The Exchanges

Q What's the trend most investors are not seeing or ignoring?

A Uh, I think it's the secondary side, which we spent most of the, the episode today talking about. I just don't think people think about this segment within venture and venture isn't this tiny cottage industry anymore that it used to be. And as a result of that, and as a result of the limited liquidity options, the secondary part of venture is going to be very significant for a long period of time. And I think pretty interesting and also a compliment from a duration standpoint If you're doing a lot of early stage venture, it's going to be one of the only ways you can make sure you're getting your capital back and complimenting what you're doing on the seed and series A side.

AI assessment note: “I think it's the secondary side, which we spent most of the, the episode”

Q interviewing 2000 managers. Now I've spoken to a few managers. And the common question I get from LPs is, Harry, we need to allocate our B fund bucket, but we don't really know where to go. There seems to be this kind of shortage in market. First, I'd love to hear, Hunter, would you agree with me on the shortage? And why do you think, if so, that shortage exists?

A Yeah, I think there's definitely a shortage of dedicated B round investors. It's called the treacherous B for a reason, because you're investing where there's generally not a ton of revenue. I mean, it's changed as everything has been pushed out from C to A. But I'd say zero to five million most typically, and at that point, I don't think you're betting solely on execution. There's still plenty of risk, and you have early adopters, but it could be companies that aren't representative of what a customer base needs to be as a company continues to scale, and so what you end up having in B round focused funds is a higher loss ratio than you would want, and typically in late stage and growth, mitigating loss rate is incredibly important. In B You can sustain some level of loss, but you also need to get upsized winners. And frankly, you're paying up in the B and it's not as metrics driven in the pricing that you're offering at that point. And so it can be very difficult to thread the needle there. I think that's why you haven't seen a lot of dedicated groups that do it. There are groups like a scale or an open view that I think are very effective in this category, but it's difficult to do. And while you're not seeing a proliferation of new B round focus groups, Back to our discussion five minutes ago, you're seeing the A round groups increasingly look to preempt and build bigger posi…

AI assessment note: “Yeah, I think there's definitely a shortage of dedicated B round investors.”

Q Where do first-time fund managers most often go wrong?

A I don't think there's enough of an emphasis spent on the selection of LPs. I think it's just taken sort of trivially, and you want to get it done quickly, and if you have someone engaged who wants to get you going and write a decent-sized check, it's tempting to just take that, but as everyone says, it's like a partnership. It's like a marriage. You're going to be involved With the LPs for a long period of time, and you really want to have people that are aligned in terms of mission values and people you like to be around and who are going to be flexible and thoughtful as you scale and evolve your business, and it's also important to have diversity by type of LP and geographically as well for a number of macro reasons that can make things very difficult for you in future fundraisers if you don't think about that up front.

AI assessment note: “I don't think there's enough of an emphasis spent on the selection of LPs.”

Q Speaking about kind of the secondary pricing there, you, I mean, maybe I'm wrong here, but I've spoken to many secondary providers and even in the good times, 20, 21, there was always a level of discount because they knew you needed to sell for some reason. Um, it's the nature of the beast. Uh, what level of discount did you buy in 2020 and 21?

A Yeah, I was looking at, uh, data from Jeffries earlier just to remind myself on industry level returns, and I believe that the average discount to venture ticked up as high as just 12% in 2021, so quite low overall, but if you were to fast forward that forward, uh, to 2022, it's back down at an industry level to 34%, um, which is deeper than you've seen for a while. So Things definitely got frothier on the pricing side in 2021, but are back down to levels, uh, and even below levels that we've seen over the past decade in overall pricing. Anecdotally, it's still a little bit deeper on the discount side in LP interest than on company secondaries. On LP interest, a lot of what we're seeing is in the 30 to 45% range. A lot of what we're seeing on the company secondaries is in, like, the 20 to 35% range.

AI assessment note: “average discount to venture ticked up as high as just 12% in 2021”

Q Hunter, I have to ask you while I have this, do you think venture investors have marked down their books adequately enough, given the repricing in the situation that we're currently in?

A I mean, it's a hard question, because if you look historically, people have generally carried things at last round pricing, or have taken a discount to last round pricing. Many of our managers actually took Discounts to last round pricing, even before correction, just to be conservative and because they didn't have an issue around interest level of other LPs wanting to get into their funds. Um, but many carried at last round pricing and have done so for, you know, decades at this point, you're going to have a much different methodology on how to approach things in this year and the coming years. I think we looked on average funds have come down around 19% On the venture side, um, somewhere between 15 and 20, I would say, is, is what we've typically seen. Whether or not you think that is enough, I, I think people have very different opinions around it. I think probably there could be incrementally more markdown than what we've seen, but I have been, um, surprised and, and happily so that people have taken discretionary markdowns more proactively for the first time in, in my history of doing this.

