Podcasts

In this episode, Ron interviews industrialist and philanthropist Tony Pritzker, Co-Founder, Chairman and CEO of Pritzker Private Capital, and Paul Carbone, Co-Founder and President of Pritzker Private Capital, on the benefits of working with family capital.

In this episode, we deep dive into the process of Venture Capital – how does it actually all work? – and what the future of VC holds. The end of our 2 part episode on the Evolution of Venture Capital.

Navigation:

• Intro (01:33)
• Section 1: The Process of VC (01:59)
• Section 2: Stats on VC (19:03)
• Section 3: The Future of VC (27:31)
• Conclusion (38:40) 

Our co-hosts:

• Bertrand Schmitt, Entrepreneur in Residence at Red River West, co-founder of App Annie / Data.ai, business angel, advisor to startups and VC funds, @bschmitt
• Nuno Goncalves Pedro, Investor, Managing Partner, Founder at Chamaeleon, @ngpedro

Our show: Tech DECIPHERED brings you the Entrepreneur and Investor views on Big Tech, VC and Start-up news, opinion pieces and research. We decipher their meaning, and add inside knowledge and context. Being nerds, we also discuss the latest gadgets and pop culture news

Subscribe To Our Podcast

Intro (01:34)

Bertrand

Welcome to Tech DECIPHERED episode 42. After our first episode, episode 41, sharing the history of venture capital as well as the business of VC, and we are starting episode 42 with the process of VC, as well as some statistics around VC and we will finish with the future of venture capital. Nuno, good to see you again.

Section 1: The Process of VC – (01:59)

Nuno

Nice to see you, and let’s start with the process of venture capital. At its essence, the process of venture capital is we’re funnel managers. We’re not just fund managers, we’re funnel managers. We manage a funnel. It’s about how healthy that funnel is that a fund can return a lot of capital or not.

Nuno

So it’s all about really two extreme positions in the funnel, the beginning of the end being deal sourcing, the quality of the deals you see in the market and the market is essentially—we’ll come back to that later—has been very inbound driven. It’s about people that come to you. That’s why you needed to create a brand, people need to know that you existed, et cetera. I suggest that’s about to change and that’s we’ll talk about in the future of venture capital.

Nuno

But it’s about the quality of the deal flow that you have, your proprietary networks, your access to key entrepreneurs that bring you other entrepreneurs, your access to scouts, your access to the market and the quality of those deals.

Nuno

And then at the other extreme is selling the asset at the right time. And really normally you sell an asset either because the company is bought by someone else, or the company IPOs, and at some point you can sell it as public equity or the company fails miserably.

Nuno

I think in the last few years it’s very obvious there is maybe a fourth mechanism for you to exit, which is secondary. Someone wants to buy your participation in that company and you can sell it to that other entity, be it an investor, be it a company, be it someone else. But maybe minority sale or selling just your stock rather than anything else.

Nuno

Also important to highlight in the business of venture capital, venture capital firms are minority shareholders. They’re not majority shareholders, they’re minority shareholders. They’re just protected by special provisions because when they buy into the company, they buy into preferred shares. Their shares are paid higher than they should be, but then they get special rights. And then if that VC gets someone on the board, the board member also gets special rights in terms of approval, minority protections, et cetera.

Nuno

So it’s not that VCs are dumbasses or stupid and they only want to have minority protection, no, we don’t run your businesses, we don’t want to own it. But we do want to have protections on your businesses to make sure that we are well represented, either because we’re on the board or because we’re a lead investor or we’re a significant investor in the company.

Nuno

Two pieces of the funnel are top-end deal sourcing, top of funnel, bottom end of the funnel, end of the funnel, you liquidate the asset in some way or the other. There is a loss ratio. Companies will fail. This is high risk. Loss ratios vary a lot, the industry seems to have different mechanisms to figure out what the loss ratio is.

Nuno

Some people a loss ratio is below 1X, so you get cents on the dollar on a company is already a loss. Some say would be 50, 60, 70% of a portfolio, others would say maybe a little bit less. In this day and age, you can always get some money back. So maybe the loss ratio is a little bit lower than that.

Nuno

You will hear a lot about power law, that most of your returns will come from 2 or 3 companies in a portfolio that might be 25 to 35. There’s this magic number of 20 to 30 companies per fund, which seems to be around. It has to do also with a number of partners and the positions you’re in. It could vary a bit more. Obviously, if you’re an incubator and accelerator, you will do hundreds of companies. But if you’re like a classic VC firm, you might do 20, 30, 25 to 35 and all of that.

