[REPLAY] Ali Hamed - Novel Asset Investing (Capital Allocators, EP.40)

Ali Hamed is the co-founder of CoVenture and Managing Partner of the CoVenture VC Fund. CoVenture is an innovative company that identifies and invests in novel assets formed by the intersection of technology and finance. The firm manages an early stage venture capital fund, direct lending fund, and crypto asset index fund, with each taking a creative twist on its market. Our conversation starts with Ali's entrepreneurial path to the creation of CoVenture, and covers examples of previously unpriced investment opportunities, including produce receivables, employee payroll loans, AirBnB accounts, and loans against employee stock options. We walk through the world of crypto assets and the state of the venture capital industry. Ali's fresh lens on the world offers a fascinating perspective on every aspect of early stage investing. If I didn't say it in advance, you'll be astounded to hear that Ali is only 26 years old. He's one to watch for the long-term. Learn More Follow Ted on Twitter at @tseides https://twitter.com/tseides?lang=en or LinkedIn https://www.linkedin.com/in/tedseides/ Subscribe to the mailing list https://capitalallocators.com/ Access Transcript with Premium Membership https://capitalallocators.com/signup Editing and post-production work for this episode was provided by The Podcast Consultant (https://thepodcastconsultant.com https://thepodcastconsultant.com/)

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

• 0:01Ted Seides?

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• 0:46Ted Seides?

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• 1:29Ted Seides?

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• 2:12Ted Seides?

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• 2:57Ted Seides?

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• 3:32Ted Seides?

  Hello, I'm Ted Seides, and this is Capital Allocators. This show is an open exploration of the people and process behind capital allocation. Through conversations with leaders in the money game, we learn how these holders of the keys to the kingdom allocate their time and their capital. You can join our mailing list and access premium content at capitalallocators.com.

• 3:59Speaker 01

  All opinions expressed by TED and podcast guests are solely their own opinions and do not reflect the opinion of capital allocators or their firms. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of capital allocators or podcast guests may maintain positions in securities discussed on this podcast.

• 4:18Ted Seides?

  My guest on today's show is Ali Hamed, the co-founder of CoVenture and managing partner of the CoVenture VC Fund. CoVenture is an innovative company that identifies and invests in novel assets formed by the intersection of technology and finance. The firm has a pre-seed venture capital fund, a direct lending fund, and a crypto asset business, each of which has a creative twist on its market. Our conversation starts with Ali's entrepreneurial path to the creation of CoVenture and covers examples of previously unpriced investment opportunities like produce receivables, Airbnb accounts, and loans against

• 4:59Ted Seides?

  employee stock options. We walk through the value of software development for pre-seed companies, finding niches in alternative lending, and the world of crypto assets. Ali's lens on the world offers a fascinating perspective on every aspect of early-stage investing. Now, if I didn't say in advance, you'll be astounded to hear that Ali is only 26 years old. He's certainly one to watch for the long term. Please enjoy my conversation with Ali Hamed.

• 5:30Ted Seides?

  Ali, thanks for joining me.

• 5:31Speaker 02

  Yeah, thank you for having me. This is really, really great.

• 5:34Ted Seides?

  Why don't we start with your background? Because in another life, I could be sitting in front of a professional baseball player.

• 5:42Speaker 02

  Yeah, I grew up in Southern California, and baseball was a much easier way to get into a four-year college than school, you know, where I grew up. And everyone we played with was either like an All-American or played minor league baseball after high school or college. My Instagram's gotten really interesting because like a bunch of my really nerdy high school friends are now Major League Baseball players. You know, these are the types of guys who I knew they couldn't even talk to a girl, and now they have like 1,000 comments on their Instagram of, you know, "Take me to prom." But, uh, yeah. Grew up in California playing baseball, went to Cornell to play baseball. And while I was in high school, I fractured my back in a couple of places. So I went from being a pretty good D1 player to an average D1 player. And realized that I was just going to be better at startups and it wasn't worth continuing to pursue.

• 6:23Ted Seides?

  Where the bugs from startups come from?

