Venture_capital_LND
00:00:00.000 | Hello everybody, it's Sam from Financial Samurai, and in this episode I want to share some insights
00:00:05.880 | on being a venture capitalist and maybe what is the hardest thing about being a venture
00:00:10.720 | capitalist right now besides making a whole ton of money.
00:00:14.600 | I recently went on this trip with my buddies to see a tennis tournament, and at the tennis
00:00:22.240 | tournament were a lot of venture capitalists.
00:00:25.800 | And I have said before that being a venture capitalist is one of the best jobs you can
00:00:30.600 | get because you get paid a pretty good salary, six figures, 150, 200, 250, 500,000, a million,
00:00:38.240 | depending on how senior you are.
00:00:40.960 | And then you get to charge, you know, your fund gets charged 2% of assets under management,
00:00:47.160 | and the fund gets to earn about 20% of profits above a certain preferred rate of return.
00:00:55.480 | So let's say the fund makes $100 million, you can take 20% of that, so $20 million,
00:01:02.400 | and then divide it among the partners, the general partners.
00:01:06.720 | Not bad, right?
00:01:08.000 | And one of the interesting things about being a venture capitalist is that you really won't
00:01:12.400 | know how good of an investor you are until maybe five, ten years down the road, because
00:01:20.040 | your fund invests with a 10-year time horizon.
00:01:24.600 | So as the general partner, as a venture capitalist, you invest for the first three years of the
00:01:29.880 | life of the fund, and then you hope in five to ten years, thereabouts, some of your investments
00:01:35.840 | will play out in terms of getting acquired or going public.
00:01:40.000 | Meanwhile, in those 10 years, not only are you earning your base salary, you're also
00:01:44.960 | starting new funds, right?
00:01:46.800 | You want to start a new fund every two to three years.
00:01:50.100 | So in a 10-year period, you could start three to five new funds.
00:01:54.640 | And over a course of five to ten years for each new fund you start, you really won't
00:01:59.000 | know how well the fund will perform until the end.
00:02:04.160 | So what do you do in the meantime?
00:02:05.960 | Well, what you do is you have to be a good marketer.
00:02:09.120 | If you want to be a good venture capitalist, you have to have a platform, you have to say
00:02:13.880 | smart things, and you need to win deals.
00:02:17.360 | That was the number one thing three VCs told me during this trip on what is the hardest
00:02:23.040 | part about being a VC.
00:02:24.960 | And that's winning deals, because if you see a hot deal, chances are high that five, seven,
00:02:30.880 | ten other venture capitalists will want to participate in that deal.
00:02:35.600 | And the company can only raise so much money, right?
00:02:39.840 | It has a target raise of a certain amount to get diluted or give up equity a certain
00:02:45.120 | amount, and that's it.
00:02:46.740 | So you have a limited supply of great companies, and you have a huge available supply of capital
00:02:53.680 | searching for these companies.
00:02:55.860 | So there is actually still, there's still a demand supply mismatch.
00:03:01.560 | And one of the other great things about being a VC is that you actually don't even need
00:03:06.480 | to build your own company, start your own company, be an entrepreneur, grind it out,
00:03:12.040 | raise capital for five, ten years.
00:03:14.160 | You can actually be a VC by going to business school and then just joining a VC shop.
00:03:21.120 | Or you can be a VC by having a large platform, and you go work at a company, maybe you do
00:03:25.880 | work at a startup, but you don't found a startup, and maybe you could get hired as well.
00:03:31.080 | The final thing I learned about the venture capital world is that it's very tight.
00:03:36.360 | So at every single stage of fundraising, whether it's pre-seed, seed, series A, B, C, D, E,
00:03:42.360 | F, and then IPO, you need to know the other players in the venture capital and private
00:03:48.160 | equity community.
00:03:50.160 | Because when you invest in a company, you sing its praises, you market it, you hope
00:03:55.880 | that it's going to do well, and you try to support it as much as possible.
