Justin Fishner-Wolfson - Secondary Investing in Private Markets - [Invest Like the Best, EP. 227]

My guest today is Justin Fishner-Wolfson, founder of 137 Ventures, a venture capital fund focused on providing liquidity solutions to founders, investors, and employees of private businesses. In our conversation, we discuss what early career experiences led Justin to start 137 Ventures, the counter-intuitive information asymmetry between public and private markets, and the interesting trend of digitization in the physical world. I hope you enjoy my conversation with Justin. For the full show notes, transcript, and links to the best content to learn more, check out the episode page here. ------ Invest Like the Best is a property of Colossus, Inc. For more episodes of Invest Like the Best, visit joincolossus.com/episodes. Stay up to date on all our podcasts by signing up to Colossus Weekly, our quick dive every Sunday highlighting the top business and investing concepts from our podcasts and the best of what we read that week. Sign up here. Follow us on Twitter: @patrick_oshag | @JoinColossus Show Notes [00:03:47] - [First question] - Why he started 137 Ventures and what’s unique about it [00:05:31] - Overview of secondary equity markets in the tech sector [00:07:06] - Step by step process of how a secondary market investment works [00:09:37] - Scale of secondary transactions in markets today [00:10:19] - Valuations of secondary transaction rounds versus primary ones [00:11:37] - Defining great in private market investments and the competitive landscape [00:13:13] - Why there seems to be more information available in private markets [00:16:23] - How better capital allocation may result from less asymmetry [00:19:14] - What excites him about companies when meeting them for the first time [00:20:34] - Example of applying his philosophy of investing in a defensible business [00:22:20] - Counter positioning and inversion models to gain an advantage [00:24:17] - Lessons learned from Palantir about unlikely competitive advantage [00:25:57] - Building good businesses when selling them to the government [00:26:59] - What technology means in the current era [00:28:34] - Methods for evaluating potential sources of defensibility and a lack thereof [00:30:30] - Considering focus and expansion when scaling [00:32:52] - Shared qualities of entrepreneurs who build these types of businesses [00:33:50] - The business that individually taught him the most writ large [00:35:01] - Defensabilities that might appear beyond the seven powers framework [00:36:21] - Thoughts on what seems to be craziest in the world today [00:37:15] - What’s surprising on the low end of the valuation side [00:38:11] - Interesting business models and ones he’s averse to [00:40:31] - Constructing a portfolio with companies that have a customer focus [00:41:21] - Additional companies in their portfolio that aren’t of a similar model [00:42:08] - Lessons learned from SpaceX’s growth [00:44:46] - Watching a SpaceX launch in person [00:46:03] - Advice for entrepreneurs when seeking capital and capital partners [00:48:04] - Investors he finds most impressive that he knows well [00:49:26] - Defining the cost of capital and what it means to him as a venture investor [00:50:56] - Is giving entrepreneurs too much money dangerous? [00:54:14] - What great capital allocation looks like to him [00:55:29] - Accelerating learning curves with tighter feedback loops [00:55:57] - Useful metrics for customer acquisition and retention [00:57:06] - Whether or not investing firms can and should behave defensibly [00:59:13] - What is going in the world that has his attention lately [01:02:06] - Key factors that have allowed him and his firm to succeed [01:03:47] - What he thinks about when his mind isn’t focused on investing [01:04:08] - The kindest thing anyone has ever done for him

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:00Patrick O'Shaughnessy?

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• 0:43Patrick O'Shaughnessy?

  the founder and CEO last year to pick his brain about SaaS businesses. Founded by a former buy-side analyst who encountered friction in sourcing, building and updating models, Canalyst is now used by over 300 institutions, including the largest money managers in North America and by a number of guests on the show. With detailed company-specific models on virtually every investable public equity, Canalyst clients are able to react more quickly. If you've been scrambling to keep up with the deluge of IPOs and SPACs these days, Canalyst has models on Coinbase, Roblox, Qualtrics and everything in between. Their pre-IPO models are built as soon as the S1 hits and include all segments, KPIs and non-GAAP figures. If you're a professional equity investor and haven't talked to Canalyst recently, you

• 1:27Patrick O'Shaughnessy?

  should give them a shout. Learn more and try Canalyst for yourself at canalyst.com/patrick. That's C-A-N-A-L-Y-S-T.com/patrick. If you're curious to hear more about Canalyst, stay tuned at the end of the episode where I talk to Canalyst's new Chief Product Officer, Jeremy Payne. This episode of Invest Like the Best is brought to you by Tegus. I started hearing about Tegus when several of my close professional investor friends sent me passages or ideas they'd found on the Tegus platform. Conducting effective primary research shouldn't take weeks, it should take hours. Searching for answers shouldn't be lengthy, cumbersome process, it should be easy and nearly immediate. Expert calls should not cost $1,000. Tegus solves these problems and makes primary research faster and better for professional

• 2:12Patrick O'Shaughnessy?

  investors. Tegus has built the most extensive primary information platform available for all investors. With Tegus, you can learn everything you'd want to know about a company in an on-demand digital platform. Investors share their expert calls, allowing others to instantly access more than 10,000 calls on Square, Snowflake, or almost any company of interest. All you have to do is log in. Still want to do your own calls? Tegus has a solution. Experts that are just as good or better than what you'd find on other networks for just $300 per call, not the $1,000 or more that others charge. If you're curious about Tegus, call the top performing investment manager you can think of. They're probably already a Tegus customer, and they'll point you in the right direction. Because customers, myself included, love Tegus. Visit tegus.co/patrick to learn more.

• 2:59Patrick O'Shaughnessy?

  Hello and welcome, everyone. I'm Patrick O'Neal, and this is Invest Like the Best. This show is an open-ended exploration of markets, ideas, stories, and strategies that will help you better invest both your time and your money. Invest Like the Best is part of the Colossus family of podcasts, and you can access all our podcasts, including edited transcripts, show notes, and other resources to keep learning at joincolossus.com.

• 3:26Speaker 01

  Patrick O'Neal is the CEO of O'Neal Asset Management. All opinions expressed by Patrick and podcast guests are solely their own opinions and do not reflect the opinion of O'Neal Asset Management. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of O'Neal Asset Management may maintain positions in the securities discussed in this podcast.

• 3:51Patrick O'Shaughnessy?

  My guest today is Justin Fisher-Wolfson, co-founder of 137 Ventures, a venture capital firm that has raised four institutional funds with total assets under management of 1.5 billion. One of their strategies for accessing growth-stage technology companies is to provide liquidity solutions to founders, investors, and employees of private businesses. In our conversation, we discuss what early career experiences led Justin to start 137 Ventures, the counterintuitive information asymmetry between public and private markets, and the interesting trend of digitization in the physical world. I hope you enjoy my conversation with Justin.

• 4:26Patrick O'Shaughnessy?

  So Justin, I think the best place to begin for those unfamiliar with 137 Ventures is to hear the thumbnail sketch of the founding story. Why did you start the business? What's unique about it in terms of how it's trying to earn great returns for its investors?

• 4:41Speaker 02

  What really happened was I was at Founder's Fund in the early days and we had a lot of friends from college who ended up at Facebook. If you kind of rolled the clock back to 2010, there was that Goldman Sachs round that valued the company at 50 billion. And I had a lot of friends who had all this wealth on paper. They owned all this stock and literally no money. And they didn't want to live with roommates anymore because they were probably getting married and maybe they were going to have a kid. And at some point, if you're going to have roommates, you want it to be people that you're related to as opposed to others. And so I kind of got a lot of phone calls around the same time where people were looking for liquidity. They wanted to borrow some money against all the stock they held, which was obviously private stock. And I tried to find people to refer them to. It wasn't that I thought, hey, we should go

• 5:24Speaker 02

  build a fund to focus on helping people get liquidity. It was really like, who can I send my friends to? Because presumably someone is in this business. And what I found out was that really no one was in this business. And so my co-founder Alex, who I knew from Founder's Fund, we basically started out in 2011 to build a firm that was focused on helping founders and executives get liquidity at these growth-stage venture-backed companies. And the thesis was relatively simple, and I think was obvious if you were on the ground, which was that Facebook wasn't an anomaly. It was the start of this longer-term trend of companies staying private longer, and therefore the market opportunity would continue to grow. And it was a way to access great companies without having to compete with everyone who is trying to do the primary rounds. And that's what we've done for the last 10 years.