• 6:25Speaker 02

  I got really lucky. My freshman year, I launched a startup. If you liked computers and you were 18 and Watson had just come out, you just wanted to play with it. And they had just come out with their SDK. And I ended up just surrounding myself with a bunch of other engineers and technologists. And if you're influenced by sort of those five people that you spend the most time with, five people I spent the most time with in college were all building applications or building software. And it was just incredibly addictive. And I think a lot of the sort of mindset of being an athlete where you become incredibly, incredibly obsessive about the sport is similar in startups or similar in technology or investing generally where in high school, I would spend Friday nights taking my truck, lighting up my headlights

• 7:06Speaker 02

  and shining on the batting cage that I could like hit off a tee from midnight to 2 AM while everyone else was out partying. And now I go home on Friday nights and get on a conference call to talk about an ABL facility from 9 PM to midnight. It's very similar, it's just a different activity. The very first startup that I tried building was really, really interesting. We raised capital, we hired a bunch of people, but it didn't end up working out financially. And I was stuck on the East Coast. And I ended up having this like sort of tricky experience where I was out of money. For about a week, I would go to different friends' places who I'd met in college and stay with like their parents. This was over the summer. You kind of wear that out after one or two nights because I didn't know any of these people very well. Because, you know, I'd only been friends with them for a year.

• 7:48Speaker 02

  And then eventually after about a week, week and a half, and I had run out of the different apartments I was welcome at. I had this like interesting experience where I was sleeping at a Starbucks on 17th and Broadway, which is actually no longer there. And then at night, when they would kick me out, I'd hang out in Union Square and I have a guy's suitcase. And like the biggest underrated part of that is your phone will usually die. And then you're really, really bored because you don't want to fall asleep. And you have like three hours until anything will open up again and you can get an outlet and charge. And during that time, I was working. Had a business called Chloe Saucer Fruit Company, which is also on Seventeenth and Broadway. And if you haven't been, it's an amazing outfit. And I was passing out flyers on that corner and this guy named Michael Sloan was secret shopping.

• 8:32Speaker 02

  And I started talking to him and I was like making these like web analytics jokes, I guess. He goes, you know, how do you know about websites? And I was like, well, I used to be the president of this tech company and that didn't work out. And I ran into a lot of issues. And so now you pay me about a dollar less an hour than I think you should. And I really, really love a raise. And, uh, you know, so it became this sort of humbling experience. Michael ended up sort of changing my trajectory. He basically said, you know what? Go back to college and continue to take risks and no matter what, I will hire you. And he was like the CFO of some big private equity firm. I went to his office in midtown. It was the first time I'd really seen like an office that that was that fancy. His personal office was probably bigger than any apartment I'd ever been in. It was like this really cool experience. And so because I always knew that I could one day work for Michael,

• 9:16Speaker 02

  it allowed me to continue working on an entrepreneurial path as opposed to just trying to get the internship at an investment bank or consulting firm or doing sort of what everyone else in undergrad was trying to do. So I had done a startup and then I was doing consulting and I wanted to start angel investing. And I would go to people and say, hey, can I invest $20, $25,000? And they'd say, sure, but I'll give you like 20 to 40 Vips of the company. I'd give you way more equity if you help me code the application. And so there was this realization that people actually needed more help building the technology than they needed cash. And they would give me more equity for it. And the other realization was I could then invest in founders I was a lot more excited about. I think a lot of great companies have been built by people who are in their early to mid twenties

• 10:00Speaker 02

  and were software engineers or CS majors at Cornell, Stanford, MIT, et cetera. But I thought that the next wave of technology or applications that were going to come out, that were going to be really meaningful, were going to be founded by people who were traditionally CEOs or industry executives or people who knew a lot about the space they were going after. Because whereas a few years ago, the hardest part of building a technology company was actually building the technology. Now, for most of these companies, it's just getting to market. The technology, in many ways, is just a commodity. And so in underwriting who the founding team should be, I think that the founding team should be best at the hardest part of that company. And for most of the companies we back, the hardest part is getting to market and scaling once in market, not just building an application.

• 10:43Speaker 02

  So we were able to get more equity for less of an investment and back better founders. So it just felt like a better thesis.

• 10:49Ted Seides?

  There's a little bit of a contradiction in that, in that if, in fact, the development of technology, software applications, the cloud, has made it that much easier to get software off the ground, why is it that a good software engineer could therefore get more equity if they're partnered up, rather than just a capital investment?

