak for LPs, but I would purport it’s the same, which is they’re going to go through all their lists, which is did you make a good investment? Do I believe in your partnership team? Do I think you have some competitive advantage? Are you getting good markups in the portfolio? Do VCs say good things about you? Do your founders say good things about you? But at the end of the day, they’re handing you a pile of money for a blind pool of capital, right? Blind pool of capital, tell me that’s based on anything other than just trust. And they have much less say in our funds than we have on the boards of directors of startup companies.

So, how do you build trust with people? And I think it’s important for GPs to think that way because if you accept that that’s true, and it may not be true, but I think it’s true, then you should do the kind of behaviours with LPs that lead to building rapport and trust. And that takes time. It takes number of meetings, it takes amount of time, it takes references and referenceability. LPs don’t want to pick up the phone and call your references because that’s doing work. But there are things you could do to drive people to send emails or make phone calls to your LPs to get them hearing from other people, and that’s mid-funnel type activities.

The ideal LP pitch, and the three levers to press

Samir: So, let’s actually go back to that for a second because I do think that’s right where people do create their own confirmatory bias by the instinct, by the rapport, and it’s often the brain that justifies what the heart or gut has already told them. And we’ve seen this time and time again, but yet often times managers, particularly newer ones, when they talk to an LP, even if it’s a warm referral, the first thing is launching into the story, let me tell you what I’ve done. Here’s my thesis, and it’s really going through this pitch deck that is speaking to the brain. What do you do? I guess before, what would you advise somebody before an LP meeting? What are you actually doing to prepare for that meeting? And what does that first 10 or 15 minutes look like to create that foundation of trust and rapport?

Mark: Look, every meeting is going to be different, and I will tell you what an ideal meeting would be. An ideal meeting to me is to start by listening rather than talking and it’s hard to do. So I’ll tell you, my opening line of almost every LP meeting, almost every LP meeting, I start by saying, we have an hour together. I know I’m going to do a lot of talking and I’m kind of hard to shut up once I start and Samir, you can attest to that. But before I start talking, gosh, I would love to learn a little bit more about your programme if you’re okay with that. And I’d say 95% of the time people say yes, absolutely. If they say, look, I’d rather just you get started, then get started, right?

Inviting someone to talk about their business is an important way of learning what’s important to them.You can learn what their belief system is. It doesn’t mean you need to pander to them. If they tell you their beliefs and that’s at odds with your beliefs, you can politely try to say, well, look, I know you said A, we’ve kind of discovered B, can I at least share with you why we feel B is true? But if you just assert B and you don’t even know that their point of A is A, you are just blindly telling ’em something that they’re not going to agree with, I would start by getting them talking. I try really hard, and not everyone can do this, but we know our deck cold, we know our data cold, we know our stories told cold, and we try to balance three things.

One is talking about the team and what we think is unique about the people we have because it’s a people business. Number two, we try to share data because we know fundamentally that’s what LPs want as both proof of how you’re performing and that you have knowledge and command of the market. Number three is storytelling and storytelling to us comes through telling you about our portfolio. So, I try really hard to pick four or five stories from the portfolio that I think will resonate with this investor. And I tell you let me tell a story about Bionaut. Let me tell you why we invested in this company that invented micro robots that they inject into the base of your spine and use magnetics to put it up at the base of your brain to perform a procedure. And I’ll tell the whole story, and there’s a very good story behind it. And we own a lot of the company, we put a lot of dollars. We’ve been in that company seven years, but then there’s a chance, not for me just to tell you about how I think we can treat glioblastoma, but also why we hired Kevin Zang and why Kevin’s been so successful at funding healthcare related things and what we think comes next for this company.

And if I can tell you four or five stories about really inspirational companies we’ve invested in, it’s a lot more memorable than telling you, Hey, our TVPI is 4.2 on the 2012 fund, or 3.6 on the 25th. I’m making up numbers, but they’re not going to remember that.

Samir: I think all of that is actually very insightful in terms of thinking about these and LPs also do like to talk about what they’re doing. And often times you get a lot of really key interesting tidbits during those first 10 or 15 minutes that allow you to tailor your conversation and pitch on things that do resonate. And one of the questions that often comes up is institutional investors versus families. And families do like to hear the stories. They want to be close to the game, but at the same time, family offices don’t have hard set allocation strategies like an endowment. Endowment might say, this is my percent target and real assets, this is how much I’m going to do in private equity and private credit, fixed income stock venture family offices tend to be a little bit more opportunistic unless they followed an endowment style. And for them it’s not just, Hey, Mark, are you a good manager and is this a good fund and have you shown something? It’s also about why venture capital, why do I need venture capital when the risk-free rate is north of 5%, close to 6% private equity? Private credit is also, generally speaking, a little bit less risky, less illiquidity rather. So, what is that bull case for venture in this type of market?

