Thread by @ryan_caldbeck

1/ I have talked before about 1 large industry with stale incumbents that is ripe for innovation (CPG). Another is financial services – particularly private mkts. Lets focus on PE/VC. Slow moving….pretty darn big…..and wildly profitable….industry that uses almost no tech.

2/ I really like this framework from Emma to understand disruption and then applying it to PE/VC (and shoutout to @erparker).
circleupblog.com/2018/04/26/you…

3/ Incumbents in PE/VC are doubling down on most profitable activity (raising larger funds). How could they not- even if returns go down it still makes sense to go bigger – the mgmt. fees (2% guaranteed every yr on larger AuM) outweigh the decline in IRR.

4/ Oh and to be clear- the returns (i.e. IRR) definitely go down with larger funds. Absolute $ carry bigger but IRR lower. That means it’s worse for LPs. Lots of proof of declining IRR w/ size but I am biased towards this one.
circleup.com/blog/2014/11/1…

5/ I should mention that carry comes from the 16th century when captains of ships would take a 20% share of the profit from the goods they CARRIED. 500 years later we are using the same term and the same number. Talk about a stale industry.

6/ “CEO” of a large consumer fund last year- which has gone from $100m to $5b+ in AuM over the last 20+ years - said to 2 people: “all we care about is mgmt fees now. We’re in the AuM business.” That’s a nice quote on the Holiday Card to your LPs... Talk about a bloated industry

7/ Heard the founder of a top PE fund say “we’re investing a lot into technology. I would love to learn more about your IT team.” Hint: if you call engineers and data scientists our “IT team”, just cash your chips in now and leave the table. Talk about being behind the curve.

8/ And funds have sourced deals in the same way for decades - through personal network. I don’t even know what a differentiated network looks like in 2018. Millions of linkedIn connections? Deal execution also hasn't changed meaningfully. Talk about a lack of innovation.

9/ We’re also seeing incumbents getting nervous throwing money half-heartedly at hodgepodge of ideas. Heard of any PE funds that are trying to team up with celebrities lately (wait for it) or VC firms that are hiring an engineer overseas and saying they are “data driven.”

10/ A barrier has been LPs ($ behind funds). “You don’t get fired for investing into [insert 25 yr old PE firm]” has been the old statement to live by. No longer. LPs are getting tired of lackluster returns from the old funds and the parade of indistinguishable pitchbooks.

11/ Investing talent, another barrier, is also looking for something new. If you’re 28 and at one of those funds, you’re staring at 20+ years of the MDs above you hogging economics. Oh and you’re a part of a melting ice cube. Talent is searching for innovation & growth.

12/ ….so LPs (the “customers”) are hungry for differentiation and talent is hungry for new opportunities. And this hunger is lowering the barriers to entry….dramatically (if you were hungry enough you’d eat something you’ve never heard of)

13/ With this hunger there are new performance dimensions at play. Old-school LPs care about (1) track record, (2) brand name of other LPs in fund, and (3) some fuzzy measure of GP heuristics and other checked-boxes

14/ I don’t know what the new performance dimensions will be- but they are coming. Could be access to new asset class, lack of key person risk because investments are driven by tech not heuristics, lower fees to expand the market, scalability with good returns.

15/ I think we could look to analogous industries to see how PE/VC will be transformed over time. In public markets Lee Kranefuss created iShares and has helped to dramatically lower the cost to investing into baskets of publics. @JeffBezos quote- “your margin is my opportunity"

16/ Or who will be the Jim Simons (Renaissance Technologies) of the private markets? He helped popularize systematic quant investing in the public markets- and made billions. A systematic approach would create a scalable, repeatable PE/VC fund - with less key person risk.

17/ So we have a large ($2.8 trillion globally), stale, bloated industry that doesn’t use tech and has declining barriers to entry. Sounds like a recipe...

18/ But let’s be realistic. The feedback loop for performance in privates is many years long - and momentum is a heck of a thing to change. Decent private funds have a way of just surviving......for now.

19/ In addition, while barriers to entry in private market investing are declining, starting something that looked like #15 or #16 would take a lot of courage and skill. This will take time- but it is coming, and there is a huge opportunity to be captured.