AI assessment note: “I think probably there could be incrementally more markdown than what we've seen”

Q Are you able to do that? In terms of some of the top names, when you downsize, they don't take it so well. For LPs listening, how should they think about being wary of losing allocation or losing relationship or trust with top tier managers when they do need to downsize?

A Yeah, it's not an easy, it's not an easy answer. I mean, I, I, we've always preferred to be consistent in our sizing and not size up and size down, but If your, your options are the, uh, the way they are in the current environment and you only have so much that you can allocate, you then have to cut off all of the middle performers or the upper middle performers and just maintain it in, in the best groups. And that has its own challenges and creates portfolio concentration, but obviously you'd want to maintain the same investment sizes in, in high quality performing groups. If you do find yourself in a scenario where you have to build that back over time, You have to think of ways to stand out as an LP partner, and be more than capital, and find ways to be helpful with directs, with secondaries, with the ability to help in business development. Um, you know, being an LP should not mean that you're just passive capital, at least for the good ones.

AI assessment note: “think of ways to stand out as an LP partner, and be more than capital”

Q people are resizing positions. If you're a manager, this is what an LP told me yesterday, if you're a manager in the last five years that has not returned cash when you had the chance to do so, Then you're first on the chopping block in terms of reallocations. Do you think that's fair, and what do you think are other core reasons why you're first on the chopping block?

A Yeah, I mean, I think LPs will pay more attention to how folks dealt with public positions, um, and whether you got out of those when you could, whether you decided to hold them much longer. Um, people increasingly got more comfortable holding publics longer than the typical, like, six to 12 months you saw historically, and so I think that will be viewed, um, as, as a negative point to some degree, but showing DPI is going to become more and more important. Mostly because LPs will struggle to evaluate what true TVPI is, and unless you really have a deep understanding of the value driving companies and the underlying assets, you really just can't do that benchmark exercise, and look at how TVPI compares to what the respective benchmark is, because people will carry stuff so dramatically differently in valuation, you're gonna end up making really bad decisions, and the ones that are the most aggressive in TVPI carrying value Are the ones that need the capital the most versus the ones that have been more conservative. So you really need to have some sophistication and knowledge of the value driving companies and DPI is like undebatable. Um, either you've generated that, uh, you have realized results and it's not going to swing in the future like TVPI is. So current carrying value becomes less important than a nuanced point of view of projected value within these funds.

AI assessment note: “showing DPI is going to become more and more important.”

Q I think kind of the big question that a lot of people have is that the spread between, you know, what people are willing to buy and what people are willing to sell is still super high. Are you seeing that converge now? Is there a realization happening now within the sell side that actually they need steeper discounts?

A Yeah, it's very different from oh eight to 2010 because then when you were buying at a 30 to 50% discount, you were causing someone to maybe get a one X or to lose money because the funds weren't written up to the level that they are currently. Now, if a fund is at a three to a four X and you're asking them to take a 50% discount, they're still going back to their board with a two X return and the ability from an opportunity cost standpoint to then deploy it. Into what we all expect to be very good vintage years, and so I think it's an easier argument to be made to consider even a deeper discount in an environment like we find ourselves in.

AI assessment note: “I think it's an easier argument to be made to consider even a deeper discount”

Q Hunter, I have to ask you while I have this, do you think venture investors have marked down their books adequately enough, given the repricing in the situation that we're currently in?

A I mean, it's a hard question, because if you look historically, people have generally carried things at last round pricing, or have taken a discount to last round pricing. Many of our managers actually took Discounts to last round pricing, even before correction, just to be conservative and because they didn't have an issue around interest level of other LPs wanting to get into their funds. Um, but many carried at last round pricing and have done so for, you know, decades at this point, you're going to have a much different methodology on how to approach things in this year and the coming years. I think we looked on average funds have come down around 19% On the venture side, um, somewhere between 15 and 20, I would say, is, is what we've typically seen. Whether or not you think that is enough, I, I think people have very different opinions around it. I think probably there could be incrementally more markdown than what we've seen, but I have been, um, surprised and, and happily so that people have taken discretionary markdowns more proactively for the first time in, in my history of doing this.