Nuno

But just to go back to the funnel, these two elements of top of funnel and bottom of a funnel are the essential ones. And then there’s one, that I would add as a corollary, is you need to get into the deal. You can do due diligence or not, you can do whatever, but you need to get in the deal. That’s pretty critical as well. So you can identify the company, but if you don’t get into the deal, well, great, you identify the company and then what?

Bertrand

You spend a lot of manpower to work and the thing happened, that’s not good.

Nuno

And getting it to the deal is more art and science. You need to be well known, you need to have a reputation, people need to want to give you an allocation, even if you’re not the lead investor, even if they want to go with someone else to be the lead investment in that round. So getting into the deal is pretty critical here. The two extremes of liquidation and deal sourcing, which in the middle the dealmaking piece, that creates that added value.

Bertrand

Yeah, and as you say also, it’s definitely a poor law at work. Some investments are going to generate outsized return, I mean, you could argue that the very definition of being a VC is outsized return on a few investment. The model for most funds of having a fund returner, I mean, one investment might return the whole fund, if not more. And then you have others that are bringing back 5X, 3X, and then you have quite a few 1X and ultimately you have the one who don’t return anything.

Bertrand

Another term that I’ve seen used is a J-curve, where you talk about from deal sourcing to liquidation, that’s what happened. You have to start investing money from your fund and usually you have your first four years of investment that are focused on investing in new companies, and the remaining of the term of the fund, as you said, a total of 12 years. So the rest of the duration of the fund is around, potentially some follow-on investment, but also quite a bit of exits, hopefully. And that’s where the J-curve come back. Initially, you decrease the amount you have in your fund and step by step you get it back through the exit.

Nuno

Exactly. You can recycle capital and do a variety of things without necessarily always calling capital from your limited partners.

Bertrand

Potentially, yes.

Nuno

The funnel, just to be very clear, this is at least my taxonomy, is about deal sourcing screening. Deal sourcing is really sourcing deals, and screening is really that first conversation that you would have with the company. Then there’s a piece around analysis which might be relatively high level and then the deep dive more into hardcore due diligence, data room analysis, looking at a bunch of data, doing outside analysis.

Nuno

If the VC firms normally, if they’re hopefully any good, they will do their own analysis. For example, on market, they won’t just trust your numbers on market sizing. Then there’s dealmaking, negotiation, getting the deal, putting a term sheet in front of someone or getting into a term sheet that’s already been signed, getting to an agreement, managing the lawyers as we we’re talking before, then portfolio impact and management.

Nuno

So we’ve already invested in a company, now we need to create impact for our portfolio, help them manage it, be on boards, the ones that we got board seats or board observer rights and really create value to the company through our own selves, through our teams, through our institutional value and the operations that we’ve created in-house—we’ll talk about that in a second—and then finally liquidate.

Nuno

So again, the two edges are sourcing and liquidation, but at the end you need to liquidate. The company needs to go somewhere. It’s either it’s gone or it’s rebought by its partners or it’s sold to someone for a lot of money or not a lot of money or IPOs, et cetera, that’s the end of the funnel. Well, that’s basically what we manage.

Nuno

This funnel is a complex funnel because if you look at it, it requires a lot of different skills, a lot of different elements of skills for you to be really good at. The skills that it takes to negotiate a deal are not the same skills that it takes to assess whether a market is amazing for a specific company or the skills that it takes to assess whether the team is exceptional and is gritty and can take it to the next level. All of these skills are super different. I always call it, it’s the ultimate generalist activity that you have a huge unfair advantage if you have some deep spikes where you’re really good at.

Bertrand

Yes, it’s a complex process. I’m not sure if we have time to go deeper in every one of these steps. But for instance, deal sourcing that has been a lot of change, as you say, from an old boy network, proprietary network, to applying data science at scale and finding companies automatically with automated scraping databases, API access and filtering these machine learning, deep learning in place to score different elements in order to find the best opportunities for your type of fund, depending on your stage, your strategy, and basically a new approach that lets you scale volumes in a very different way, but also scale geographically in a world that is even more connected than where an investment is a zoom call away.

Nuno

Indeed. It’s a playbook that’s been followed by hedge funds, private equity funds, late stage funds, maybe some growth funds as well. For a while. The use of data, having data scientists in house mined a lot of data, et cetera. But shockingly enough, it’s not been used that much in early stage VC… Actually, in classic VC in general.

Nuno

The use of technology and quantitative methodologies in venture capital. And, you’re laughing because you know where I’m going with this, there is obviously parochial interest. That’s the whole ethos of Chamaeleon, my latest VC firm. But it’s shocking that we invest so much in technology and we don’t use technology ourselves.

