Hello everybody, it's Sam from Financial Samurai, and in this episode I want to share some insights on being a venture capitalist and maybe what is the hardest thing about being a venture capitalist right now besides making a whole ton of money. I recently went on this trip with my buddies to see a tennis tournament, and at the tennis tournament were a lot of venture capitalists.

And I have said before that being a venture capitalist is one of the best jobs you can get because you get paid a pretty good salary, six figures, 150, 200, 250, 500,000, a million, depending on how senior you are. And then you get to charge, you know, your fund gets charged 2% of assets under management, and the fund gets to earn about 20% of profits above a certain preferred rate of return.

So let's say the fund makes $100 million, you can take 20% of that, so $20 million, and then divide it among the partners, the general partners. Not bad, right? And one of the interesting things about being a venture capitalist is that you really won't know how good of an investor you are until maybe five, ten years down the road, because your fund invests with a 10-year time horizon.

So as the general partner, as a venture capitalist, you invest for the first three years of the life of the fund, and then you hope in five to ten years, thereabouts, some of your investments will play out in terms of getting acquired or going public. Meanwhile, in those 10 years, not only are you earning your base salary, you're also starting new funds, right?

You want to start a new fund every two to three years. So in a 10-year period, you could start three to five new funds. And over a course of five to ten years for each new fund you start, you really won't know how well the fund will perform until the end.

So what do you do in the meantime? Well, what you do is you have to be a good marketer. If you want to be a good venture capitalist, you have to have a platform, you have to say smart things, and you need to win deals. That was the number one thing three VCs told me during this trip on what is the hardest part about being a VC.

And that's winning deals, because if you see a hot deal, chances are high that five, seven, ten other venture capitalists will want to participate in that deal. And the company can only raise so much money, right? It has a target raise of a certain amount to get diluted or give up equity a certain amount, and that's it.

So you have a limited supply of great companies, and you have a huge available supply of capital searching for these companies. So there is actually still, there's still a demand supply mismatch. And one of the other great things about being a VC is that you actually don't even need to build your own company, start your own company, be an entrepreneur, grind it out, raise capital for five, ten years.

You can actually be a VC by going to business school and then just joining a VC shop. Or you can be a VC by having a large platform, and you go work at a company, maybe you do work at a startup, but you don't found a startup, and maybe you could get hired as well.

The final thing I learned about the venture capital world is that it's very tight. So at every single stage of fundraising, whether it's pre-seed, seed, series A, B, C, D, E, F, and then IPO, you need to know the other players in the venture capital and private equity community.

Because when you invest in a company, you sing its praises, you market it, you hope that it's going to do well, and you try to support it as much as possible. And what happens is you then call your friend who works at another venture capital company that does later stage investing than your company, and you say, "Hey, this company is going to be raising a new round of funding, would you like to participate?" So in other words, it's a network effect, and it's about selling your deal to the next VC buyer, or next private equity buyer, all the way up so you can get some exit.

And then the next guy buys, and then hopefully they can get an exit by selling to the next larger private equity or venture capital fund. Given how tight the community is, it's so important for you to have a good reputation. Because if you have a bad reputation, you're bad-mouthing, you're undercutting, then it's going to be much harder for you to win deals, and then it's going to be much harder for you to build relationships to sell your company to the next venture capital firm.

And it goes on and on until the initial public offering, where retail investors get to invest at that stage. And we know from studying companies over the past 20 years that private companies are staying private longer, which means a lot of the gains are going towards private equity investors, venture capital investors, versus the gains going towards retail investors.

So a lot of people have asked me, why bother investing in venture capital, private equity, when you can just invest in the S&P 500, it's proven to return about 10% a year since 1926, low fees, and it's just a simple way to get rich slowly. Well, as I just said, the main reason, or one of the main reasons, is because gains are accruing more towards private investors versus public investors.

So the days where Microsoft went public and retail investors were able to profit 10x, 20x, 50x, is becoming harder and harder. At the same time, investing in private companies is very risky. So investing in a fund, in a venture capital fund, or private equity fund, helps diversify the risk.

And hopefully you invest with the top GPs with the greatest network and the best reputations. And when you can, you hold on and you try to keep on investing in every single vintage period year. Now one of the reasons why I'm talking about venture capital is because recently with the bank run and the shutting down of Silicon Valley Bank, the venture capital community has been in the spotlight.