AI assessment note: “I think probably there could be incrementally more markdown than what we've seen”

Q I've spoken to many GPs at kind of multi-billion dollar funds, and they say, ah, Harry, don't worry, we're good. We've got four billion raised last year that we haven't touched yet. We've got six billion raised last year that we haven't touched yet. Do you think there's any risk on those, actually, in terms of their ability to call, given the size of those funds? Yeah.

A I mean, there are plenty of people in, in those advantage positions, but most of what I've seen from growth funds and late stage funds, or even if they have the capital, they're not actually deploying it. Um, and, and good for them because it would be even worse if we find ourselves in a scenario like now and people are pushing money out the door aggressively, um, just for the sake of doing so to come back to market faster. Um, but it does become a question of like, how long, um, should they be able to just sit on the money and not invest it? And it also goes back to, Whether or not the fee structure is on invested capital versus committed capital, and if it truly is on invested capital for some of these growth funds, then I think LPs are fine being patient and, and respecting the discipline of the manager. If it's on committed, that becomes a more problematic scenario, and I think everyone should be more cognizant of what fund sizes make sense in the go-forward environment, because round sizes are smaller across the board, and growth financings just aren't happening at the same clip.

AI assessment note: “Whether or not the fee structure is on invested capital versus committed capital”

Q We saw such large funds in the last few years being raised. Do you think managers should return capital, make them smaller, readjust?

A Yeah, I mean, I think on the growth fund side, a lot of funds became way too large, um, and there's just not going to be as much, uh, opportunity in the near term. I think that will change in the medium term, although a lot of what you'll continue to see are extensions to last rounds or slight upticks. I don't think you're going to see massive upticks like we saw before where companies were raising it, you know, two X last round after six to nine months. Um, I think we're, we're not close to that environment, um, nor will be in the near to medium term, but You'll see some interesting extensions, companies that grew into the pricing, and you can come in at what some, someone paid year and a half to two years ago. So, I mean, I'm not completely bearish on growth investing. I just don't know that it makes sense immediately. You can be patient. You can wait for more companies to need to come back to market, to show more operational metrics, to show efficient growth, um, and not rush it. But yes, I think some of these funds are probably too large overall for the opportunities that we now find ourselves in.

AI assessment note: “I think some of these funds are probably too large overall for the opportunities”

Q Absolutely, and we said what we saw in 2020, 2021, and what we saw was crazy pricing in, in most markets. How active were you over the last few years in secondary buying markets, given the levels of pricing?

A What we did more of in prior markets was on the company secondary side. So we would come in, we'd buy out those, uh, early shareholders, and Most of what we were doing was buying, uh, common early preferred and then shifting it to the recent round or converting it into more recent preferred, um, which obviously provides better downside protection than buying straight common outright, where you're buried under a waterfall and where you have uncertainty on what future capital raises could look like, and that can be pretty scary. We also targeted businesses generally where the runway was like three to five years. Um, my, my friend E. Ty calls those businesses can, uh, camels. Um, where they have no reason to come back and raise capital quickly and have pretty extended runway. That's the type of profile of business that, that we'd really look for on the secondary side. In this environment, it's been much more balanced because the LP interest side has, um, become so much more significant. Um, and we're seeing one-off LP interest opportunities to pursue in conjunction with the company secondaries.

AI assessment note: “What we did more of in prior markets was on the company secondary side.”

Q We saw such large funds in the last few years being raised. Do you think managers should return capital, make them smaller, readjust?

A Yeah, I mean, I think on the growth fund side, a lot of funds became way too large, um, and there's just not going to be as much, uh, opportunity in the near term. I think that will change in the medium term, although a lot of what you'll continue to see are extensions to last rounds or slight upticks. I don't think you're going to see massive upticks like we saw before where companies were raising it, you know, two X last round after six to nine months. Um, I think we're, we're not close to that environment, um, nor will be in the near to medium term, but You'll see some interesting extensions, companies that grew into the pricing, and you can come in at what some, someone paid year and a half to two years ago. So, I mean, I'm not completely bearish on growth investing. I just don't know that it makes sense immediately. You can be patient. You can wait for more companies to need to come back to market, to show more operational metrics, to show efficient growth, um, and not rush it. But yes, I think some of these funds are probably too large overall for the opportunities that we now find ourselves in.

AI assessment note: “I think some of these funds are probably too large overall”

Q We're big fans of Michael too, a former guest. What common advice, O'Hunter, do you hear most given that you disagree with?