00:03:59.700 | And what happens is you then call your friend who works at another venture capital company
00:04:05.180 | that does later stage investing than your company, and you say, "Hey, this company is
00:04:10.960 | going to be raising a new round of funding, would you like to participate?"
00:04:14.680 | So in other words, it's a network effect, and it's about selling your deal to the next
00:04:20.600 | VC buyer, or next private equity buyer, all the way up so you can get some exit.
00:04:26.580 | And then the next guy buys, and then hopefully they can get an exit by selling to the next
00:04:31.800 | larger private equity or venture capital fund.
00:04:35.760 | Given how tight the community is, it's so important for you to have a good reputation.
00:04:42.600 | Because if you have a bad reputation, you're bad-mouthing, you're undercutting, then it's
00:04:48.080 | going to be much harder for you to win deals, and then it's going to be much harder for
00:04:53.040 | you to build relationships to sell your company to the next venture capital firm.
00:04:58.440 | And it goes on and on until the initial public offering, where retail investors get to invest
00:05:05.120 | at that stage.
00:05:06.680 | And we know from studying companies over the past 20 years that private companies are staying
00:05:11.180 | private longer, which means a lot of the gains are going towards private equity investors,
00:05:18.880 | venture capital investors, versus the gains going towards retail investors.
00:05:24.840 | So a lot of people have asked me, why bother investing in venture capital, private equity,
00:05:30.880 | when you can just invest in the S&P 500, it's proven to return about 10% a year since 1926,
00:05:37.600 | low fees, and it's just a simple way to get rich slowly.
00:05:42.240 | Well, as I just said, the main reason, or one of the main reasons, is because gains
00:05:48.560 | are accruing more towards private investors versus public investors.
00:05:52.880 | So the days where Microsoft went public and retail investors were able to profit 10x,
00:05:57.840 | 20x, 50x, is becoming harder and harder.
00:06:01.840 | At the same time, investing in private companies is very risky.
00:06:05.860 | So investing in a fund, in a venture capital fund, or private equity fund, helps diversify
00:06:12.040 | the risk.
00:06:13.360 | And hopefully you invest with the top GPs with the greatest network and the best reputations.
00:06:19.180 | And when you can, you hold on and you try to keep on investing in every single vintage
00:06:24.080 | period year.
00:06:26.600 | Now one of the reasons why I'm talking about venture capital is because recently with the
00:06:31.200 | bank run and the shutting down of Silicon Valley Bank, the venture capital community
00:06:35.780 | has been in the spotlight.
00:06:38.440 | A lot of venture capitalists, prominent venture capitalists, were shouting over Twitter, save
00:06:43.280 | SVB and all the depositors, and also entrepreneurs and politicians and regular folks.
00:06:49.040 | If not, there was going to be a huge negative knock on effect on the economy.
00:06:53.440 | And I got caught up in this as well because several weeks, I would say three weeks before
00:06:58.640 | SVB collapsed, I sent $20,000 to SVB through a wire to meet a capital call for a venture
00:07:07.080 | capital fund I'm invested in.
00:07:10.320 | Now never in my wildest dreams did I think wiring money to SVB would put me at risk of
00:07:17.760 | losing that money within three weeks.
00:07:20.640 | I didn't think about that.
00:07:21.880 | I didn't calculate that in my risk because where the venture capital fund banks with
00:07:29.120 | is up to them.
00:07:30.940 | For me, I'm deciding, OK, whether I should commit capital to this venture capital fund
00:07:35.980 | in the first place.
00:07:37.440 | So now after this entire sequence of events, I'm now thinking, OK, I got to decide which
00:07:45.180 | general partners I believe in, which venture capital fund or other private fund I believe
00:07:50.560 | in.
00:07:51.560 | And I got to ask them, how are your banking relationships?
00:07:55.160 | How many do you have?
00:07:56.640 | What are your contingency plans if there are future bank runs?
00:07:59.980 | And how do you plan to get capital out?