• 6:10Patrick O'Shaughnessy?

  Can you describe this whole part of the world, which I don't think I've ever talked about before on the show, and is very opaque, which is the secondary market for valuable, privately-held shares, especially in fast-growth, we'll call them startups. There's tons of people who have this Facebook situation, happens every year. They're worth a lot of money on paper. They have no cash. They want some cash. Secondaries are a thing. Like, can you just describe like how that market has evolved, what it looks like, like what the volumes are? Sort of give us like a primer on secondary equity markets in this space.

• 6:42Speaker 02

  I think it's gotten much bigger, which is really just a statement to how many companies there are that are very simple metric is how many companies are worth a billion dollars. This used to be a unicorn. That was like something that was unique because unicorn is something that doesn't really exist. And now the number of companies last month, I think eclipsed like the number of companies when this term was created. So just the sheer volume of opportunities is so much bigger. I mean, I think it's probably grown by a factor of 100 over the last 10 years. That's part of it. I think the secondary market itself is somewhat opaque, but in many respects is similar to the primary market. If you wouldn't ask someone like, hey, who's going to go lead whatever round you're looking at,

• 7:25Speaker 02

  a series A round, it's like, there are lots of firms. You could almost certainly list a dozen of them, but there's probably 200 of them. People only know like the part of the ecosystem that they're familiar with. As I think the secondary market matures, there's a small group of firms that people know and it's getting more mature as time goes on.

• 7:45Patrick O'Shaughnessy?

  Walk us through how these things actually work. So primary is very straightforward. Let's say it's SpaceX, a company you've invested in 10 years ago or whatever. Let's say it was worth a billion dollars. You invested 100 million, you buy 10% of the company, it goes in the company's balance sheet, they use it to do stuff. Very straightforward. Secondary is really interesting because on the one hand, you want people working at the company, especially the founders, to remain super incentivized to build a huge business. On the other hand, in many cases, they've earned real wealth and they want to monetize that. Just walk us through like the way this actually works when one of these rounds happens. Let's say you wanted to bid for employee shares at company XYZ. Like, what is the actual step-by-step process?

• 8:24Speaker 02

  A couple of things that I would focus on first. One is, we are very interested in having a good relationship with the company and doing things that are supportive of the business. And so it matters in terms of able to access information, the time you're making the investment, but also on a going forward basis. And then you also want to know what's going on because you can actually be helpful to the business. I think that's like an important distinction. I think people sometimes think of the secondary market as just random players who don't necessarily have money, who are just calling random employees and annoying them. What we're trying to do is transactions that are sponsored by the company effectively. And then you also made this comment about wanting founders to be incentivized for the big exits. And I think the industry has mostly come around to this by now, which is that Liquidity actually incentivizes people to go for the big exits.

• 9:08Speaker 02

  The challenge that people have is if they have no money and a lot of people have student debt or things like that, when you have acquisition offers that come along that put tremendous amounts of money in people's bank accounts, that is great for them, but may not be really what the investors want because if you're trying to drive fund level returns, you need companies that are going to return the fund or multiples of the fund. And so you want people to go for the five, $10 billion exits. If they have no money, they're much more likely to get taken out earlier. And I've watched really great entrepreneurs. They have decent sums of money in their bank account, but nothing like what that acquisition offer would give them, and they turn them down left and right. There's a huge difference between zero and one. And so I think liquidity helps align both the entrepreneurs and investors for the much

• 9:53Speaker 02

  bigger outcomes because the investors have a portfolio, right? If any one company doesn't succeed, that may be annoying, but not necessarily a disaster for the portfolio. If you're an entrepreneur, you have one company, it needs to work. Otherwise, you end up with nothing. So the way to align incentives better is to let them take some liquidity. So I think the industry has mostly come around to this understanding. It's not universal yet, but it's mostly there. It's changed a lot in the last 10 years.

• 10:17Patrick O'Shaughnessy?

  Do you have a sense for what the size is, even just in like percentage terms? Like secondary transactions represent X percentage of primary transactions in the venture markets? Do you have any sense for like scale?

• 10:27Speaker 02

  I'm going to talk a little bit just off the top of my head, but if I had to take an educated guess, I'd probably say it represents 15, 20% of primary dollars, depending on how you define the term secondary, right? Obviously, there are things like LP secondaries where the dollar amounts are quite large. You'll see some like institutional secondary from one institutional investor to another. Those things would be quite large. But I think if you defined it, you know, more narrowly as liquidity for founders and executives or employees at companies, it's going to look something in that 15 to 20% range would be my rough estimate.

• 10:58Patrick O'Shaughnessy?

  Do these transactions tend to happen at similar valuations and terms as alongside a primary round or let's say on the same terms as a very recent primary round like it, or is there some sort of discount that that secondary transactions have tended to happen at historically?

• 11:13Speaker 02

  I think people talk about discounts, but I'm not sure they necessarily understand what the discounts are. I think it's just something that people say a lot. There's definitely an anchor point, right? Like the thing that never changes are the people. And so like a round is an incredibly anchoring psychological point. So think about if some company raises money at a billion dollars, just as the random round number, it's very hard for them to convince me that I should pay 2 billion and it's very hard for me to convince them that I should pay 500. Even if either one of those numbers might be correct based on some fundamentals analysis, that anchor point of the round is just incredibly powerful. It's not that it's the right price, it's that transactions outside of that range tend not to happen. So like what I tell people is, most deals are kind of plus or minus 20% of a round, not because the round price is correct, but once you start

• 11:58Speaker 02

  getting outside of that band, it's very hard for one party or the other to really accept that as a transaction price. The psychology of the round is very powerful. Sometimes those rounds are incorrectly priced, whatever the heck that means, but that doesn't mean that like all deals will necessarily get done. It just means if they do, they're going to kind of be in a tighter band.

• 12:16Patrick O'Shaughnessy?

  So there's an interesting thing you said, which is, let's call it 15 or 20% of the volume, even if that's off by a lot, the point will stand. I could definitely name a lot more than a dozen firms that are doing primary. I can name your firm and I don't think any others that are doing secondary. So what does the competitive field look like? And what does great mean here? Like, I think we know what great means for, we have an intuition for what that means for primary investors. Is it different for secondary investors? Talk us through that weird dynamic.

• 12:41Speaker 02

  It's not any different for us. I mean, we're raising, our capital comes from the same sorts of investors as people in venture firms that focused on primary investing. Our cost of capital isn't different, so I don't think our definition of success is any different. We're still looking at, can you generate net 20s? Can you do real cash on cash returns at the fund level, right? Like, these are the things that matter. And if we fail to do that, I mean, maybe you could take off a fund, maybe you have a bad fund or something, but if you fail to do that consistently, you're going to get fired. From a returns perspective, we need to hit the same things that any of the primary guys do. The one thing I always find somewhat odd is, private markets, people think primary is normal. That's sort of the quote unquote, "normal" way of investing. And yet, if you look at the public markets,

• 13:24Speaker 02

  99.99999% of the volume is all secondary. And people think primary is actually quite weird. It's just like this bizarre thing that happens every once in a while when companies issue shares in exchange for money to put on the balance sheet. That's sort of odd and it's not a good sign for the company. Everything is secondary. And it's just completely flipped in the primary, in the private markets. And I don't understand why people think it matters. At the end of the day, you're investing in a company and you have to think that that company is a good long-term bet.

• 13:52Patrick O'Shaughnessy?

  So one interesting that's happened in capital markets is the shift to, I like Brad Gerson's term lifecycle investing, where you can invest early on in the business as it's private, all the way through when it's public. And most, as you said earlier, like it's funny that in public markets, it's all secondary transactions. You know, 99 point whatever percent is secondary. And what's funny about all that is that there seems to be more information in private markets than in public markets. Can you talk through that strangeness and how you think that'll affect the investing landscape and how it affects your own investing?