Nuno

That’s about to change, we’ll talk about it in the future venture capital. We certainly believe deeply in it at Chamaeleon, that the use of quantitative methodologies, AI methodologies around machine learning and deep learning and the use of technology is the next wave of fund management augmentation for venture capital and early stage in particular. It is difficult because data is noisy, it’s very, very spread out, but it is possible and that’s the endeavor that we’re on.

Bertrand

Maybe to go on on this being an entrepreneur in residence at Red River West, French-American VC, that’s something we have also invested in some of technology and in some ways it’s way too rare, what you know has been doing with Chamaeleon, with what we have been doing at Red River West, it’s still early stage of VC. Most VCs have known don’t do that, and probably especially in Europe as well where it’s very new.

Nuno

They’re using Affinity. I think that’s what it means, that they use technology is Affinity or something like that. Or Pipedrive, they have a CRM.

Bertrand

Yes, it will use some pre-made solutions, and that’s not the same.

Nuno

It’s not the same, not the same thing, and I don’t think it will be. It is horses for courses. Obviously, in the process of venture capital, there are operations. A venture capital firm is also is managing one or more funds, but it’s also an entity in of itself that has its own areas and domains. It has to acquire talent, talent acquisition, HR, it has to market itself, be present in the market, develop thought leadership. It has to have maybe some shared services that it makes available to its portfolio companies. So there’s obviously a complication on operations, but just to make this very precise, VC firms are small things.

Nuno

This is way back when… I think I’ve probably quoted this stat to the Nth degree, it was 2018 numbers, 95% of all VC firms in the Bay Area have less than ten people. 95% of all VC firms, not funds, firms, have less than ten people. Which means if you have then assistants and community managers and maybe you have someone for IT, and then it’s like your deal team is tiny, so it’s not magic. It has to be magic. If you’re doing like 20, 30 deals per fund and helping the companies and whatever, I mean, how do you make it work? So you have to figure out how you make it work.

Nuno

Obviously, there are exceptions to this, we’ve talked about some of them already. The NEAs, the Andreessen Horowitz’ of the world, the Sequoias of the world, that are much larger in size, and in what do they do for their portfolio companies, because of the assets they have under management, they are obviously much more significant. But by and large it’s a startup. It’s how do you make operations work with a small, tiny team and how would you take it to that next level.

Nuno

The final thing I would say about the process of venture capital is probably the most essential part of the process of venture capital is raising money. You need to raise money from the LPs we talked before. These are not magical beings that come to you and give you money because they like you, right? You have to go to them, you have to do roadshows, you have to fundraise like a startup would, but as I always say, it’s 10X more difficult.

Nuno

Because you’re not raising normally on a product, you’re raising on a team that has a track record, that has maybe a methodology that maybe has a core, a couple of distinctive aspects to their angle, either thesis or operating model. The life cycles of raising are two years plus, right? You could be having discussions with LPs for 3, 4 years until they give you their first capital commitment.

Nuno

You don’t get a check, the check you get is a capital call. So when a fund says, I’m managing 100 million, they don’t have 100 million in the bank. They call the capital as they need it, for their management fees and for the investments they need to make. So it’s a very different animal. It’s a very complex…

Nuno

I think entrepreneurs normally don’t understand this, but this is very important for entrepreneurs to understand. Our cycles of fundraising are not 3 to 6 months. You could be talking to someone today and they’re like, “Love you guys. Your track record is amazing. We’ve spent weeks looking at your data room or whatever. Yeah, we won’t come into this fund.” And that means they’ll come into the next one, which is probably 3, 4 years down the road when we’ll raise the next fund.

Nuno

And so that’s it. It’s not like a VC tells you, “Oh, come back to us in the next round, which might be a year away, eight months in the good times and be 18 months in the bad times.” No, no, no. This is like, we could be talking like five years, six years at a time, a couple of funds. So very different ballgame.

Nuno

There’s many ways to do fundraising. If I knew the silver bullet, I wouldn’t tell you. I still don’t, I’m still figuring it out. I’ve been doing this for 12 years. It’s about connection, it’s about value add to LPs, it’s about being distinctive and very clear about what you are as a VC firm, what stands out in your team, your thesis, your operating model, what is unique in particular for more evolved LPs, it’s about track record. That’s the chicken and egg issue. If you don’t have a track record as an angel or you’ve done a micro fund or other funds before, it’s super difficult to raise a first fund. Very, very difficult.

Nuno

So there’s all these things that are around it. And then there’s an ecosystem, there’s private placement agents and there’s banks and there’s all sorts of things that can or maybe not sometimes help with your fundraising, but it is complex. The type of actors we see are a lot more diverse than the type of actors normally a startup would see to raise for their own company. Because again, it could be a family office, a pension plan, an endowment, a corporation of any size, et cetera. So it’s very, very different as a landscape.

