Thread by @ryan_caldbeck

1/ There are a lot of problems to be solved in PE/VC. Human bias, bad investors, crazy arrogance, behavior that comes at the cost of the entrepreneurs.

But one that has a bigger impact than most realize, is the desire by the General Partners (GPs) to raise larger funds.

2/ Lets first establish that approximately 99.63% of PE/VC investors are in it for the money. That’s ok- but let’s just have that as a foundational truth.

3/ To make more money, they either have to be exceptionally good (Benchmark, USV, Sequoia) or raise a lot more money. Every GP realizes that if they raise more money they will get paid more (fees), even if the returns go down.
Time for (super basic) venture math.

4/ If we assume 10 year fund and exclude other expenses:

$50m fund: $10m from mgmt fees (2% * $50m * 10 years) + $40mm from carry ($50mm * 5x MoM = $250m returned capital - $50m initial capital = $200m profits * 20% carry = $40m) = $50m total to GPs

5/ $500m fund: $100m from management fees (2% * $500m * 10 yrs) + $100m from carry ($500m * 2x MoM = $1B returned cap - $500m initial capital = $500m profits * 20% carry = $100m) = $200mm total to GPs

So in first example = $50m. In second = $200m

Did i mention they like money?

6/ Think about that. The fund with 2x returns makes more money than the firm with 5x returns. Sure the team of bigger fund is a bit larger -but main GPs make a ton more with larger funds.

7/ Almost every single GP in the world chooses to raise larger funds. Exceptions = Benchmark, USV and a small handful of others that could raise larger funds but dont. Most can’t resist.

8/ Your micro VC fund that is super arrogant because they manage $37m but says they “like this end of the market?” That’s BS- they just cant raise a larger fund.

I totally blew up some dude’s real smooth game at @TheBatterySF in SF.

9/ The AL Syndicate lead that says they just like giving access to dentists and doctors in Ohio? Nope- that “investor” (often someone that was employee 4,000 at FB etc) just isn’t good enough to raise a fund.

Good luck on your investment Chief!

10/ GPs want to raise larger $. Here is prob: As funds get larger, they expand their scope- invest into “adjacent” categories (read: we’ll experiment on your dime). Invest into larger co's which typically have lower returns because a bigger base.
cdn2.hubspot.net/hub/305037/fil…

11/ And to preempt questions, here is another piece we did several years ago about the same point. But references consumer.
circleup.com/blog/2014/11/1…

12/ Entrepreneurs also hate it. When fund sizes grow, partners don’t know each other. There is more turnover at the GP level. Orphan companies. It looks more like a factory. The operating partners almost never add value.

This one was not popular: pehub.com/2015/07/privat…

13/ The investors at that large VC hate it. They are pressured to “put money to work”- read: invest into stuff they have less conviction in because they have to deploy capital. I see that constantly and I hear the investors complain about it privately every chance they get.

14/ They also tend to pressure entrepreneurs to take > money than they need. Leading to larger pref stack for company and post-money trap.

[Editor’s note: I like threading different Tweetstorms. I don’t know if that’s a thing but it’s my jam right now.]

https://twitter.com/ryan_caldbeck/status/1017264896830914560

15/ Fundamentally: Traditional VC/PE is not scalable or repeatable. Meaning that the way it is done NOW is not a scalable product. What drove the success of the $50m fund isn’t scalable or repeatable to the $500m fund.

Scalable and repeatable. Keep that phrase top of mind.

16/ Lots of problems: Typically the star GP’s time, but also just the ability to invest in the same strategy. The $500m fund can’t write the $1-3m checks (as the $50m fund could)- so it has to write bigger checks into bigger companies. Returns go down.

Scope creeeeeep.

17/ If a GP tries to grow firm’s AuM, they find they also need to hire a lot more bodies. There is zero operating leverage….unless you do much larger deals. No one is ever as good as the original star GP....until they get to be as good- and then leave to start their own fund.

18/ So…...what if Lucky #15 here weren’t true? What if VC/PE could be scalable/repeatable?

19/ I think the future of private investing is systematic. Building the Renaissance Technologies or Blackrock’s SAE of the private markets. Decisions made algorithmically -not just based off human intuition/gut.

20/ Imagine finding/evaluating companies algorithmically. Driving insights through data - not through gut of the GP. What could that look like- what would the challenges/benefits be?

I'm not sure it is possible in every industry- but I am confident it is in some.

21/ First, you need an industry where there is a problem to be solved. Doing this in early stage tech is a waste of time. If I get a call from a systematic fund, I can still just call 1 of 700 venture firms in my backyard and shop the term sheet.

22/ Second, you need an industry where there is a ton of data, and fairly similar business models. This way you are comparing apples to apples, not to fish.

23/ If one can build algos on top of the data to find companies more efficiently, and evaluate them effectively, and help them- then the process is repeatable & scalable. I.e. I don’t need to worry about keeping my star GP focused on doing 300 small deals. The algo does that.

24/ Problem though- how do you deploy it? In public mkts you can press button to trade. Here you have to reach out, win deal, and help post-close. The approach has to be Faster and Better than current private market solutions. Maybe even Cheaper.

25/ Faster.
Reach out could look like Summit/TA army- but armed with real data (already know they want to invest in the companies). I envision a world in which that algorithmic approach can do deals in 14 days instead of 140 on average. (in consumer avg to raise is 8-12 months).

26/ Better.
Instead of spending $ on a ton of “star” GPs that say they can do everything, we allocate resources post close. Provide insights to co's. Valuable and complementary to other investors on cap table.

27/ Better for entrepreneur than having yet another VC sit on their board with the same advice. Constant access to differentiated insights, driven by data not just heuristics.

28/ Cheaper.
This one is perhaps murkier- but I can imagine that for the entrepreneur having an investor that can make the decision 10x faster and more efficiently, while helping provide insights through data, will help the company save $.

29/ There will be challenges and reasons to not do it. No question. Nothing great was ever easy. But systematic investing today makes up >⅓ of public markets. I’m betting in 10 years it will make up ⅓ of privates.

wsj.com/articles/the-q…