00:08:03.720 | Now I've just assumed you know what a capital call is.
00:08:07.440 | But if you don't, it's simply when a private fund asks for a percentage of the capital
00:08:12.660 | you've committed to investing in their fund.
00:08:15.460 | For example, there could be a 10% capital call of $100,000 you committed.
00:08:21.280 | So that equals $10,000.
00:08:24.020 | And any of these private funds tends to invest your committed capital over a two to four
00:08:31.760 | year period usually.
00:08:33.800 | And then after it invests, it's a J curve.
00:08:36.080 | So they invest, you don't make money, you actually kind of lose money in the beginning
00:08:40.160 | years.
00:08:41.160 | And then over time, you hopefully make a profit.
00:08:44.060 | So that's a capital call.
00:08:45.760 | Don't confuse that with a margin call.
00:08:48.280 | And in a pretty detailed post, I talk about how to better manage your capital calls.
00:08:54.160 | Because it's nice to invest in private funds once you've done the research and made a commitment.
00:09:00.040 | You don't really have to think about what to buy, when to buy, and when to sell.
00:09:04.600 | All you've got to do is meet your capital calls when they are called.
00:09:09.720 | And if you don't meet your capital calls, that's no good because you're going to put
00:09:15.200 | the general partners who've likely already funded the deal in a bind.
00:09:20.240 | And I was speaking to one of the general partners of a venture debt fund that I invest in.
00:09:24.320 | I've invested with him for the past eight years.
00:09:27.120 | And he said that generally, his fund funds the deal, makes the investment after the term
00:09:33.760 | sheets are signed immediately.
00:09:36.720 | And where do they get that capital?
00:09:37.920 | Well, they get that capital from the line of credit from the bank they use.
00:09:42.540 | So in this venture debt fund's case, it was First Republic Bank.
00:09:47.240 | Aha, another bank that is seeing a lot of deposit outflow because this run on regional
00:09:54.320 | banks.
00:09:55.320 | So the private fund's bank provides a line of credit of between 30 to 60 days usually.
00:10:02.920 | You think about it as a bridge loan.
00:10:04.880 | So the fund borrows this money so it can invest in an identified investment immediately.
00:10:11.760 | And then the fund announces a capital call, usually with a 30 day maximum time limit to
00:10:18.400 | get all the LPs to send in their funds.
00:10:22.200 | Now sometimes LPs are late because they're traveling or they haven't seen the emails.
00:10:28.760 | It's generally fine.
00:10:29.800 | You generally have like a 30 day grace period, right?
00:10:32.720 | Because if you have a 60 day line of credit with a bank, if the fund has a 60 day line
00:10:37.020 | of credit with a bank and they do a 30 day deadline capital call, they still have a 30
00:10:42.680 | day buffer.
00:10:44.360 | But after 30 days, it's going to be problematic.
00:10:48.600 | The GPs will send you reminder after reminder.
00:10:51.040 | And if you don't send in that capital call, I would think that the funds will withhold
00:10:56.420 | any future distributions so you can become whole on your capital commitments.
00:11:02.220 | And then worst case, they could go after you.
00:11:05.780 | And then at that point, you're clearly blackballed from any future deals in that fund and probably
00:11:12.600 | any future funds in the industry because it's a small industry and everybody talks.
00:11:18.120 | Nobody wants that cancerous virus LP investor.
00:11:23.360 | Now what do all these bank runs mean for investors, VC investors, private equity investors, borrowers
00:11:32.280 | and the banks?
00:11:33.440 | Well, at the moment, I would assume for the next 30 to 60 days, all banks, especially
00:11:40.040 | regional banks, smaller banks are going to be much more stringent on their lending.
00:11:45.920 | Lending to refinance, lending to new potential homeowners, doing venture debt lending to
00:11:53.260 | private companies.
00:11:55.080 | And I assume the terms for these bridge loans might be more stringent.
00:12:00.540 | They might be shorter and they might have a higher interest rate as well to account
00:12:05.240 | for more risk.