Bertrand

Yes. I think especially entrepreneurs might not realize how much time and effort is spent by VCs on that side of the puzzle. Obviously, the bigger names have an easier time in terms of fundraising, but doesn’t mean that they don’t have to spend time on this as well. They certainly have.

Bertrand

But if you are a newer fund, it’s definitely harder and it’s a very entrepreneurial experience in a way, because you are definitely starting this relationship with SLPs. You have to build a brand, you have to build your metrics. And a lot of LPs are only going to invest once this metric. So it means it will be your fund three, because your fund one will be too early after just a few years to provide the results for your fund two. So it’s already a long time because fund three will typically be after eight years, so it will be a long time before you you get access to some LPs.

Nuno

There’s this famous thing, I think it was Arthur Rock with Kate Mitchell, who was the first woman chair of the NVCA, the National Venture Capital Association for the US, and she tells the story—I’m probably butchering it—but she always says that she met him when she was an associate, so she was very early into her career in venture capital, and Arthur was already sort of a celebrity having invested in Apple in a bunch of other companies.

Nuno

And she asked him, “When did you know that you had made it, that you were the real deal as a VC?” And he said, “It must have been 25 years into it.” That’s not the punchline, she’s like, “And when was that?” And he’s like, “No, it hasn’t happened yet, it’s next year. I’m 24 years doing this, so it must be next year, right? 25, I’ll know if I’m good, right?”

Nuno

And that, I think, is the thing about the profession of venture capital. The feedback loop is tremendous. Your fund could be looking like the best thing since sliced bread and then not be, could be the opposite, your fund could be a dud and then it’s amazing. The cycles are literally decades and keep doing it, and improving, and learning, and getting to the next level, and getting pushed with all these short term things.

Nuno

I always say we suffer from ADHD because we have to suffer from ADHD. We have to think like 10 years, 15 years out, strategy stuff. And then we need to think back to today, I have an entrepreneur who has a problem and is depressed or SVP is collapsing, and I need to get the money out, so our world is a world where you need to make decisions to the minute. You’re never really off the job at any point in time, even on weekends. Something can happen, anything can happen really.

Nuno

But at the same time, you only know how good you are, like 10 years down the road or seven years down the road for this fund. How silly is that as a profession? It’s a profession that has totally misaligned timelines. You have to be doing everything you can on a daily basis and then the reap benefits thing is literally years. I mean, it’s cool.

Bertrand

I think it’s very true and it makes this profession extremely difficult to get into because of that lack of clear feedback loop and KPIs. People always joke about marketing.` You don’t know where your investment dollars go in the sense that it might take you a while to understand which part of your marketing dollars get you return.

Bertrand

But if you think about a VC, it might take them five years plus to know where some returns are going to come from and potentially even longer than that. So it’s a very tough place to be as an entrepreneur. It’s much easier to understand where you are in terms of success for your business. You have a lot of metrics from revenues, to profit, to number of clients, to pricing, to competition, that give you a sense of where you stand and where it’s going and might be disagreement there, but a lot of pretty obvious metrics. As a VC until you have made your exit, [inaudible 00:16:39] of place to be.

Nuno

It is not done until it’s done. Until you have the money in the bank account, it is not done. One thing that is even worse than startups, if you think about it, is we manage funds, which is let’s say you’re building a franchise like I’m now building Chamaeleon with my partners and the whole team. As we’re building the franchise, maybe we have a first fund and it’s amazing, we still need to have amazing fund two, and a fund three, and a fund four. It’s not like an entrepreneur’s.

Nuno

My first startup was an amazing the second one wasn’t so good. You never hear this from VCs. VCs don’t come out and say, “Well, my first fund was great, my second wasn’t so great. The third, we’ll see.” it’s always about the franchise and the franchise is all your funds that you’ve done underneath it. This is really, really tough. Again, very long cycles, various funds, that’s what builds a franchise. It is an asset managers world just happens to be in startup plan, but it’s an asset managers world. So maybe just sharing some stats around venture capital.

Section 2: Stats on VC (19:03)

Bertrand

Yes. Do you want to start with the global stats, Nuno?

Nuno

Yeah. There seems to be a wide disparity on the numbers we read globally on many VCs are there globally. I believe there is a Crunchbase number that states around 20,000, a 2021 number. I suspect actually in 2022, there were even a lot more micro funds being created. So they mentioned, I believe, 19,000 active VC firms globally as of 2021, of which more than half would be in the US. I can buy that number, I think more than half will be in the US.