A Yeah, I think there's two things. One, going back to the LP side, I think GPs are very good to their existing investment And want to continue to give them allocations that resemble what they had in prior funds, but I think there can be too much complacency around that, and ultimately, what you want to do is to have long-term oriented folks that you think have the ability to continue to be backers of you in the future, and that are differentiated partners, and that's what we try to be to our GPs, where we're more than just capital, and where we help with customer and strategic partner introductions, recruitment, or whatever area we can be helpful around, and so For those folks, that's who you really would want to emphasize, and just because someone's backed you in the past doesn't mean you necessarily need to continue to have them back you at that level. There should be more of a rigid focus paid to that, and I'd say on the VP side, internally as well, I think people keep non-performing partners for too long, and there's not as much of a focus on transitioning those folks out or giving them the ability to fix a portfolio rather than continue to deploy at the same clip. All of that needs to be metrics driven and thoughtfully composed.

AI assessment note: “just because someone's backed you in the past doesn't mean you necessarily need to”

Q Absolutely, and we said what we saw in 2020, 2021, and what we saw was crazy pricing in, in most markets. How active were you over the last few years in secondary buying markets, given the levels of pricing?

A What we did more of in prior markets was on the company secondary side. So we would come in, we'd buy out those, uh, early shareholders, and Most of what we were doing was buying, uh, common early preferred and then shifting it to the recent round or converting it into more recent preferred, um, which obviously provides better downside protection than buying straight common outright, where you're buried under a waterfall and where you have uncertainty on what future capital raises could look like, and that can be pretty scary. We also targeted businesses generally where the runway was like three to five years. Um, my, my friend E. Ty calls those businesses can, uh, camels. Um, where they have no reason to come back and raise capital quickly and have pretty extended runway. That's the type of profile of business that, that we'd really look for on the secondary side. In this environment, it's been much more balanced because the LP interest side has, um, become so much more significant. Um, and we're seeing one-off LP interest opportunities to pursue in conjunction with the company secondaries.

AI assessment note: “In this environment, it's been much more balanced because the LP interest side has”

Q the fault of the managers who are so AUM hungry, or is it the That is well known with 25 years of experience and maybe not such high upside as a smaller fund where a five, six X is much more possible. Where does that accountability lie with the manager, with the LP class that allows these kind of ever scaling AUMs to happen? What are your thoughts on that?

A Yeah, I mean, I think within venture, there's still limits to scaling that you don't see in large growth equity or in elements of buyout. I think there still is a limit You don't see a ton of multi-billion dollar funds, and even the funds that are above a billion, there are definitely more than there used to be, but there aren't a ton. And I think the groups that have gotten there will need to prove it with thoughtful portfolio construction and the ability to select great value drivers. But the other dynamic that's happening is groups want to be greedier and want to build bigger positions in companies that are working. And I think to the extent that they're a great partner to entrepreneurs are able to have that kind of ball control. Then you will see the continued emergence and raising of opportunity select and growth funds, and to the extent that those are backing companies that they're already in and building bigger positions behind it as a life cycle partner, I think it very much can make sense. Where I become more skeptical is groups that add later stage focused funds or other vehicles like that that aren't actually playing off of the inherent advantage that they have being in companies already. If they're just sourcing late stage companies they think are interesting at higher prices, I think that's less interesting than an opportunity selector growth fund where they're loo…

AI assessment note: “I think within venture, there's still limits to scaling that you don't see”

Q Final one. As I said, I'd like to finish on an air of optimism. What are you most hopeful for when you look out to the next 24 months?

A Yeah, I mean, I'm, I'm known as a pretty sarcastic, pessimistic person, which I guess is a little bit counterintuitive for someone who invests in venture. Uh, but I, I have to say, like, at the core, and we talk about this at, at all of our annual meetings, like, I'm super proud to, to be a part of this asset class. Um, I think there has been bad behaviors in the past few years, and certainly frothiness and, and mispricing. But venture at its core is all about outsource innovation, and it's the job growth engine for our country, and it represents a very high majority percentage of public market cap, a very high percentage of R&D, and I think it's critical for the next few years in our country from an efficiency gain standpoint, from the utilization of technology, to, to, to make, uh, what we do as a, a country, um, more efficient on the growth side, and so, We need it. Um, it's going to be important at a macro level. It's an important thing. Um, I think just in terms of like a workforce standpoint. And so I'll always be long on venture. Um, even if I'm disappointed by some of the behaviors that, that we've seen in, in recent years.

AI assessment note: “I'll always be long on venture”