Venture in a high interest rate regime

Mark: Well, I think one has to have a long-term outlook in general, and one has to be a good student of history and data, and it’s helpful to read about that so you can answer that question with LPs. But if you look over the last 30 – 40 years, people who have invested in private illiquid markets and people particularly who have invested in venture have gotten a premium relative to putting your money in the stock market. Stock markets, I guess pay on average 11, maybe 13% per year, somewhere in that range. I think corporate bonds are paying like 9% per annum. You can get risk-free five and a quarter or not totally risk-free, because the US could default one day, but let’s assume that the US doesn’t default. And so you have these baked in rates of return that you typically get in asset classes. Now in order to invest in venture, they better do better than that because if I put my money in an index fund and get 11% per annum, that’s liquid, I can take that out anytime.

So, if you’re not able to get 18, 20, 22, 25% per year IRRs, why should they give you money? And so you’ve got to show a premium. There’s actually an analysis that we do called PME. I don’t know if you guys ever look at PMEs, but we do, they’re called public market equivalents. And so we say if we were going to write a dollar in the NASDAQ or what the Russell, what is it, or the Wilshire 5000 or I forget what it’s the benchmark is. If we were going to write this in 2016, 2017, 2018, and those are the three years we deployed a fund for every dollar we put into that index, what if we instead put that dollar into Upfront? How would those two things have performed differently? And then we produce a comparison to show how we perform relative to the public markets. And frankly, if you’re not beating the public markets, I don’t think you deserve to raise LP money.

Samir: And just the sense, I was just actually looking this up, I mean long-term S & P, about 9.5%, NASDAQ about 11.5%…have done a little bit better, especially over the last 14 years. But at the end of the day, private markets, especially if you have proper manager selection, is going to outperform. One thing that I wanted to test and maybe pull on a little bit is you mentioned this premium that you have to get over the public markets in terms of justifying the liquidity and risk you’re taking. But it also does seem now that venture is not this singular asset class, but a composition of almost sub-asset categories within it where somebody like an insight is very different than that $30 million pre-seed fund. How do you think about LPs thinking about venture as an asset category and thinking about the risk premiums or the liquidity premiums across the entire market?

Mark: So, first of all, if you are an emerging manager and you talk to LPs, you’ll hear one message and then you’ll see different actions. What you’ll hear is the big platforms have gotten too big, they’re way too big. You’re not going to get returns from those. They’re like 2x at best, probably going to do 1.5x, and then they turn around and commit to them anyway. And it’s sort of nobody ever got fired for buying IBM type situation versus I’m going to pick five managers no one’s ever heard of and put my name and reputation on the line. It’s much harder to do that. The person I maybe respect the most in LP world historically was Lindel Eakman, who on behalf of Utimco, a very large pool of capital backed Union Square ventures, Spark Capital, True Ventures, thankfully Upfront Ventures at a time where none of those brands were known.

And he really put his neck out on the line and made a lot of money for the University of Texas, but that was not the norm. The norm was writing your checks to Sequoia and Greylock and Kleiner Perkins. And by the way, those are great funds too. I’m just saying it’s really hard to get people to break from IBM. So, what they say is they really want small funds, but what they do is they write their capital into big funds.

Yes, there are multiple asset classes. So, people generally think about early stage as one distinct category, let’s say sub $300 million funds. Then they think about the full cycle investors, the people who have seed and growth and opportunity and Asia and Europe. And those are, let’s call it the platform funds. And then they think about venture growth equity, like Insight. And I think those are really three distinct markets. Now, if you’re a public pension managing $75 billion and you have a small team of public servants using a manager to write cheques and you’re writing $150-200 million cheques, you’re backing Insight. And Insight has for their size and scale, from my understanding, performed incredibly well, in good markets and bad.

Samir: And going back to that a little bit, so if I’m a big pension, of course I’m limited in terms of time, I have resources. Writing a single $150 million cheque is degrees of magnitude easier than picking 15 managers and doing $10 million each. And oftentimes what I’ve heard is, and I’d love to get your take on, is like, well, if I invest in those 15 managers at $10 million each, there’s more volatility with those small firms. I might have an outperformer here, but I might have a bunch that are underperforming and I might end up with a 2.2 to 2.5 X, maybe a little bit more versus 1.75 X with a big firm. And that comes up a lot with the big institutions. But even family offices sometimes say, I’d rather just buy the brand because it’s easier, and if I build a huge portfolio of emerging managers, maybe I get around the same return. Now, I don’t think that’s statistically true, but it’s too early to test because the last seven years we’ve seen only one world which is markups, markups, markups. And we haven’t seen the full effect of what’s going to happen with a lot of these companies that were minted unicorns. What’s your take on these asset categories when you think about that early stage sub300 return profile versus the multi-platform, and what does make sense?