Nuno

That said, if you check PitchBook for the same year, 2021, they’re talking about 4,500 active venture capital firms, which obviously is not 54% of 19,000, so they seem to have a difference of opinions on what the numbers are. The PitchBook numbers do include traditional VC firms and corporate venture capital firms.

Nuno

If I had to go closer to a number, I believe the PitchBook number more, maybe around 5,000 VC firms in the US, active VC firms in the US, that sounds about right, and likely that the US is the majority of global. So if the US is the majority of global and it’s around 5,000, then global would be maybe 8 or 9,000 VC firms that are active.

Nuno

This would probably exclude angel syndicates that are not really structured as a VC firm or fund, probably exclude some of the bigger private equity guys who are not necessarily doing venture capital per se in earlier stages. But that number is palatable to me. I don’t know, what do you think, Bertrand?

Bertrand

Yeah, it’s big numbers. 5,000 VC firms in the US, I can buy that. It’s definitely a big number, but I’m not surprised. Double that, I don’t know, I’m not sure. If we look at on a more global basis, US 50%, I definitely buy this number, and I think a big chunk in Asia you are saying.

Nuno

Yeah, the belief from Crunchbase was that 24% was Asian, then Europe was 17%, so Europe actually was smaller in terms of the number of VC firms that are active that it has, I can also buy that. I think China in particular skews those numbers dramatically. It’s such a huge market that I could buy that maybe around 25%. So a quarter of the world, around half, a little bit more than half US, a quarter of the world Asia, then less than a quarter in Europe and then the rest of the world, Africa, Latin America and other parts of the world.

Bertrand

If we zoom on the US market, the US VC market, what are the top regions? We have the Bay Area number 1, I have metrics around deal value at 75 billion for just the Bay Area alone. If I look at then it will be New York. Number 2 at 31 billion invested, and then we will have Los Angeles actually with 23 billion investment, and finally, Boston at $21 billion investment. I feel Boston has been the big loser of the past two decades, because it used to be the very clear number 2 place for venture capital, but it’s now number 4 in the US.

Nuno

Yeah, New York boomed, LA boomed for obviously different reasons. For some reason, Boston has stopped the limit. If I had to make a guess, I think there’s been a lot of inflow in California from Boston. I don’t know if it’s a weather related thing or something, but certainly I see a lot of MIT undergrads and grads moving to California, Harvard.

Bertrand

It’s cold in Boston in winter. It’s cold.

Nuno

It is very cold in winter, sadly. But it was the bastion of deep tech and frontier tech in the US. It still has a lot of stuff going on there, but I agree with you. It was, for a while, discussed as this next Silicon Valley. It’s going to, at some point, match order… Its matched order of magnitude, but at some point it’s going to be closer to the Bay Area. In reality, what we’re seeing is not that, it’s that New York has scaled, LA is scaling really fast, but somehow Boston isn’t really going to the next level.

Nuno

If we look at the migration or the exodus that has been portrayed certainly by the media or part exodus of people going away from the Bay Area in California, it’s not to Boston, it’s to Miami, to Austin, Texas. So the movements are certainly not aligned with Boston recovering anytime soon that second spot.

Bertrand

Yeah, Boston has this bad reputation in terms of, especially early stage business angel investing, where investment conditions are pretty poor, you would get very poor deal terms. That’s what it is. And in terms of numbers, fifth market is Chicago with 10 billion invested. We have Seattle, where I’m based, at 7.8 billion. And surprisingly, Miami and Austin are still pretty small in the $5 billion range of deal value.

Nuno

Could you tell us these numbers are for the whole of 2022 or?

Bertrand

Whole of 2022, and this is based on PitchBook NVCA venture monitor.

Nuno

I’d be surprised if Austin and Miami don’t grow up quite a bit on the list. 10 billion is a lot. 10 billion in investing in a market is a lot. It means that probably you have a lot of early stage investments or you probably have a lot of mid to late stage companies growing. And so the build up of that bulk of capital might take a while even in markets like Austin and Miami, but I would see them going quickly through the ranks, to be honest.

Bertrand

That’s true. When a new market is starting, it starts from the bottom up. So definitely it’s a possibility that keeps going strongly.

Nuno

We also want to talk a little bit about loss ratio. We talked about it earlier in our previous episode, where we discussed loss ratio is where a specific investments, so a portfolio company that a venture capital firm invested it in, out of one of its funds, doesn’t return at least its principal. So it’s not a positive return, it’s not above the amount I put into it.