• 11:08Speaker 02

  Because there's still a huge scarcity. You can be one of the greatest experts in hard money lending, real estate. You just still don't know a lot of people who can code. There's just still a lot of capital out there. And even people who are good at going to get the capital often don't have the social network they need to be able to go find software engineers. And even if they were able to go find software engineers, they wouldn't be able to underwrite whether or not they were good at whatever the heck they were trying to build. You're not going to go into their GitHub account and look at their code. And if you're paying them a salary, there's sort of this misaligned incentive. You're giving them cash to build equity value in your business. When we invest in a company by building software in exchange for equity with them, they know that if we mess it up, we get nothing too, right? We have this incredible alignment. And by the way, even the term "software engineer" is really broad. Like, what does that mean?

• 11:52Speaker 02

  Does that mean it's a front-end developer with some design skills? Does it mean it's a backend engineer? Does it mean it's a systems architect? Does it mean it's a CTO, a VP of engineering? And as soon as you start to get into these different nomenclatures, you start to realize that not only do you need someone to build the code, you need like a technical advisor and somebody who can help you navigate all those different questions. At the end of the day, we sort of felt like a lot of VC firms were built to teach engineers how to become CEOs. But there weren't a lot of VC firms that were built to teach CEOs how to manage their product. And we wanted to be on the other side of that.

• 12:26Ted Seides?

  So once you had this idea that you could build software for equity, how did you turn it into a venture business?

• 12:32Speaker 02

  In a really unglamorous way, I took a little bit of capital I had and I partnered up with another guy and we sort of pooled it together and hired some engineers and tested out whether or not this would work. And once we had some basic conviction, so this was my senior year in college, I basically went to anyone I had ever done consulting for. I had met, I had shared an elevator with and said, hey, this is the idea. Will you give me 10, $25,000, $50,000, et cetera? And we scrapped together $396,000. A thousand of it actually came from my little fraternity. That's why it was 396 and not 395 and he Venmo'd it to me. And then we ended up continuing to invest in businesses that started to actually become quite successful. And I partnered up with two other people. One is a guy named Thatcher Bell.

• 13:14Speaker 02

  And Thatcher was a Cornell alum who had spoken in one of my classes and he was the type of person who, when he would come back to school, all the undergrads would be like, I want to be like Thatcher when I grow up. And I continued to bug him over and over and over again, until finally we were at sort of this party at South by Southwest. And so we were having this conversation and I was telling about the things that we invested in and I convinced him to work with us a day a week. And we'd pay him proradic because I couldn't afford to pay him more than a day a week. And at the same time, I started recruiting another guy named Mike Beller. And Mike was the dad of my best friend in college and he had started a company that he had taken public and sold to PWC. Both of them joined to work with us a day a week and they recruited each other to the firm. And using their resumes, we went out to raise a few million more dollars.

• 13:55Speaker 02

  We went to this guy who was a pretty well-known venture capitalist and I said, look, we're raising $3 million. If we get to 2.975 million, will you give us the last $25,000? And he said, yes. So I said, great, we have you in and I'm going to use your name to raise the capital from everyone else. And that worked. And it worked. And we kept kind of going from there. So then we found a portfolio company that was an alternative lending platform. We syndicated the debt of that business and through that we met a whole other pool of capital. And that went from a half a million dollar pool to a $6 million pool to a $60 million commitment. And so suddenly we were raising capital from people who could write real checks.

• 14:31Speaker 02

  And they started converting from being a lending, an investor or lending business to an investor of the venture business. And so it kind of, you know, was a combination of referrals, meeting people, making money from people, sending Dividends and then reinvest in the dividends of the venture fund. So again, it was really, really scrappy and nonlinear.

• 14:47Ted Seides?

  How do you describe what co-venture is?

• 14:49Speaker 02

  Co-venture is an alternative asset manager and we look to build funds in asset classes that have newly existed because of new technology. You know, we think that there's a ton of opportunity to invest in spaces that have just been traditionally ignored or have never existed before. And because of our DNA and heritage of having a technical expertise and understanding capital markets, we can play in spaces and underwrite assets that most traditional investors cannot underwrite. You know, the examples we like to give are either new lending products that had never existed before or assets that no one's ever tried to buy before.

• 15:24Ted Seides?

  Dive into an example of one of these investments.

• 15:27Speaker 02

  So the idea that we like to talk about a lot because I think it tells the story of co-venture in a positive way. You know, there's this company called Produce Pay and Produce Pay was started by a farmer in Mexico named Pablo. And Pablo is a fourth generation farmer. He ran a fairly large family farm there. And he realized that farmers have a huge cash bottleneck during the harvest. And the reason is often the harvest is only 45 days and he 10x's his workforce. And by the time he gets paid by a retailer, it's day 50. So it's like his whole year's expenses with no revenues in a short period of time. And he found a way that if he built technology to track the inventory of where the produce was, he could actually purchase that produce while it was on consignment at below its market price and basically finance the farmer.