• 14:25Speaker 02

  We're sort of grappling with this right now because you've had a number of companies go public over the last 12 to 18 months. I kind of started by complaining about the public markets and how they're valuing these companies. And maybe they were crazy high, which generally speaking, I was a fan of. And some of them, I thought they were very low, which obviously I wasn't excited about. And then I just quickly realized that the amount of information that we have as an investor in the private markets is orders of magnitude bigger than what the public market guys get. We like actually talk to management a lot for hours. You can ask them for things like cohorts, right? It's not like an earnings call where like you get three questions and then they like half avoid them and don't send you the cohort data. We actually get so much more information about these companies, especially over time.

• 15:10Speaker 02

  And so I think that to expect public markets investors to take an S1 and maybe like two earnings calls to really understand that business, it's just unfair. There's no way that people could legitimately build the model of that business accurately. In the private markets, they'll give you the model, like they actually are giving you the model on how they're forecasting their business, which they don't do in the public markets. And in fact, they give you like three points of data. Obviously over, you know, a two, three, four year period of time, you can take all those single points of data and start to build a model that's more refined and more accurate. And there are great public markets investors who've been successful at that. It's just that you have to recognize all the volatility that comes with being a newly public company.

• 15:54Speaker 02

  And it's going to take the public markets a while to even that out. And I think that there's an interesting trend. And it's not clear to me how much the crossover guys are taking advantage of this. But if you look at D1 or you look at Tiger or Co2 or whatnot, they're these big public markets investors who are investing a lot in the private markets. And you know, as far as I understand, most of the capital that they manage is actually in the public markets. And so all of this private market investing, even if you assume it doesn't inform anything else, which I suspect it does, just the companies that they're invested in, they know those management teams so much better. So when you listen to an earnings call and a guy says, hey, I'm definitely going to do this, you know, there is zero chance he's not going to, because when he says definitely, he means it. Or it's like, ah, 50/50, right? He says definitely, right?

• 16:37Speaker 02

  Just little things like that, irrespective of you actually have the model. And so it's so much easier to update the model over the five quarters after a company is public than to try to create the model from scratch. You're so much more likely to make errors that are very understandable. So I think that the crossover guys have an interesting opportunity to leverage the data they get in the private markets to inform a lot of better decision making in the public markets.

• 17:02Patrick O'Shaughnessy?

  Do you buy that better capital allocation results from less asymmetry? And if so, and we can figure out a way to make, as you've done, make private markets more liquid, why bother with public markets if it creates those conditions longer term?

• 17:16Speaker 02

  I'm not necessarily sure that liquidity is the solution. So part of the reason why companies are private is because they don't want to be public. And so the question is, well, why don't they want to be public? And part of that's regulatory. All of this changes with Sarbanes-Oxley and Dodd-Frank. Like it changed, what did it take to be a public company from a reporting standpoint, from a liability standpoint? So like those things don't seem to be going away. And then the public markets, they're liquid every day. And so people don't want their employees watching the stock price every day. That's super distracting. I mean, you could talk to the folks from Facebook, when the stock went down 50%, a large fraction of the conversation amongst employees was What's going on and how does that affect me personally? And I really can't focus on my work because I'm watching the stock price. Right. I mean, that was a big problem.

• 18:02Speaker 02

  So there's that dynamic. And I think that that ties into a belief that's somewhat true, that public markets are more short term focused. And so companies can't do some of the hard things that they would want to do if they were public. And so being private allows them to build more interesting, bigger businesses. And I think there's certainly truth to that. So there's a lot of dynamics that liquidity actually doesn't solve. Right. It actually makes worse. So it's about what's the stage of the business when it goes public? What's the leadership of the business? What's the control structure of the company? And all of these things matter. And broadly speaking, have incentivized companies to go public at a much later stage. I don't think you want to bring the public markets to the private markets, because that's what makes the private markets good. I think all of the major players will resist that.

• 18:47Speaker 02

  And in fact, they have, right? If you look at what happened with like second market or shares post years ago, right? They tried to create a more liquid market. And that's not what people wanted. You don't have the disclosures in the private market that you do in the public market. So it's like, in one sense, the public market has a lot more information. But in another sense, it has a lot less information. It has a lot more information for everyone, but a lot less information for the actual real investors in the company. There are plus sizes.

• 19:12Patrick O'Shaughnessy?

  It's almost like the right solution would be a once per year or twice per year tender, like a source of liquidity, but not a constant source of liquidity. It seems like an interesting concept.

• 19:22Speaker 02

  Well, I mean, honestly, that's where SpaceX ended up, right? They're doing one or two winters a year and they're dealing with informed investors. So it's an opportunity to educate people on the business occasionally. It's the opportunity to provide liquidity to your employees on a regular-ish basis. And that's where they ended up, which is, I think, the comment I made earlier was I can tell you how to run a good process. That's not necessarily core to your business. You don't have to think a lot about this. And I can tell you how Lantier did it and how SpaceX did it. And what were the good and bad things that came with that?

• 19:53Patrick O'Shaughnessy?

  Well, let's talk about that. So good long-term bets are key to all the success metrics that you're measured on. Talk us through your approach. You mentioned you came from Founders Fund. I think Founders Fund is one of the most interesting places that I've met investors from for sure. They tend to have like a very distinct, unique view of the world and are just fun to talk to about companies. So when it comes to companies specifically, what excites you about companies? Like when you're meeting one for the first time or seeing one for the first time, what does exciting mean?

• 20:19Speaker 02

  It comes down to the people initially, right? Because you're you're meeting someone who is passionate about whatever it is that they're building. And so that's kind of the first filter. But the thing that we care a lot about is investing in companies that have some kind of long-term defensible business model. The challenge, especially in venture, is that, you know, everyone's basically a minority investor. And so you're along for the ride and you and you don't know whether or not that ride is going to be two years or 10 years or longer, quite frankly. And you want to be comfortable being invested in that business over whatever period of time it ends up being. And you don't want to find yourself in a spot where the business, you know, you're in some business that's growing really well. And then you get a bunch of competition and margins compress and then

• 21:01Speaker 02

  multiples compress and then growth gets harder. And suddenly, you actually don't make any money. You really want to find things that have good, long-term, defensible business models. So that's the big issue you look for.

• 21:13Patrick O'Shaughnessy?

  Can you go back to the first time you sort of thought about or applied this concept of what a good defensible business model was as early in your career as you can remember? Because then I want to hear how your views have evolved from that original take.

• 21:27Speaker 02

  In some sense, the first investment was probably SpaceX. That goes back to 2008. They did two things that, in some sense, one was very simple, right? They got the government to agree to fixed-price contracting, right? Historically, when they were buying all of launches and such, they were doing cost-plus contracting. If you were a vendor, you didn't really care what your costs were. In fact, the more costs you had, the more money you made in an absolute sense, right? Even if your margin was fixed, you didn't have any incentive to do things better, faster, cheaper. And it was a struggle, but they got NASA and the DOD to pay for a launch. And if SpaceX could build a launch vehicle for a dollar or $100 million, like that just impacted their margins, right? Maybe they'd make money,

• 22:10Speaker 02

  maybe they'd lose money, but that was their problem. And that's a very hard thing for a competitor to shift from. It's an entirely different business model, even if the end product is nominally speaking the same. It's also fundamentally like an economies of scale business, right? The bigger they are, the less expensive everything becomes. And I think you're seeing that right now, especially with things like Starlink, right? So they're launching this global internet constellation to provide service anywhere in the world at high speeds. And the reason why they can do it so much more efficiently than everyone else is that they own launch. So they're reusing their launch vehicles. They're the only people who have a reusable launch vehicle to begin with. And they're vertically integrated. And so their cost of launch is much lower than anyone else who might want to build a constellation.

• 22:55Speaker 02

  And so you're just seeing a really valuable economy of scale in that business.

• 22:58Patrick O'Shaughnessy?

  Can you say more about this cost plus idea? Like back when SpaceX was starting, what companies does that apply to? Like, where has that been a standard business model historically? Say a bit more about kind of what it leads to, because I love the counter positioning idea that if you invert the business model, you can have an advantage.