A lot of venture capitalists, prominent venture capitalists, were shouting over Twitter, save SVB and all the depositors, and also entrepreneurs and politicians and regular folks. If not, there was going to be a huge negative knock on effect on the economy. And I got caught up in this as well because several weeks, I would say three weeks before SVB collapsed, I sent $20,000 to SVB through a wire to meet a capital call for a venture capital fund I'm invested in.

Now never in my wildest dreams did I think wiring money to SVB would put me at risk of losing that money within three weeks. I didn't think about that. I didn't calculate that in my risk because where the venture capital fund banks with is up to them. For me, I'm deciding, OK, whether I should commit capital to this venture capital fund in the first place.

So now after this entire sequence of events, I'm now thinking, OK, I got to decide which general partners I believe in, which venture capital fund or other private fund I believe in. And I got to ask them, how are your banking relationships? How many do you have? What are your contingency plans if there are future bank runs?

And how do you plan to get capital out? Now I've just assumed you know what a capital call is. But if you don't, it's simply when a private fund asks for a percentage of the capital you've committed to investing in their fund. For example, there could be a 10% capital call of $100,000 you committed.

So that equals $10,000. And any of these private funds tends to invest your committed capital over a two to four year period usually. And then after it invests, it's a J curve. So they invest, you don't make money, you actually kind of lose money in the beginning years. And then over time, you hopefully make a profit.

So that's a capital call. Don't confuse that with a margin call. And in a pretty detailed post, I talk about how to better manage your capital calls. Because it's nice to invest in private funds once you've done the research and made a commitment. You don't really have to think about what to buy, when to buy, and when to sell.

All you've got to do is meet your capital calls when they are called. And if you don't meet your capital calls, that's no good because you're going to put the general partners who've likely already funded the deal in a bind. And I was speaking to one of the general partners of a venture debt fund that I invest in.

I've invested with him for the past eight years. And he said that generally, his fund funds the deal, makes the investment after the term sheets are signed immediately. And where do they get that capital? Well, they get that capital from the line of credit from the bank they use.

So in this venture debt fund's case, it was First Republic Bank. Aha, another bank that is seeing a lot of deposit outflow because this run on regional banks. So the private fund's bank provides a line of credit of between 30 to 60 days usually. You think about it as a bridge loan.

So the fund borrows this money so it can invest in an identified investment immediately. And then the fund announces a capital call, usually with a 30 day maximum time limit to get all the LPs to send in their funds. Now sometimes LPs are late because they're traveling or they haven't seen the emails.

It's generally fine. You generally have like a 30 day grace period, right? Because if you have a 60 day line of credit with a bank, if the fund has a 60 day line of credit with a bank and they do a 30 day deadline capital call, they still have a 30 day buffer.

But after 30 days, it's going to be problematic. The GPs will send you reminder after reminder. And if you don't send in that capital call, I would think that the funds will withhold any future distributions so you can become whole on your capital commitments. And then worst case, they could go after you.

And then at that point, you're clearly blackballed from any future deals in that fund and probably any future funds in the industry because it's a small industry and everybody talks. Nobody wants that cancerous virus LP investor. Now what do all these bank runs mean for investors, VC investors, private equity investors, borrowers and the banks?

Well, at the moment, I would assume for the next 30 to 60 days, all banks, especially regional banks, smaller banks are going to be much more stringent on their lending. Lending to refinance, lending to new potential homeowners, doing venture debt lending to private companies. And I assume the terms for these bridge loans might be more stringent.

They might be shorter and they might have a higher interest rate as well to account for more risk. When there's more risk, banks charge more. Given more stringent lending standards and higher interest rates and fees, we can logically assume that fewer companies will get funded, fewer people will get loans, and just the economy is deflationary for the economy.

As a result, it is important for all of us to continue staying patient. Yes, the Fed raised rates again to 5% on the Fed funds rate on March 22nd, 2023. Will they raise one more time? It seems like the Fed funds future is expecting yes, one more time, 25 base points and that's it or no more times and that's it.

But the futures market is expecting up to a 1% cut in the Fed funds rate by the end of 2023. However, Jerome Powell is saying, no, we plan to hold the Fed funds rate flat at least for the remainder of the year. Therefore, it's really hard to tell the direction of the S&P 500.