• 16:10Speaker 02

  And this year, whole probably move a meaningful amount of all produce moved to the United States. Squash, tomatoes, peppers, watermelons, you know, it's actually really interesting.

• 16:21Ted Seides?

  So walk me through that one financial transaction.

• 16:24Speaker 02

  Yeah, so the farmer goes out and he has a hundred dollars, let's call it grapes. He sends the grapes to a distributor in the US and basically purchases those grapes for 40%, 50% of its market value. And immediately sends the cash to the farmer within about an hour. And then at the sale, Produce Pay takes a point, point and a quarter. And then whatever is left goes to the farmer. They have a recourse on all the other shipments of that day. In many cases, the distributor Is responsible for getting whatever is not sold back to produce pay. And they also, the farmer is obligated as well to get whatever is owed back to produce pay. So you have what essentially feels like a low LTV financial product that's cross collateralized with multiple courses of recourse.

• 17:09Speaker 02

  They moved hundreds of millions of dollars of produce last year doing this. Their default rate is the minimus and it's just become an incredibly, incredibly high quality financial product. But we got into that deal because Pablo had the ability to finance this business himself. He comes from a successful family, but he didn't have the expertise to build the technology. So we could find a founder who was uniquely positioned to sell to a demographic that not many people in Silicon Valley understand well. We could make sure he got his product to market. And then we also helped him fund all of his capital to finance these farmers. And it was really an amazing experience watching him raise his early rounds of equity capital. Like the responses we get from venture capitalists was, hey, sorry, I don't understand farming. He's built this incredible product.

• 17:52Speaker 02

  If you talk to anyone in specialty finance or hard money lending or factoring, they look at it and they say, wow, this is phenomenal. It's solving a problem for fruits and vegetables. That's like a pretty big market. It's got massive barriers to entry and it's just the type of thing that you don't see built in Silicon Valley very often.

• 18:08Ted Seides?

  And that investment itself sort of turned the co-venture venture business into a whole new line of business of specialty lending.

• 18:15Speaker 02

  We had this philosophy around lending businesses generally where the first wave of lending businesses was really the on decks and the lending clubs were. What they were doing is they were taking products that banks always used to offer offline and put them online. And they were originating loans cheaper. They were doing stuff banks used to do, but weren't doing anymore. They had these like really, really marginal data points that they were using to underwrite a little bit better. But they weren't really inventing a new product. And we really were fascinated by alternative lending platforms or online lending platforms, or whatever you want to call them, that were using their technology to invent a completely new type of credit. And it was a type of loan that you could get a really high yield on, not because you were taking way more risk, but because you were inventing something that no one had tried to underwrite before.

• 19:00Speaker 02

  And so there just wasn't capital in that space. We try very hard not just to find mispriced assets, but rather unpriced assets. And that for us was exactly what Produce Pay was originating. And the other thing that's really interesting about a lot of these businesses, if you look at like version 1.0 of lending companies, it's still, you know, you send a bunch of direct mail to people and online advertisements and you sell them a product. And if you sell someone an unsecured consumer loan, the next time they're looking for an unsecured consumer loan, they're still going to shop it around. So you're selling them a commodity. With a business like Produce Pay, like they're building real relationships with these farmers. They're providing them a financial solution and a financing partner. If you look at the relationships that they have with their customers, they actually have negative churn.

• 19:41Speaker 02

  Most of their customers end up becoming bigger customers over time, which is really, really rare for lending. And yeah, it's just that that felt way more exciting to us than just taking a product banks used to have in a branch and putting on a website. So we made a few equity investments in, again, these alternative lending platforms. And it really came back to that thesis of there was still a massive opportunity in lending. Lending was completely in vogue. You used to go to LendIt and like the person who did your hair was at LendIt. And that was the first wave. And then everyone realized, well, you know what? These companies aren't really much more than lending businesses like we've known in the past. And they're probably not going to trade at like a 20 to 50x PE multiple.