• 23:14Speaker 02

  It is absolutely a counter positioning model, right? And this is true, especially along a lot of government contracts. If you think about like getting to the moon originally with NASA, it's like we were solving a problem that no one had ever solved before. And so the government solution was, well, we'll pay whatever it costs plus 20%. And that's a really incredible thing to do when you're trying to solve a problem that no one has ever solved before. No one knew how much it was going to cost. So you just keep spending money until it works. But the weird thing, Elon always used this analogy, it was like, we have planes. If you build a plane and you fly it from New York to LA, and then you throw it away at the end of that, ticket costs are going to be really expensive. On the other hand, if you keep reusing the plane, you end up just having to pay fuel costs back and forth and some maintenance.

• 23:59Speaker 02

  And then ticket prices are a hundred bucks. The question is, how do you build the Boeing 747 of rockets? That's effectively what SpaceX went out and did. And I think you find this cost plus modeling across a lot of government contracting, right? And we've seen this with Palantir and Anduril and other companies that we've been invested in that touch that space. And the government's gotten a lot better and smarter about buying things that work, generally speaking, in the enterprise space. They're not necessarily solving unique problems anymore. For launch, it's like, it's not a unique problem. You shouldn't cost plus this stuff. For software, broadly speaking, you don't want customized solutions because they're very hard to maintain, right? So you'd rather buy things like Palantir.

• 24:43Speaker 02

  If you're trying to do drone defense and things like that, like there's a bunch of technologies that you can leverage today. You don't need people to build like crazy customized stuff where you just want to say, hey, let me know how much it costs and I'll just add 20% to it.

• 24:56Patrick O'Shaughnessy?

  Something like Palantir is interesting, just sort of staying in this government theme for a second. I remember when there was this big batch of S1s coming out, Palantir was sort of in them. It'd be fun to, in a minute, talk about term "technology company" because I think it's become sort of bastardized. But with something like Palantir, I remember it seeming like a lower margin business, more of a contract-based business, less of a recurring business, just generated seemingly less excitement at the sort of S1 stage prior to being public. Talk us through your reaction to that, and that may be just my subjective interpretation, but a company like that seems like pretty unique in this landscape. What did that company teach you about competitive advantage?

• 25:31Speaker 02

  That criticism of Palantir was, in many respects, anchored on the company from 10 years ago. So while I'm not sure that it was ever totally a correct criticism, it was certainly a more correct criticism a decade ago, and then I think people never updated their views. So one of the big problems that I think investors have to overcome is, especially in technology, these companies change pretty rapidly. So just because you didn't like the company six months ago, doesn't mean you shouldn't like the company today. The entire business may have shifted, and I think if you looked at Palantir, they did a really good job of making the transition from a more consultative sales pitch, where it was more customized, to a more standardized product

• 26:13Speaker 02

  that you could literally stand up in a short period of time with a government customer, or an enterprise customer for that matter. It took them a long time to build that sales motion efficiently, but they got there and they built a really big, sticky business that's quite high margin, actually. I think that's what the public markets realized, that the private markets guys were just kind of stuck in the old view because they hadn't paid attention to the business in a long time.

• 26:36Patrick O'Shaughnessy?

  If you think about government, so there's like B2G businesses, which don't get talked about as much. You've mentioned three of them that you've been involved with. What have you learned, generally speaking, about building good businesses where government is the primary purchaser?

• 26:47Speaker 02

  I think it's about navigating the sales process and having the balance sheet, which gives you the time to do it right. You can't rush the government. Fast for them is just not fast in startup time. And so you need to have the balance sheet to have the patience in order to navigate that process effectively. And you need to know how to talk to the government. There aren't a lot of people in Silicon Valley who've spent a lot of time in that ecosystem. And so you can't just be like, hey, we're going to save you money because that's not necessarily their incentive. They're not running a business. You can't just say, well, it's going to save you time because they have different incentives. So it's like, you need to understand what the problem is that they're trying to solve and then how to navigate that politically. It's a

• 27:30Speaker 02

  much more political process. I mean, big companies are political as well, but it's just you take a big company and multiply it by 100 and that's the government.

• 27:38Patrick O'Shaughnessy?

  I want to go back to this term technology, which we were joking about a little bit before we hit record. It's come to be this strange binary. If you're a tech company, you deserve an X crazy sales multiple. And if you're not, you don't. And that seems obviously kind of a dumb way to think about the world. Talk me through this term technology. What does that mean to you anymore in today's world?

• 27:57Speaker 02

  Technology has gotten used for anything that uses like a cellphone. So if you have an app, you're a technology company. I mean, like, I think Target's actually done a great job with them. I was kind of shocked at how good they've made this. I'm not sure I would describe Target as a technology company. There's nothing bad about Target. It's just I don't think that they're like a technology company in that regard. The thing that we focus on is margin. The weird thing the industry has kind of gotten lazy on, I think this is partially just heuristics are great, but when people forget why the heuristics were created, everything breaks. And so there used to be like a quasi magical, like things traded at 10x revenue. Now, obviously, that's changed. Things trade at much higher than 10x revenue these days. But there was like no distinction between an 85% gross margin business and a 25% gross

• 28:42Speaker 02

  margin business. People would say, oh, well, you just multiply revenue by 10 and that's the valuation. And that sort of laziness, I think, is continuing to carry on without people looking at the underlying margin profile of these businesses, right? The reason why technology companies traded at high revenue multiples was partially gross margin, but ultimately that flows through to net income and free cash flow. And you look at businesses like Google and Microsoft. I mean, these are giant businesses with incredible free cash flow. And so that's why they trade at higher revenue multiples than a traditional retailer would.

• 29:13Patrick O'Shaughnessy?

  Say a bit more about your method for evaluating these potential sources of defensibility. So got some of these famous frameworks now, like I think we both like Hamilton-Helmers, Seven Powers, or there's lots of terminology for these things. And maybe like something like scale economies, demand or supply side are common ones. What matters is that you can see these things developing or in the early stages or predict them to make good investments. What is your process to do that? And maybe the other way to ask this question is like, what do you look to avoid? What doesn't defensibility look like?

• 29:45Speaker 02

  It's an interesting question because it depends a little bit on the stage of the business. You know, if you're investing in a seed company, you can have a theory about what these things could be. And I think it's actually important to have that theory. But what ultimately happens is somewhat uncertain. You know, if you're investing in a later stage business, I think you actually want to see, you actually want to see the marketplace dynamic, right? If you're investing in Airbnb, you actually want to see that there's a marketplace and that as you grow supply of homes and that actually increases engagement amongst consumers. You actually can track that with data. So depending upon the stage of the business, I think you're looking, you know, anywhere from having the story about how this will play out to clear, understandable data about why this competitive advantage is going to persist.

• 30:30Speaker 02

  We've seen this a lot. We like these enterprise SaaS businesses, you know, which you could think about like Gusto, or you could think about Flexport, where they built these great products. And then you layer on sort of financial services where the financial services are less in underwriting decision and more information arbitrage because they know something about the customer that a third party finance partner, they wouldn't know, or they would have less confidence in because they don't have direct access to the underlying data. And so I think those are really great businesses because the core business is like a good business anyway. And then you can layer on these other sort of information asymmetry opportunities that make it incredibly compelling.

• 31:09Patrick O'Shaughnessy?

  What are your thoughts on focus for companies? There's this interesting dichotomy that I've seen right now where in the US, it seems like everyone says, narrow the focus, increase the quality, that famous Frank Slootman line, I love that line. You can be a real great niche provider of something and do exceptionally well because markets are bigger than we thought versus like what I'll call the international model where there's like super apps or super companies that seem to sort of do everything for customers. And the examples that you just gave, there's like ancillary business models that follow on from the original product. How do you think about focus versus expansion in companies?

• 31:43Speaker 02

  I think I would frame the question about focusing on the customer. So you want to focus on the customer and what their problems are and what they trust you to do. So in Asia, like you have all these super apps. I think it makes more sense than it does in the US because there aren't that many places where a consumer can go do their banking and get a ride hailing car. These things make more sense in Asia than they would in the US. At the same time, if you're Gusto and you're doing payroll for people, you may actually also want to provide health insurance. Like that's a thing where like if they're trusting you with payroll, then they will also trust you with health insurance. And this is another thing that you can bundle together that actually makes that customer's life a lot easier. I think you do want to stay focused and you want to stay focused

• 32:28Speaker 02

  on like what the customer needs, what they trust you with, and how you can make their life easier. It's not necessarily that like Gusto should start helping people buy office supplies. That's like a different thing. But these other products that are very natural extensions, that's not about lack of focus. I think it's actually just focused on what the customer needs.