Nuno

And we discussed actually in the last episode loss ratios and stuff. And so the loss ratio seems to be a bit of a mythic number. People say 50, 60% is okay, there seems to be a stat from the National Bureau of Economic Research that mentions and I don’t know exactly the year this is for, but actually mentions that the average loss ratio for a VC fund is around 23%, maybe a little bit surprisingly on the low side for me, I would expect it to be a little bit higher, maybe not 50%, but a little bit higher, maybe 35, 40%, something like that.

Nuno

But in any case, it might mean that sometimes people do recoup their money. They just get 1X back or something like that. Or maybe this is a stat of a market that has been relatively bullish, where there’s been acquisitions, acqui-hires, and so there’s positive exits, maybe that’s it. It seems to me loss ratio may be a little bit lower than I would have expected to see as a number.

Bertrand

Yes. Obviously, it’s a mix of different investments, and the more money you put, usually you would put money in the winners. So from a dollar basis, it could definitely make sense, but more early stage, you might not get these metrics.

Bertrand

For me and other metrics, and this is going back, we have a focus today on venture capital, but if we look at capital as part of a bigger environment of private investment, for me, and therefore we compare it to private equity, real estate investment, private debt, fund of funds.

Bertrand

For me, what’s interesting is that venture capital both provide the highest range of return, and also the lowest range of return of the whole private investment, so definitely it means that it’s high risk. It means that you have to extremely well pick your funds in which you are going to invest, because you are going to be there for the long run, and if you have always stories of insane returns, people talk about those stories of poor returns.

Nuno

Indeed. Talking about the influence of venture capital in the broader markets like the labor market, these are numbers that I would take with a grain of salt, but we’ve seen numbers from NVCA and PitchBook from 2019 that talked about 40 million jobs that are held by and supported by the US VC industry. So venture backed companies that drive 4 million jobs, not the VC industry itself. So just to be clear, venture backed companies, 4 million jobs.

Nuno

And then there was a similar analysis done by Atomic in Dealroom that mentions 2.6 million employees in VC backed companies in Europe as 2019, I would expect the number to be higher. I don’t know if they start discounting or taking out the numbers of companies that were VC back, but they are no longer VC backed, because they’re public or whatever.

Bertrand

I would guess so.

Nuno

Yeah, I would expect this to be much higher. In any case, there’s an interesting analysis, this was done, just to be clear, I actually have some of the context. Back then I was participant in some of the discussions around this, so there’s a little bit of a skew towards these numbers because it was related to visas, and getting visas for venture backed companies, et cetera, et cetera.

Nuno

But I can believe that employment of VC backed companies grew almost 1,000% between 1919 and 2020s, so three decades. Whereas the market in general for private companies grew 40% in terms of employment, and that’s pretty silly. Obviously, it’s startups, it’s the heyday of startups, the 90s and then going forward. But it’s still incredible, the growth is really very much fueled by startup companies and how they go to the next level.

Section 3: The Future of VC (27:31)

Bertrand

So moving maybe to the future of VC, Nuno?

Nuno

Yes, I love talking about the future of VC, you know that. I love talking about it because I think we are… I rarely do sales pitches on Chamaeleon, but this is my sales pitch on Chamaeleon. I think we are creating the future right now. That’s the theme of that fascinates us all in this team, which is really the first piece of that future is the use of quantitative and technology methodologies and systems and platforms, the use of AI in particular machine learning and deep learning on certain parts of our data sets to really help us with the core processes of venture capital.

Nuno

As I mentioned in the previous episode, it’s an industry that hasn’t really been innovated that dramatically and its operating model certainly doesn’t use much tech. The odd CRM system here and there, Pipedrive, Affinity, et cetera, but certainly not its own quant team and its own technology team and its own software developers. Maybe a few data scientists here and there, but certainly not their own development stack. And we believe dramatically that is the future, we need to use it, we need to be more fact based.

Nuno

There’s a variety of reasons why that is in the future. We have biases, we have geographic biases, we have biases in terms of the founders that we’re looking for. Our networks intrinsically have biases because they’re very limited. It’s the places where we work, the places we got access to.

Nuno

And in some ways it’s been exciting to go on this journey because you see a lot less biases, you see a lot more distribution, diversity, also diversity in the types of companies we can see in particular for more of a generalist fund with a spiked approach around the partners, but still a generalist fund. And it’s really, really exciting that you can really innovate around the core pieces of the funnel. Deal sourcing, due diligence, and portfolio management and how do you scale that. And I think that’s the future.

Nuno

Just to give a few examples, it would be difficult for you to go to a VC firm, or it would be actually easy for you to go to a VC firm and ask what their risk profiles look like for their portfolio companies. So if they have 30 portfolio companies in the fund, what sort of risk profiles do they have? What’s the correlation and cohorts on that risk profile? Who fits what?