00:12:06.740 | When there's more risk, banks charge more.
00:12:09.800 | Given more stringent lending standards and higher interest rates and fees, we can logically
00:12:15.940 | assume that fewer companies will get funded, fewer people will get loans, and just the
00:12:23.380 | economy is deflationary for the economy.
00:12:26.600 | As a result, it is important for all of us to continue staying patient.
00:12:31.920 | Yes, the Fed raised rates again to 5% on the Fed funds rate on March 22nd, 2023.
00:12:40.940 | Will they raise one more time?
00:12:43.340 | It seems like the Fed funds future is expecting yes, one more time, 25 base points and that's
00:12:49.100 | it or no more times and that's it.
00:12:52.420 | But the futures market is expecting up to a 1% cut in the Fed funds rate by the end
00:12:57.740 | of 2023.
00:12:58.740 | However, Jerome Powell is saying, no, we plan to hold the Fed funds rate flat at least for
00:13:06.780 | the remainder of the year.
00:13:08.780 | Therefore, it's really hard to tell the direction of the S&P 500.
00:13:14.440 | The median target price is again around 4085.
00:13:19.380 | And it seems like at this rate, it could be pretty spot on plus or minus 100 points.
00:13:25.420 | It's really hard for me to chase equities at this level.
00:13:30.460 | However, there are good signs in the housing market, right?
00:13:34.840 | Because mortgage rates have come down by at least 50 base points and you're seeing a rebound
00:13:40.240 | in new home sales and existing home sales.
00:13:43.560 | Pay attention to that, folks.
00:13:45.020 | I still think this summer, 2023 is a good time to buy, good time to get a deal, especially
00:13:51.420 | if mortgage rates continue to come down.
00:13:54.220 | And I am seeing more activity pick up.
00:13:57.700 | Now, in conclusion, let me share some tips on how to better manage your capital calls
00:14:02.980 | if you decide to invest in more private funds.
00:14:06.300 | I think you might if you get wealthier and older because there are more opportunities
00:14:11.660 | to invest in interesting private opportunities.
00:14:15.340 | Maybe the returns won't be as good as the public stock market or maybe they might be
00:14:19.220 | really, really good.
00:14:20.700 | It depends like everything on what you invested and who you invest with.
00:14:25.040 | But in terms of capital calls, it can get pretty hairy if you have multiple funds in
00:14:30.420 | your portfolio.
00:14:31.980 | So one, organize everything in a spreadsheet.
00:14:34.580 | Put a date of investment, fund name, investment commitment, amount, lifespan, range of the
00:14:40.100 | fund, estimated capital call amounts by year, capital call as a percentage of cash flow,
00:14:46.860 | capital call as a percentage of investments.
00:14:49.420 | And you've got to consistently update the spreadsheet so you can manage your cash flow
00:14:53.740 | and never be late in sending in your capital calls.
00:14:58.320 | You want to be a good LP.
00:15:00.060 | Two, be realistic about your future income and cash flow.
00:15:04.820 | When investing in private funds, it's easy to get all hyped up and amped up after you're
00:15:09.660 | reading the marketing material.
00:15:11.540 | After all, good marketing makes you want to buy.
00:15:14.740 | And whenever you read any kind of marketing material, if they do it well, you're going
00:15:18.780 | to want to probably invest a lot more money.
00:15:21.980 | And you could commit more than you think because you're thinking, "Well, that money is invested
00:15:26.820 | over a two to four year period."
00:15:29.020 | And then you might end up investing more than you should and in more funds than you should.
00:15:33.740 | So you've really got to be realistic about your future income and cash flow because everything
00:15:39.020 | tends to look good when you are getting marketed to by a private fund manager.
00:15:44.500 | Three, be stringent with your capital allocation percentages.
00:15:48.540 | You got to know your risk tolerance and your financial objectives.
00:15:52.620 | Also take into consideration your age.