Sub-$300m funds vs Multi-platform funds; Reserve strategy and SPVs

Mark: If you’re not putting in the time or hiring an expert to help you figure out who people think the good performers over the next 10 to 15 years are going to be, it is more rational to hand your money to Lightspeed if you want to get better returns or have a bigger seat at the table, a better strategic relationship or maybe better co-invest. If you’re putting in the effort either yourself or working with somebody like Allocate to better understand managers, you’re probably better off with the 10 because you’re diversifying your risk and having diversified set of underlying assets is more likely to have less risk. And also if you back 10 managers and you get to know six of them really well, you might size up on one or two in your next fund. And those one or two, you might have a bigger seat at the table. I often say to family offices, when I talk to them, I’m like, okay, so you’ve got $7 million to commit. Do you want to be $7 million of a billion and a half dollars or would you rather be $7 million of a $250 or 300 million fund where people care about you more where you’re not just a line item, you’re not, you’re putting $7 million into a billion and a half dollars fund. I can just tell you, you’re just not that important to them.

Samir: And this goes the same for big funds, investing in companies at seed where you’re a million dollars out of a 600 million, 800 billion fund.

Mark: Every analogy holds Samir. I think the markets and generally how they work between VCs and entrepreneurs is how they work between VCs and LPs. And I think managers are best off thinking about their own personal behaviour and then saying, well, if this is how we behave with founders, this is how we should expect LPs to think about and behave about us. The other thing I’d like to encourage your managers a little bit off topic, but I’d like to encourage your early stage managers to think more thoughtfully about reserves because it’s been one of my pet peeves over the last few years. We invest 42% of our fund and we reserve 58%, and that’s a pretty conservative but thoughtful approach to venture markets. So, I might deploy $300 million, but I’m really thinking about 42% of that being in first cheques, and I pace ourself on 42%.

Why does that matter? Let’s put things into multiple buckets, three buckets in particular. I want a large pool of my dollars then backing my winners and being able to deploy places where I have asymmetric data on something performing well. Number two is there’s always those companies that they’re doing well, but it’s taking longer or the market slows down and they need to get over the hump. And not having dollars to deploy is unhelpful to that. But the third is a correcting market like this where people start doing pay to plays and you think there’s value in a company, and if you don’t have dollars to protect your position, you get wiped. And for those three reasons, having reserves really matters. And I think what a lot of emerging managers did is they deployed as much as possible of their fund into first cheques and they assumed, let’s say I did 25 deals.

I assume my best eight or 10 I can do as SPVs. Now, that was very GP friendly, but I think that market is going away and people realise that what you’re doing there is you’re getting deal by deal carry and it misaligns the incentive between LP and GP. We have not done SPVs in 26 years. And what I tell people is then if I’ve allocated 80 to 90% of my fund to first cheques, I have no ability to protect myself. So, I think a more prudent strategy is to keep a lower first dollar check and more reserves.

Samir: Yeah, it’s actually a topic that we talk about a lot in terms of portfolio construction. And many managers are 50 – 50, or in some cases the smaller funds are almost no reserves, or it could be 80 to 90% initial. And now the logic was, I get more ownership of these companies when it’s the cheapest and everything will be fun. I can raise an SPV. What I think a lot of people lost in the SPV side is number one, if that SPV goes wrong, LPs remember, and they may not back your core business, which is your actual fund business. And we’re seeing some of that. And I do agree that pay to plays are happening, the washouts, they highly diluted rounds, things that we hadn’t seen for 8 to 10 years almost. Now we’re in play

Mark: Low reserves, high SPV is a bull market behaviour.

Samir: Agreed, totally. Well, Mark, this has been great. Thank you again. This is the second time you’ve been on. Very, very timely given all the things that are going in the fundraising world. But thanks again for coming on.

Mark: I appreciate it, Samir. As you know, we often have these conversations and it’s nice to occasionally turn a video camera and an audio camera on. I always enjoy talking to you. I love following you on Twitter because you actually put out real data in the market, and I encourage entrepreneurs, managers, LPs, all to follow you because there’s so much misinformation about how markets work out there, and the fact that you have decades of analysis I think is really helpful to kind of ground the market. So, thank you.