The median target price is again around 4085. And it seems like at this rate, it could be pretty spot on plus or minus 100 points. It's really hard for me to chase equities at this level. However, there are good signs in the housing market, right? Because mortgage rates have come down by at least 50 base points and you're seeing a rebound in new home sales and existing home sales.

Pay attention to that, folks. I still think this summer, 2023 is a good time to buy, good time to get a deal, especially if mortgage rates continue to come down. And I am seeing more activity pick up. Now, in conclusion, let me share some tips on how to better manage your capital calls if you decide to invest in more private funds.

I think you might if you get wealthier and older because there are more opportunities to invest in interesting private opportunities. Maybe the returns won't be as good as the public stock market or maybe they might be really, really good. It depends like everything on what you invested and who you invest with.

But in terms of capital calls, it can get pretty hairy if you have multiple funds in your portfolio. So one, organize everything in a spreadsheet. Put a date of investment, fund name, investment commitment, amount, lifespan, range of the fund, estimated capital call amounts by year, capital call as a percentage of cash flow, capital call as a percentage of investments.

And you've got to consistently update the spreadsheet so you can manage your cash flow and never be late in sending in your capital calls. You want to be a good LP. Two, be realistic about your future income and cash flow. When investing in private funds, it's easy to get all hyped up and amped up after you're reading the marketing material.

After all, good marketing makes you want to buy. And whenever you read any kind of marketing material, if they do it well, you're going to want to probably invest a lot more money. And you could commit more than you think because you're thinking, "Well, that money is invested over a two to four year period." And then you might end up investing more than you should and in more funds than you should.

So you've really got to be realistic about your future income and cash flow because everything tends to look good when you are getting marketed to by a private fund manager. Three, be stringent with your capital allocation percentages. You got to know your risk tolerance and your financial objectives. Also take into consideration your age.

If the fund has a 10 year horizon and you're 65 years old, well, unfortunately, chances are, I don't know, maybe 40% you might die before the fund actually sees a liquidity event. So be realistic. As you get older, maybe private funds aren't for you because you won't be able to reap any of the rewards unless you plan to invest for a younger generation.

Personally, I try to allocate no more than 10% of my net worth or 10% of my investable assets into private investments. And I let it fade up to 15%, hopefully if there's good returns. And then once it's at 15%, I throttle it down. If you look at endowment funds, like from Yale endowment fund, it's like 25 billion or something.

A lot of these endowment funds actually invest in venture capital, private equity, and all sorts of other private funds. So it's not unique. In actuality, it's more common than investing in public equities and public bonds. And the returns have been okay, not bad. But again, it's all about who you know and which funds you invest with.

Finally, to better manage your capital calls, I highly encourage you to read the quarterly updates. They will be in your portal. Or listen in on the quarterly conference calls. And get to know one of the GPs and ask them questions offline. Especially if you feel like you're not going to be able to meet a capital commitment, just ask.

Any thoughts on future investments? Any estimate on when you'll do another capital call? You can gain clarity if you want because you're all on the same team. My problem is that I barely read or listen to any quarterly investment reports or calls because I'm more interested in writing on Financial Samurai, recording this podcast, working on my next book, spending time with family, and playing sports.

My thought is the less time I spend staying on top of my private investments, the greater the return on investment. I've already done all the due diligence. I've asset allocated appropriately. But because I don't pay that much attention, it's good for the stress. If I don't pay attention, it's out of sight, out of mind.

But I also get in trouble where I can't meet some capital calls or I need to scramble to meet them because I improperly managed my cash flow and savings. Especially with treasury bonds yielding over 5%. I've just been funneling any normal operating cash flow into treasury bonds recently. Alrighty folks, that's it for me.

I know this topic might not be too pertinent for most of you investing in private funds and all that. But it's something interesting to know given the bank runs, given the liquidity issues, given the need to have important banking relationships, and also my realization that, huh, I didn't think I would get caught up in this because I was properly diversified with my banking relationships, but I have.

Now thankfully nothing bad has happened to anybody's deposits and let's hope it continues that way. Thank you everyone for listening and special shout out to Maureen for leaving that awesome five star review on Apple. It really means a lot to me. I just try to be as honest as possible.

I try to highlight the blind spot that I have so we can all learn. And I'm always trying to learn from all of you. So thank you so much for your support and thank you all for leaving a nice review. It's very motivating. Don't forget to sign up for my weekly newsletter at FinancialSamurai.com/news so you never miss a thing.