• 32:46Patrick O'Shaughnessy?

  I love the framing. Do you have a favorite example of this that really drives home the point from your portfolio?

• 32:53Speaker 02

  I hadn't really thought about it until you asked the question. I mean, I do think Gusto fits really well. I mean, that is a very customer driven organization where everything that they do is thinking about how to serve their customer and their customer being the person inside the organization that manages like payroll and HR and all that sort of stuff. So they're actually a really good example of that. I think Flexport would be a good example. I think SpaceX, I actually think like as I talk it out, 30 Madison would be a good example of this. I really think that our companies. Are very focused on understanding their customer and then expanding to cover all of the related things for that customer.

• 33:31Patrick O'Shaughnessy?

  Is there something unique about the entrepreneurs that tend to go that direction? Maybe we could talk about Ryan on the show and love him and what they're doing. He's one example that springs to mind. Is there some sort of DNA, do you think? If it's shared by all the companies, it stands to reason that it might be shared by the entrepreneurs behind them.

• 33:47Speaker 02

  I think these things are related to really big outcomes. It's not people who are trying to solve a small problem. It's not people who are trying to build a company and sell it. It's people who are trying to solve a really large, complex problem. If you can do that, you tend to have very big outcomes. That's a little bit of a psychology of the people who build these sorts of businesses. You can be a great seller on something on Amazon and like, that's a totally great business. But I think it's a somewhat different personality than people who are going to go take a whole bunch of venture money, not make money for a long time, and then ultimately scale a business that dominates some individual market. They're different businesses.

• 34:29Patrick O'Shaughnessy?

  What business, whether you invested in it or not, individually has taught you the most about business writ large? And why?

• 34:37Speaker 02

  I mean, I think we've, I think you always learn the most from the stuff that didn't work. The things that we invested in that we were wrong about, because when you're right, generally people stop looking for reasons. And also you were right, so you attributed to the things that you assumed made you right in the first place, which may or may not be true at all. We invested in, we've been doing this for a long time now, so we've definitely invested in things that didn't work out. But we invested in a company that was in kind of e-commerce marketplace space. They allowed the individual people in the marketplace to advertise on the platforms like Google and Facebook. And when those people violated terms of service, the major platforms would turn off advertising flow for everyone on the, on their platforms. This obviously broke, and so we just learned that you can't have that sort of single platform risk.

• 35:22Speaker 02

  You either need to control the ad spend, or you need to make sure that individual sellers take on that responsibility and don't create collateral damage. So like, there are lots of things that we've learned along the way that I think we apply to how we view the world now. But yeah, it's usually the things that didn't work where you learn the most.

• 35:40Patrick O'Shaughnessy?

  Can you say a bit more about, we've covered seven powers quite a bit on the show. So I don't want to go through those headlines for defensibility. Are there kinds of defensibility that you've seen in businesses or look for that wouldn't be cleanly covered by the sort of seven powers framework for defensibility?

• 35:57Speaker 02

  I think seven powers does a good job of listing out all the potential ways people can be defensible. The things that we've struggled with is like, I think brand is actually a very powerful thing that is defensible. I just don't know how to identify which brand is going to be the one that ends up being defensible. So like, we've struggled with that in terms of the kinds of companies that we would invest in. I think people like underestimate like the adjacencies when it comes to data that companies can leverage. So there tend to be a lot of interesting areas that companies can branch into once they have access to the data. And so it's a lot about like, how do you set up your infrastructure to allow data sharing across your customers? So that way you have the right to do interesting things.

• 36:39Speaker 02

  And this is evolving right now, but I think it's sort of like the move to the cloud. Right? Everyone said, oh, I never put all my data in the cloud. That's just not secure. And then everyone said, well, I can't keep my stuff on prem anymore because that's clearly not secure. I think companies are getting more comfortable with these sorts of arrangements, which will allow a lot of the enterprise SaaS companies to do interesting stuff on a going forward basis.

• 36:59Patrick O'Shaughnessy?

  If you and your friends are sitting around, let's say other investors that you respect, and you're sort of riffing on what is craziest in your mind about the world today? What would you guys be talking about?

• 37:10Speaker 02

  I'm confused about various valuations across the board. I think some are very high and some are very low, and I can't quite figure out why this is the case. I think people, just like I said earlier, aren't paying as much attention to margin profile, how these things should trade. You can't just normalize everything on revenue. Theoretically, at the end of the day, everything is discounted cash flow. And obviously for businesses that are losing money, it takes a while to model that out. It's very easy to be wrong, but I think you at least have to start from first principles. We talked about this, it's like, technology just gets used for everything. Like, what company isn't a technology company right now? I mean, if you're not at least somewhat of a technology company, you're probably not going to be in business for very long. But it's a term that just gets incredibly abused.

• 37:53Patrick O'Shaughnessy?

  I think we know what you mean by the high end of the valuation range. There's a lot of pretty interesting stories happening there, at least the ones that have been publicized in the open. What about that low end of the spectrum? So what's surprising you there on the low end of the valuation spectrum?

• 38:08Speaker 02

  I mean, I just think they're companies that investors that target market for. It's like we're invested in Wish, right? It's a global e-commerce marketplace, but it's focused on people who aren't rich, that aren't willing to pay Amazon for Prime and things of that nature, right? And their customer base is absolutely not the investor class. And so I just think, you know, investors buy things that they understand. And I mean, that makes sense because people are people and people like to buy things that they understand. On the other hand, there are lots of things that have nothing to do with investors who are broadly speaking, very rich people. Most of the world is not very rich. And so there are lots of companies that are focused on other problems. And so clearly some things are just getting ignored.

• 38:49Patrick O'Shaughnessy?

  Do you think often about different types of business models or revenue models and the evolution of those models through time in terms of like your preferences? You've mentioned some of these marketplaces. That's a very well-worn, really cool business model. If it works, it works really, really well. Do you have that same sort of structured thinking around business or revenue models? And if so, what are the ones that really interest you or really turn you off?

• 39:13Speaker 02

  We found it hard to invest in lending-like businesses because the easiest way to drive growth is to dial up risk and just put out more loans. And even if you believe management is great and they're smart and they're awesome, you don't have a guarantee that management won't change. And so even if you like the book today, it's like somewhat hard to understand if you like the book tomorrow. It could be because management turned over. It could be because they changed their underwriting criteria to chase growth or whatever other metric they're being incentivized to chase. I think these things are somewhat of a challenge for us. The interesting opposite, the counterpoint to that is I really like platform businesses that layer in financial services because I think there's just an incredible information advantage when you do that, right?

• 39:58Speaker 02

  If you're gusto and you're going to offer a loan to a consumer, but you know that consumer has actually been Employed the last two weeks and that person, they're lending that money to their employer, right? Because everyone gets paid two weeks behind in the US. And you have direct access to the company bank account because you're the one who pulls payroll. That's a risk free loan. So there's a huge arbitrage there and Gusto is taking advantage of that to provide much lower cost capital to consumers, right? If you walk into a check cashing store, they're going to charge you a crazy amount of money because they're going to assume you're not paying them back. Whereas Gusto actually knows that you're paying them back because they know that you worked and they know you have the money, things like that. Or you look at Flexport where they're lending against the freight that they have in the system, right? Because they're the freight forwarder, they actually have like physical possession of the goods, which is very important for a lending perspective. But they, not only that, they know how much the goods cost because they're coming through customs.

• 40:43Speaker 02

  In general, I think people don't lie on the customs forms. They know what your velocity is because they see how much you order. They know what you sell at Force, they know what your gross margins are. Some of these things you could figure out as a third party lender, but in that case, they just have much better access to data. So it's like, I find a lot of these lending businesses that are standalone very challenging, but if they're tied to a real information advantage that's sort of structural based on some kind of like enterprise SaaS product, I think that's really interesting.

• 41:09Patrick O'Shaughnessy?

  So there's a kind of a cool profile emerging here in your answers, which is companies very customer centric, not so much product centric, but customer centric. And that naturally sort of start to generate proprietary data about that customer that can then be fueled to expand how they serve that customer. Is that the most common definition of how you think about the most interesting businesses out there today?