Nuno

You can also ask them, if you add a company in this space, this specific type of company, how would that change your risk and which cohort would they belong into? So the question would be very easy, the answer would be impossible. Nobody would give you an answer. Nobody does Portfolio management at scale, not even some of the top VC firms in the world are known to do that at scale. What they do is a little bit more Mickey Mouse.

Nuno

They do look at their returns, they look at optimizing the returns of not the top three, but below the top three, how do you optimize that those returns and how do you get stuff into it? But for example, risk analysis in venture capital is quasi nonexistent. If you think how vital it is to liquidate a company at the right time to make those returns, it’s shocking that there hasn’t been more work done, more things done around it.

Nuno

So again, I think that’s the first piece that I would put on the table. Again, it’s parochial. It was a bit of a sales pitch, I apologize in advance, but it’s what we’re thinking through at Chamaeleon. We think that the use of quantitative methodologies, technology platforms and AI is vital to the development of the category. It’s what I call the Renaissance capital moment for venture capital. Renaissance capital was actually the granddaddy of quant hedge funds. I think it’s now the moment to do this for early stage venture capital and venture capital in general.

Bertrand

Yeah, Renaissance Capital has amazing return. There is a book about Renaissance Capital, it’s an amazing with how they started this quantitative approach, I believe in the 90s or actually maybe even 80s. So it’s been a while and strangely it was not applied to to venture capital until very recently.

Bertrand

And I can say that, I mean, having started a firm, App Annie, now called data.ai, that has among its clients, a big chunk of the VC industry. You know, you are one of the very first, one of my very first client in the VC industry space. You were definitely one of the pioneers in that space. If many are trying, not so many are definitely succeeding or even really a machine that is organized around that quantitative approach.

Nuno

And there’s a problem, which is if you haven’t tried it and you have, you haven’t done it to scale, how do you know if it works or not? Once you’re given assets under management and you have management fees, where are you going to spend it? Well, you’re going to spend it in the classic things deal team support staff. Maybe if you have a lot of assets under management in portfolio management and impact stuff, but you will not spend a ton on tech because you have not pattern recognition. You haven’t done it before, you haven’t tried it before, you don’t know if it works or not, so it’s a huge risk.

Nuno

And I think there’s other issues in the industry. It’s an industry that has been driven a lot by—I’ll exaggerate—by ego, I’ll probably say ego in a different way. It’s been driven a lot by personalities, by relationships, by the way people interact. And that’s the legacy, that’s the legacy that we’re combating. So that’s definitely one of the forces that we’re seeing for the future of venture capital. Again, this was my parochial thing, I’ll apologize and move on.

Nuno

There’s definitely been a movement of mega funds with the VisionFund. We’ve talked about it in previous episodes about really occupying space and writing very large checks very early on in the development of the company, almost the blitzscaling theory of Reid Hoffman, and Chris Yeh, who are…Chris is a good friend, but taking it like to the nth degree very quickly. I’m not sure it’s worked really well. What do you think, Bertrand?

Bertrand

I mean, it does not work very well, at least right now. The metrics are clear for VisionFund as well as some others, like cross-over funds, who have had a lot of troubles. They went to scale big time. The investment approach, especially at the later stage of the game. The problem is that more money doesn’t mean better business, and capital as a moat does not exist. You don’t have capital as a moat. You can always find more capital somewhere. So it does definitely increase the capital needs of startups, but it does not increase the returns.

Bertrand

And what we have seen is that in a higher interest world, it’s a very difficult game to play, because some of this capital was actually loaned. Let’s not forget that VisionFund is mostly backed at this VisionFund, one, by loans. That’s a very difficult model if you have very high interest rate. And the other piece of high interest rate is a decrease in valuation of more risky business like high tech business. So pushing a lot of capital in companies that are less and less valuable is a difficult game to play.

Bertrand

And the other piece, I remember someone telling me some time ago and I think he’s right, it’s not because there is more money that there are more good entrepreneurs. I believe you have a certain limit to the numbers of true entrepreneurs, and that’s true that entrepreneurship has become a bit more sexy of late, more people interested to go into entrepreneurship.

Bertrand

But that doesn’t mean we have more talented people. That’s always been a worry. With more capital coming, it might be wasted on entrepreneurs that are the wrong ones. It might be wasted on industries that are the wrong ones, so that’s something that’s a worry to me.

Nuno

Yeah, I mean it’s… Also of course, it’s right cross-over funds like, “Oh, I have this advantage and I can put more money later, cool.” But what’s your edge in early. Mega funds is like… It’s a mess. Then, that’s a very complex risk profile. You’re coming in at Series C for some company, Series B for others, maybe Series A for others, and then Series D, almost IPO… I mean, it’s a mess of risk profiles.