00:15:55.200 | If the fund has a 10 year horizon and you're 65 years old, well, unfortunately, chances
00:16:00.420 | are, I don't know, maybe 40% you might die before the fund actually sees a liquidity
00:16:06.740 | event.
00:16:07.740 | So be realistic.
00:16:09.060 | As you get older, maybe private funds aren't for you because you won't be able to reap
00:16:12.700 | any of the rewards unless you plan to invest for a younger generation.
00:16:18.100 | Personally, I try to allocate no more than 10% of my net worth or 10% of my investable
00:16:25.060 | assets into private investments.
00:16:27.920 | And I let it fade up to 15%, hopefully if there's good returns.
00:16:32.720 | And then once it's at 15%, I throttle it down.
00:16:36.220 | If you look at endowment funds, like from Yale endowment fund, it's like 25 billion
00:16:40.740 | or something.
00:16:42.020 | A lot of these endowment funds actually invest in venture capital, private equity, and all
00:16:47.220 | sorts of other private funds.
00:16:49.620 | So it's not unique.
00:16:50.940 | In actuality, it's more common than investing in public equities and public bonds.
00:16:57.860 | And the returns have been okay, not bad.
00:16:59.980 | But again, it's all about who you know and which funds you invest with.
00:17:04.820 | Finally, to better manage your capital calls, I highly encourage you to read the quarterly
00:17:10.140 | updates.
00:17:11.260 | They will be in your portal.
00:17:12.840 | Or listen in on the quarterly conference calls.
00:17:15.860 | And get to know one of the GPs and ask them questions offline.
00:17:19.900 | Especially if you feel like you're not going to be able to meet a capital commitment, just
00:17:24.420 | ask.
00:17:25.460 | Any thoughts on future investments?
00:17:28.260 | Any estimate on when you'll do another capital call?
00:17:30.900 | You can gain clarity if you want because you're all on the same team.
00:17:34.940 | My problem is that I barely read or listen to any quarterly investment reports or calls
00:17:40.500 | because I'm more interested in writing on Financial Samurai, recording this podcast,
00:17:45.580 | working on my next book, spending time with family, and playing sports.
00:17:49.620 | My thought is the less time I spend staying on top of my private investments, the greater
00:17:54.500 | the return on investment.
00:17:56.780 | I've already done all the due diligence.
00:17:58.380 | I've asset allocated appropriately.
00:18:00.860 | But because I don't pay that much attention, it's good for the stress.
00:18:05.780 | If I don't pay attention, it's out of sight, out of mind.
00:18:08.540 | But I also get in trouble where I can't meet some capital calls or I need to scramble to
00:18:13.420 | meet them because I improperly managed my cash flow and savings.
00:18:19.620 | Especially with treasury bonds yielding over 5%.
00:18:22.260 | I've just been funneling any normal operating cash flow into treasury bonds recently.
00:18:28.580 | Alrighty folks, that's it for me.
00:18:30.780 | I know this topic might not be too pertinent for most of you investing in private funds
00:18:36.140 | and all that.
00:18:37.140 | But it's something interesting to know given the bank runs, given the liquidity issues,
00:18:41.500 | given the need to have important banking relationships, and also my realization that, huh, I didn't
00:18:47.540 | think I would get caught up in this because I was properly diversified with my banking
00:18:51.660 | relationships, but I have.
00:18:54.220 | Now thankfully nothing bad has happened to anybody's deposits and let's hope it continues
00:18:59.860 | that way.
00:19:01.140 | Thank you everyone for listening and special shout out to Maureen for leaving that awesome
00:19:05.420 | five star review on Apple.
00:19:07.140 | It really means a lot to me.
00:19:09.540 | I just try to be as honest as possible.
00:19:11.460 | I try to highlight the blind spot that I have so we can all learn.
00:19:15.980 | And I'm always trying to learn from all of you.
00:19:17.980 | So thank you so much for your support and thank you all for leaving a nice review.
00:19:22.580 | It's very motivating.
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