• 41:31Speaker 02

  I think that's like a good description of large segment of the stuff in our portfolio. That definitely reflects a lot of the portfolio. And I think that you some of the traditional, as you mentioned, seven power fittings to talk about marketplaces, you mentioned work rise, it's a big labor marketplace. It's just incredibly important, but they've also then layered on things like insurance and factoring and whatnot. So there are lots of other products that you can build to serve their customers.

• 41:57Patrick O'Shaughnessy?

  What are the companies in the portfolio that don't meet that criteria? And what's uniquely different about them?

• 42:02Speaker 02

  And we've done some direct to consumer healthcare businesses that I do think are actually very data driven and interesting businesses, but are maybe a little bit more focused on a specific product for a specific customer. So that might. Not be as easy of a fit, though most things we're invested in, I mean, Intercom is a great business where they just collect a ton of interesting information that they use to make their services better. So I think a lot of things, you might have to shoehorn a few things in. I mean, SpaceX really isn't using data externally. I mean, they're definitely improving their products with data. It's one of the most data-driven organizations in the world, but it certainly wouldn't fit that model, I think, very well that we're talking about.

• 42:46Patrick O'Shaughnessy?

  I recently read, speaking of SpaceX, it's a very good book called Liftoff about the early days of building and engineering. Two thousand eight was a long time ago that you first started getting involved with the business, fairly early days. What has been most remarkable about having a front row seat to watching that business grow? And I'd love to hear about the launch you went to recently.

• 43:06Speaker 02

  I mean, the crazy thing is that it worked.

• 43:09Speaker 02

  If you really think about it, and Elon, he freely admits to, is not necessarily the best at hitting his deadlines. But no matter what he has said that they would accomplish, they absolutely will accomplish that thing. It might take longer, but just the ability to deliver on the things that you said you will in that arena is pretty amazing. I remember right before, I can't remember what year this was, but right before they landed the first Falcon nine booster, there was, I think it was the CEO of like Orion Space, public was like, ah, they're not going to be able to land that thing. Two weeks later, it lands. It hasn't been that many years, like it's been five years or something since they've landed boosters. And now everybody thinks it's normal, right? Like, it's amazing what people get used to and how quickly they get used to these things.

• 43:52Speaker 02

  Right now, if they don't land the booster, people are like, oh, well, they had a failure. And you're like, wait a second, guys, this is something that wasn't even considered practical 10 years ago. Like, nobody even thought this was possible. And now if they don't do it, it's like some kind of weird error. I mean, the fact that they're launching Crew now is incredible, right? The US hasn't had the ability to launch astronauts from US soil for a decade. I think this is incredibly important for the country, if not the world. What they're doing with Starlink is amazing. They're going to ultimately provide service to people who haven't been able to participate in the global economy in a meaningful way. It's crazy, even in the US, you've got over 10 million people who don't have access to high-speed internet. I mean, this is in the US, right? Like, this isn't a global number, right? This is literally just in the US.

• 44:34Speaker 02

  They're about to bring service that's the equivalent of cable speeds to everyone. It's incredible, and I think the interesting thing about great entrepreneurs and great teams is that they just keep expanding their total addressable market. Like, when we first invested in 2008, this was the Falcon 1. It didn't even work yet. It had two failures. They didn't even have a working rocket. Then they got the Falcon 9. The Falcon 9 could service a whole bunch of other missions. They upgraded the Falcon 9 to service even more missions. Then they got Crew working. They're building a satellite constellation. Now they're building Starship. I mean, it's just how big the opportunity set for the company is today versus 2008 is crazy. And if we'd only been right about the stuff that we thought in 2008, it still would have been good, right? Like, it still would have been a good outcome.

• 45:19Speaker 02

  But now you can still look at this thing and understand how you can get a 10x from here. That's the crazy part.

• 45:25Patrick O'Shaughnessy?

  What was the story with, I think you brought some of your entrepreneurs to watch one of the launches? Is there anything interesting to note? Why'd you do that? What was the story there?

• 45:32Speaker 02

  Ironically, it was kind of a bad timing thing. We've got a few companies that are talking about doing some business with SpaceX. We'd mentioned Workrise, and they've got a big labor marketplace. And SpaceX is building, they have some of the largest construction projects going on in the world, right? And especially when you include things like Tesla that are related entities. These are some of the biggest construction projects going on in the US. And so we were going to go down to Boca Chica, where they're building Starship. And the day that we were going, they scheduled a launch, because they don't really schedule these things far in advance. So, like, literally just happened to be the same day. And when they do that, they close the roads. You can't get on-site for, like, liability insurance reasons. So, we kind of got stuck just waiting around for them to launch.

• 46:15Speaker 02

  Because then we could go and actually have some meetings, which is not uncharacteristic. The launch kept getting pushed back and pushed back and pushed back. And so it basically burned the whole day, but we did get to go see the Starship launch, which is the one where it did land, but then the skirt cracked and it trapped some methane there. And that ultimately blew up the rocket like 10 minutes later. So I think we technically were at the one that landed first, but they've now gone on to, I guess, land it more successfully.

• 46:41Patrick O'Shaughnessy?

  I love this notion of entrepreneurs that naturally expand their TAM. If we kind of reframe some of these ideas as advice for entrepreneurs out there that might fit that bill, what advice would you give them when seeking capital and seeking capital partners?

• 46:55Speaker 02

  I think if you're going to raise money, you have to understand what your investors need from you. And I think that you have to understand where they sort of are in their capital cycle. Are they going to raise a new fund? Are they at the end of a fund? Are they beginning of a fund? What's their ability to follow on? I think there are a lot of rather specific technical things that entrepreneurs generally don't ask. And I think broadly speaking, it'd be easy to find out and do affect how investors think about whatever they're investing in. So I think those are really simple things that entrepreneurs broadly speaking should do. But also, like when you raise venture money, it comes with a lot of strings. You're looking for certain kinds of exits, certain size exits and like all the things that come along with that. So I think people want to factor that into their decision making. And then in terms of what kind of capital partners,

• 47:40Speaker 02

  I think you want people who have the opportunity to be helpful, but aren't going to be the ones who are trying to run your business. That's usually not a good recipe for a good working relationship in this industry. Especially you can get a lot of value from your investors if you leverage them for things that are not core to your business. For example, obviously we're in the space, but like if you want to know how to run a tender process successfully, call me, I can just tell you what's going to make your life better, faster, easier. But that's not core to your business, right? It is important to your business, right? You want to be able to manage liquidity for your employees and help people achieve their financial goals. But that's not core to your business. That's like not a product level decision at a late stage. So I think you want investors who can take all of the non-core parts of your business and just make it easy. These are the 10 things that you should do. It'll make your life a lot easier.

• 48:24Speaker 02

  When you're a really early stage business, like having people that you can talk to about product and bounce ideas off of, maybe help you up with sales to get you some customers who might not otherwise be willing to talk to you if there wasn't like a really strong relationship. Investors can be helpful. I generally think investors overstate how helpful they can be or should be for that matter.

• 48:43Patrick O'Shaughnessy?

  I like this perspective, like, yeah, investors can help in certain things, maybe not in others. Who are the investors that you've spent enough time with to know well? That you find to be most impressive? And what things do you take away from your relationships with them?

• 48:57Speaker 02

  I mean, I spent a lot of years with Peter Thiel. I think Peter's very impressive. He's very smart and he's very good at focusing on the one issue that might matter in that situation. So that's a real skill, right? I mean, people can get distracted by lots of things. And the other thing that Peter's really good at is new information. He's willing to change his mind very quickly. A lot of people kind of get stuck in whatever decision they make and then it doesn't change. Even when there's new information, they don't update. I think David Sacks, he's really a great operator. He's a great product person. I think he can give people very practical advice from both a product and a sales perspective, given his operating experience. I think different investors add different value. It just kind of depends on what companies need at the stage that they're at. You've got to find the right fit.

• 49:42Speaker 02

  A lot of this stuff is personality and it's kind of like a marriage. People are going to be running this company for a decade and you don't want to include investors who you're effectively going to be married to for longer than a lot of marriages, quite frankly. If you're not going to see eye to eye about how you want to have that relationship. There are lots of great investors. It just depends on what you're looking for.