Nuno

And for a while, the world looked it was going super well, super positive, and then it wasn’t. And even before all this collapse that we’ve had recently with dramatically increasing interest rates, let’s not forget the whole vision fund strategy start getting put into question way before this whole increase in interest rates, whatever. Maybe it was a great play, maybe it was this big bet on just occupying and creating moats around capital, because you have so much capital, you create a moat around it, but it probably didn’t scale and it didn’t really go to the next level.

Bertrand

Yeah, it created an arms race where suddenly every VC firm had to have billions and billions of dollars under management. So okay, they started it, but many others followed because they realized that they cannot lose to the VisionFund. But I think many stayed more careful, closer to their roots in terms of analyzing business, analyzing opportunities.

Bertrand

And to be frank, we also have to be careful because all of this money, if you are an entrepreneur, if you raise too much, it’s going to be trouble at some point, because you are more lazy the way you run your business as well as when it’s time to exit the business. You have a big cap table and it’s creating a huge threshold in terms of how much you have to sell in order to profit from the sell of the business.

Bertrand

And not just the entrepreneurs, the employees who have been promised stock options and the like suddenly might wake up with a hangover. And that’s certainly what has been happening in 2022, by the way.

Nuno

Maybe moving to other layers of augmentation. Obviously, we’ve already talked a little bit about, if you have a lot of assets under management, you have a lot of management fees, you can hire a lot of people and a lot of these people can really be used as a significant value add for your portfolio companies, market developing, helping them with sales, helping them getting to companies, business development, even M&A. If you want to push some companies to potentially exit and get out of it down to acquisition.

Nuno

For me, it’s more interesting the hacks that you have into people augmentation, and I would take my hat off to Chris, set at SignalFire and the whole team there in the model they created around their advisors, some of them are also their LPs, and how they support their portfolio companies, and how do you create the graph to get people to really connect with each other. Obviously a lot of it comes from the origins of the firm. There was a lot of background in the firm of people that were in the executive recruiting space, but that’s definitely super hacks, super well done, super well thought through.

Nuno

We had Chamaeleon do that with #KIN, which is our network of advisers, scouts, operators, et cetera. It’s a smaller network, but it’s probably a more deep network in some ways in terms of involvement, and we quite like the way that that works well in our ecosystem, building with our portfolio companies, their LPs, et cetera.

Nuno

There’s people that are doing other types of elements in terms of how do you put Rolodexes at the disposal, we also use technology to do that internally, but how do you put your Rolodex at disposal of your portfolio companies? How do you help them scale? How do you help them get help from the right people?

Nuno

Because sometimes you hire someone for your organization as a VC firm because you have all these management fees, but maybe this is not the person that really can help the portfolio company. In some ways, having maybe a looser advisory and operator network and creating some prioritization around that might actually be, in some cases, even more valuable, I would argue. But there’s definitely a lot happening around what I would call the people augmentation layer of venture capital.

Bertrand

I think it’s quite important to be able, as a VC, to provide support to your portfolio companies. For me, the first report I’ve always looked into is how do you help me recruit more and better, so that part is definitely critical. I think the other piece of the puzzle is how do you help me make better strategic decision, I think that’s really key not to miss a big strategic decision.

Bertrand

Maybe by intros to smart people in the industry, it might be to introduction to independent board members, maybe a lot of things. But I think that strategic box not missing something is key. I think, obviously, there’s a lot of value there and it’s always a fine balance about how much you can invest as a VC firm versus other ways to invest to run your VC business.

Nuno

And then finally, in terms of the future of venture capital to extreme angles, the impact investing piece and a refocus back into deep tech and frontier tech and big disruption, some of it actually intersects, a lot of clean tech is deep tech in many cases. Not all of it, of course. But yeah, certainly a lot of exciting things happening.

Bertrand

Yeah, I think it would be an episode in itself to focus on what’s next in terms of VC investment, in terms of industries. Luckily tech is there, VC investment is there, as you say, deep tech, frontier tech, there is a lot of disruptions coming, of course, AI, quantum computing, there is a lot of stuff.

Conclusion (38:40)

Nuno

Very good. In with this we conclude episode 42. In episode 41, we talked about the history of venture capital and the business of venture capital, and in this episode we went into the process of venture capital, its operating model, we talked a lot about funnel, and then we share some stats around venture capital to show the importance of the industry and where it’s at. And finally, we ended with a couple of notes on the future of venture capital, which we all believe is bright despite the turmoil of recent months. Thank you, Bertrand.

Bertrand

Thank you, Nuno.