• 50:04Patrick O'Shaughnessy?

  In your bucket of the things maybe that good investors can help with because they're non-core to a business, brings to mind two things. One is cost of capital and two is capital allocation. Investors are thinking about these things a lot, probably more than individual founders are. I'd love to do sort of a dive into each of the two, starting with cost of capital. So we'll do it from both sides. So how do you think of your cost of capital as an investor? Maybe even define what that means to you as a venture investor? And then we'll go to how entrepreneurs should think about their cost of capital and how to build lower cost of capital, what trade offs are, et cetera. But let's start with yours. How do you think about your own cost of capital?

• 50:37Speaker 02

  I mean, for us, our cost of capital is based on where we're raising money from, right? So if you look at the Endowments and Foundations, kind of large family office is that in our investing venture, broadly speaking, they're looking for net twenties, IRRs. Everyone will say they want higher fund multiples, but broadly speaking, people want at least 2X net. Generally speaking, the industry doesn't accomplish that. So those are sort of the very basic things. If you roll that down to an individual investment level, we're looking for things where we can get a 5 to 10X because we're not going to be right 100% of the time. We're going to blend this stuff out. That'll get you to, I mean, we think, you know, we can do 3X net funds. That's what you need in order to hit those numbers. That's our cost of capital. And actually, when I tell entrepreneurs that, it clicks for them because I think a lot of people just never bother to explain what they're

• 51:22Speaker 02

  trying to accomplish. They just say, well, we're trying to invest your company. It's like, that's great, but what are you trying to get out of this? My view is if you don't know how people are making money, then they're probably screwing you. This is just a general view on life.

• 51:34Patrick O'Shaughnessy?

  So probably the more interesting question, which is, cost of capital, especially in certain business models, becomes a really key ingredient in success or opportunity, at least on the upside. What do you think entrepreneurs that do this well do? Is it building great narratives, which lowers the cost of capital? Like, it seems like it could be a source of competitive advantage, having cheaper access to money. You don't hear a lot of entrepreneurs talking about like their strategy for cost of capital. So it just seems like an area that might be worth exploring. I'm curious what you think.

• 52:02Speaker 02

  I think that's interesting. I would maybe give you the opposite view. I do think having access to more capital at lower prices can be an advantage, but there are also situations where if you give people too much money, it ends up killing the business. It's not all people, right? But some people don't do well if you just give them an unlimited line of credit. They'll just run the business into the ground, whereas if that hadn't been the case, they would have been totally successful. So I think there's actually some danger in that side of things. The opposite view is, I think people optimize on price a little bit too much. It's oftentimes better to get long-term partners than it is to save an extra point of dilution that when all is said and done, isn't going to matter. I think that the other way to think about raising money is insurance. Some of the best times to raise money

• 52:47Speaker 02

  or take a little bit of extra dilution is when there's a lot of uncertainty. And if that additional capital costs you 1% or 2% of the business, To me, that's an insurance premium, and I think people should frame it that way as opposed to dilution, right? That insurance premium might really save you because it extends your runway by six or 12 months that gets you past a tough spot, either in a macro environment or in the business itself. When everything was getting really weird in March of last year, I was talking to some of our portfolio companies. I was like, look, raise money now. If it turns out you didn't need it, fine. The marginal dilution isn't astronomical. And if it turns out you did need it, it's the difference between the whole business going

• 53:28Speaker 02

  to zero or not. So it feels like it's pretty worthwhile to take the insurance. And a few companies were sort of in that process of raising money, and it basically got them to accelerate it and get term sheets and close things when things were looking really ugly. Now, it turns out that the capital market stayed open and it wouldn't have ultimately been a problem. But no one knows that upfront, and this is why insurance exists, right? You're trying to protect yourself against black swan events. So I guess that's like my more contrarian answer to your question. But I do think having access to lower cost capital is important. I think too many people equity finance businesses that could otherwise be debt financed. And you're starting to see more startups trying to help companies debt

• 54:07Speaker 02

  finance businesses, which I think is generally speaking, correct. I think there's a gap in people's knowledge. So people do what they know how to do. And so when you learn how to raise a seed round, that's kind of very similar to learning how to raise an A round and a B round and a C round. At some point, you have to make a transition to the bigger capital markets and deal with Goldman Sachs and JP Morgan. And that's not the same thing as raising a D round. It's actually a very different process with different people who expect different things, and you have to talk to in a different way. People are not as efficient at making that transition as you might hope for understandable reasons. But I think that is one of the, for people who are good at making that transition faster, they have access to much larger amounts of money and much lower cost of capital.

• 54:52Patrick O'Shaughnessy?

  Once you get capital, you have to allocate it. What does great capital allocation look like to you?

• 54:58Speaker 02

  I think people really need to think about time when they think about capital allocation, right? This shows up very obviously when you look at customer acquisition. So everybody likes to talk about LTV and like LTV by CAC. But the one major thing that you forget when you look at it like that is time. If I tell you that you can invest a dollar on a customer and you get back A hundred thousand dollars, you would think that's amazing. If I told you that customer only costs a penny to acquire, you'd be like, this is even better. But if I told you that that whole process took 20 years, you'd be like, oh, well, this is completely irrelevant and useless to my life. And I think that the problem that people have is they don't make the right trade offs between getting cash flow sooner, even if it's slightly less versus cash flow later. And so it's not obviously on the scale of 20 years because that's obvious

• 55:43Speaker 02

  to everyone, but it could be on the scale of six months or three months, because once you get the money back that you spent to acquire a customer, you can reinvest that to acquire a new customer. The compounding effect of that can be astronomical. So you really do need to think about the time that it takes for a customer to pay back and how that customer pays back over their lifetime, because it dramatically affects growth rate. This is to me is a simple example.

• 56:07Patrick O'Shaughnessy?

  Is some natural advice version of that to focus on tighter feedback loops, just as a general principle to learn more and faster?

• 56:15Speaker 02

  I think that that's always true, but you need to be able to make trade offs, right? If I told you that if you waited from three months to six months, but you got 100x more money back, you should probably wait. So you need to understand what the trade offs are. And I think the thing that people don't think about are the trade offs relative to time. I think time is sort of the missing variable in a lot of these decisions.

• 56:35Patrick O'Shaughnessy?

  What's the best of what you've learned about customer acquisition and retention? You mentioned that equation there. I think especially at later stage companies, almost like in public markets, there's sort of become these like standard metrics that everyone uses as benchmarks. And maybe they're useful, maybe they've misled you. What have you learned about some of these metrics like retention and acquisition, et cetera?

• 56:55Speaker 02

  It's really great to be able to benchmark things. All of these metrics are useful because they're consistent on a relative basis. But for every individual company, there's always something wrong with them. So it's like, sure, you want to look at net dollar retention, but maybe net dollar retention is high logo churn. You're somehow churning a lot of customers, but the ones that you keep are really expanding with you. And so net dollar retention is good. And like, that might be okay. It might also not be okay. But like, you want to understand what's going on. So I do think that the metrics that the industry is kind of standardized around are helpful, but it's kind of just the first pass on understanding the businesses, because averages hide all sorts of numbers. Not looking at things on a cohort basis can really hide things. If you have a fast growing business

• 57:37Speaker 02

  and you're just looking at averages, everything is basically a week old because all the customers are a week old. You got to break things out.

• 57:43Patrick O'Shaughnessy?

  It's often funny to me what a high standard, and we're doing it here in this conversation, investors hold entrepreneurs to in terms of things like defensibility, without turning that same lens back on ourselves. Do you think that investing firms can have defensibility in the same way that the operating companies they invest in do? And should?

• 58:03Speaker 02

  I think the answer is absolutely, although ironically, it does to a large extent, go back to my comment about brand, which is, I think it's hard to identify, at least for us, like which brands are ultimately going to be the ones that are defensible. I'm not sure it's as important, quite frankly, because if you think about a venture firm, it's much more like a small business than it is in equity-driven business. It's like a law firm or a consulting firm, like all the talent walks out every day. If that's true, there's no value in that business if all the people are gone. Whereas I think if you looked at Salesforce, if you fired all the people tomorrow and replaced them with different people, I'm not sure it would be as good a business, but like it would still be a business, right? Like there's still equity value in that business. I do think they're different businesses, but I do think that they can be defensible. I'm not sure it's as important.

• 58:47Speaker 02

  I don't know if that's a metric that should matter to an entrepreneur, like is this venture firm going to be defensible for the next 20 years? I do think you care if they're going to be stable for maybe like the next 10. You want good long-term partners. I do think brand matters a lot. There's a very virtuous cycle in the industry, which I think is heavily driven by survivor bias, which is if you can survive long enough and you have a good reputation and you're a good long-term partner for people, then better people want to work with you. Even if you're like a somewhat random picker of companies, the companies that you're now picking from are a better pool of companies to pick from. So you'll make better investments, then that cycle just perpetuates itself. And so over time, if you make one good investment, you're more likely to make other good investments in the future in a way that's like very not true in the public markets.

• 59:32Speaker 02

  There's no virtuous cycle to being a good investor. In the public markets, like every day is a new day, it's a hard game to play. The venture ecosystem, the better companies that you're associated with, the more good entrepreneurs want to work with you. And therefore you're more likely to invest in good companies, which causes more people to want to work with you.

• 59:51Patrick O'Shaughnessy?

  I'd love to step back and think a little bit about the world writ large, not necessarily just through an investing lens or a business lens, but one of the cool things about investors like you is you see a lot of stuff, you see things happening on the ground, things changing the fastest. What is going on in the world that has your attention that maybe other people aren't as focused on?

• 1:00:10Speaker 02

  It's hard for me to answer because I'm not always sure what other people are focused on. We've been seeing more and more businesses that are taking large, complex things and breaking them up. And so in some sense, like the first iteration of this was the cloud. And I think the second iteration of this is actually physical things. Think about warehouses in the context of Flexport, which is like a simple example. It's like you can have less than container loads. The more customers you have, you can break up the container, you can put six people in the container, you can just drive efficiencies. I mean, that's something that's been true and freight forwarding for a long time, but it's just like an understandable way where you're taking infrastructure and you're fractionalizing it. So you can see this then with like warehouses, there are all these warehouse owners who own five warehouses in this city, and then some other guy owns five warehouses in another city.

• 1:00:53Speaker 02

  If you're a customer, you want to actually put stuff in both cities. You don't want to actually talk to any of these people. You don't want to buy a whole warehouse. You want to make it like AWS. And so Amazon did this with the cloud. They've done this to some extent with warehouses, but you're seeing this at every level, whether or not it's cars, whether or not it's all the transit things. Like I think there's like an interesting story here.

• 1:01:17Patrick O'Shaughnessy?

  And what do you think the knock on effects of fractionalized infrastructure then become? Why is that interesting in terms of what it enables?

• 1:01:25Speaker 02

  So it makes everything faster. And then all the things that are then built on top of it grow even faster. The fractionalization makes all of the stuff that people had to internalize before. Go away and they can just buy it as a unit. You don't have to go buy your servers, set them up and hire people. You can just buy an instance. You don't have to know very much to do that. And so all of that expertise gets moved off out of your operating costs onto someone else's. And then they hire people who really know what they're doing. I was talking to the founder of Stored, who's kind of building this for warehouses, which is why warehouse is on top of my head. And all of that management is actually quite hard and all that software is really quite hard. And the owners of these warehouse businesses are basically REITs. Like, these are not technology companies, like they're real estate companies.

• 1:02:09Speaker 02

  So if you can build the software layers on top of a lot of the infrastructure in the world, and then sell it off in unit sizes, you can make it so much more efficient for everybody. Because most of the people who are the customers don't want to buy a unit that is a warehouse. They want to buy a unit that is a package. And then everything can be super efficient. And all the people who then build on top of that layer can grow their businesses exponentially faster.

• 1:02:35Patrick O'Shaughnessy?

  So it's basically like the API, software mindset, but for physical stuff?

• 1:02:38Speaker 02

  Yeah, I think the physical piece of the world is starting to happen and that's interesting.

• 1:02:44Patrick O'Shaughnessy?

  Have we missed anything about what you think is important to the success of 137? Or you personally, whether that's in how the firm is structured, this kind of unique secondary style of investing that you focused on historically? You know, what you look for in business? Any big ingredients in the recipe of your career that we haven't touched on?

• 1:03:03Speaker 02

  For us, because we've now been doing this for 10 years, we've sort of earned the right to think about it for the next 20. And for me, the important thing for the firm is what is our team? And is our team set up for the generational transitions that will ultimately happen? Because I'm not going to do this for the next 50 years. At some point, I will just be too old and no one will want to talk to me anymore, or I'll be dead. So we need to set things up in a way where we can build this team. And I think this is what we want to do, and I don't think all firms need to do this, but where this thing will outlive any one of us. And so that's really about hiring. It's really about getting people the right experience, promoting people from within. I think we've done a good job. I mean, one of our investment partners, Nick, he joined.

• 1:03:46Speaker 02

  As a summer intern and is obviously an investing partner now, we didn't obviously promote him because we wanted to tell the story about how you could do that. But by doing that, I think we've demonstrated to other folks that you can join our team, start at the bottom and end up at the top. And that has allowed us to get really great junior talent. And I think that's a long term competitive advantage in our industry. That's part of how we're thinking about the business today that we didn't quite touch on, but I think is important. I would like the firm to have not just a good next 10 years, but if you have a good next 10 years, then you're you're going to have a good 10 years after that.

• 1:04:22Patrick O'Shaughnessy?

  If you're not thinking about investing or business at all, what else are you thinking about? Where does your time and your mind go if you're not thinking about these two primary things?

• 1:04:32Speaker 02

  I just had a kid. My daughter's four months old, actually today, which basically sucks up any time that's not on that list that you made. So that's the rest of my time.

• 1:04:42Patrick O'Shaughnessy?

  I love it. I love it. I asked the same closing question of everybody, which is to ask, what is the kindest thing that anyone's ever done for you?

• 1:04:49Speaker 02

  In a business context, when I was at Founders Fund at the very beginning, there was a limited partner who really put me front and center to that fundraising process and that LPA negotiation and really helped me get an incredible amount of credibility inside Founders Fund very quickly. And so I will forever be grateful for that.

• 1:05:12Patrick O'Shaughnessy?

  Well, Justin, this has been so much fun. I love the unique angle that you've taken on this market and just the love for business that I think we both share. Thanks so much for your time.

• 1:05:20Speaker 02

  Yeah, I appreciate it. Thanks for having me.

• 1:05:22Patrick O'Shaughnessy?

  This episode was brought to you by Cantlist. In this four part mini series, I sit down with Cantlist's new chief product officer, Jeremy Payne, and talk about his background in fundamental data, the role Cantlist plays in the investment process for its clients, and how Cantlist's products help investors better model and understand companies and their key drivers. In this week's episode, Jeremy and I discuss why joining Cantlist was a no brainer for him. So Jeremy, in closing, you've been in your career at a couple of the key firms that have driven the trend we've talked about today, this sort of surfacing of information and data into useful tools for investors, working at Capital IKEA, working at Bloomberg, these are huge, successful companies, doing this exact function. Why change? Why go to Catalyst?

• 1:06:04Patrick O'Shaughnessy?

  What was it about this firm, given your experience, that got you excited?

• 1:06:08Speaker 03

  Where do I start? There's so many exciting things about the Catalyst business that had me excited to join. I would say that one of the most exciting things about the product, from the perspective of a client, is how in-depth the level of the financial statement to detail is. The quality of the actuals at the as-reported level for segments, for KPIs, and for all of the non-GAAP information that's important for an investment manager in their process, was just a starting point beyond which I couldn't have even imagined. So in terms of fat pitches, I've rarely seen something as fat as this one, more aligned

• 1:06:49Speaker 03

  with what my own personal strengths and experiences are, and the amount of incredible hard work and accomplishment that the team has put in over the last six years. Put this in the quality and category of opportunities, literally, once in a lifetime.

• 1:07:04Patrick O'Shaughnessy?

  If you enjoyed this episode, check out joincolossus.com. There you'll find every episode of this podcast, complete with transcripts, show notes, and resources to keep learning. You can also sign up for our newsletter, Colossus Weekly, where we condense episodes to the big ideas, quotations, and more, as well as share the best content we find on the internet every week.