• 20:21Speaker 02

  So let's like pull back the valuations here. And then the whole space like became completely out of vogue. And we actually viewed that as an opportunity because the companies that we were investing in actually had barriers to entry because they were creating new products, had defensible distribution networks to originate their loans. And we thought that in itself had equity value because you had recurring customers. You did not have as much of a price sensitive customer. You had a differentiated product and a differentiated capital base. And because we had that thesis on the venture side, we also wanted to be the people providing the capital to finance those loans. And again, you know, we were realizing that we could get mid to high teens yields, or even in some cases low to mid twenties yields

• 21:03Speaker 02

  on stuff that was asset backed. It was low LTV. We could put it into an ABL structure that we felt comfortable with. We could almost be the outsourced capital. Capital markets arm of the company that we were equity investors in by teach them about how to structure their debt financing and how to sort of structure their documents and walking them through the benefits of a forward flow versus an ABL versus a warehouse facility. And we could provide this level of expertise that other venture capitalists couldn't. And so we could get in on the ground floor, give them their initial debt capital right when they started to need it, get a high yield for coming in early, and then protect our yield by writing in our documents, you know, we're giving you this capital now before other people are willing to because we can underwrite with a smaller financing.

• 21:46Speaker 02

  In exchange, we want to protect that yield for the next three to five years. So that way we get paid back from having taken an early bet.

• 21:52Ted Seides?

  As being the exclusive provider?

• 21:54Speaker 02

  Either the exclusive provider or some portion of the allocation, right? Some cases we say, look, we want 33% of your loan book at X rate, and you can go find cheaper capital elsewhere to demonstrate that you're able to so that your equity investors can underwrite to a new cost of capital later. The other thing that we found is there's so much mentorship we could provide. You know, entrepreneurs, they often don't really associate cost of capital with all the other things that come with cheaper capital, whether it's, you know, a loan box that or a credit box that's incredibly narrow, whether it's some less attractive advance rate, whether it's events of a default that are overly onerous. So every single basis point in your cost of capital comes with pages and pages of legal docs of other types of structures to protect the lender. So it's not like just one person's offering you nine and the other person's offering you 14. There's a lot that comes with it.

• 22:40Ted Seides?

  How many different niche opportunities have you found to sort of create a market for loans?

• 22:46Speaker 02

  It's been really amazing, actually. So as a firm, we see at this point hundreds of deals a month. Not all of them are in lending, but a large part of them are. And we're just really fascinated by how many new types of assets are being originated because using technology, you can either observe a different data point that didn't exist before or finance a receivable that's so short term in nature that traditional lending wouldn't have allowed you to do.

• 23:08Ted Seides?

  Yeah. So what are some examples of this?

• 23:10Speaker 02

  Yes. So for example, like if you're trying to factor a three day receivable, a traditional lender can't do that because they can't really underwrite it. There's too much fraud that could exist. Like it's just too hard of something to finance traditionally. Have to charge a really high APR for your troubles because the cost of origination is so high. Technology strips out a lot of those costs and enables a shorter term asset to suddenly be able to be financed in a cheaper, more reasonable way to the borrower. Title lending is one example of that. Title lending is an incredibly abusive type of loan because you basically have this 30 day loan. It's secured by a car. The person doesn't pay their loan back in 30 days. You take their car because it's only 30 days and you have to pay for the transfer, the title and the origination costs. You often see 500% APRs, right?

• 23:54Speaker 02

  That's an example of a loan that's too small and too short term for a traditional lender to originate in a cost effective way. But technology will allow you to do that. You know, there's other things like, for example, we have a portfolio company. And what they do is they build scheduling software for large companies. And they say, look, use this app to figure out when your employees are going to come into work. And don't pay your employees anymore. Pay us every two weeks. It then goes to the employees and it says, you can now take your paycheck any day of the week you want for a small fee. And so what it's doing is it's essentially lending to the employee, but on the credit risk of the employer. And so instead of these employees who are often hourly workers going out and getting a payday loan. Instead, they can take an advance of three days.

• 24:36Speaker 02

  We know it's going to get paid for as long as their employer actually makes payroll. And they're paying, let's call it a 20 something percent APR as opposed to a thousand percent APR. And now we're getting a mid twenties return on a Fortune 500 company. So it's like one of these win win products for everybody. That's again, an example of a newly invented product that could have not existed before without technology. It's also the type of lending company that has barriers to entry because it has a proprietary source of originations. Because it's going through that large employer that other people would have to integrate with. And so it has a lot of the great characteristics of a SaaS company where you have recurring revenue and switching costs with a lot of the benefits of the best parts of a lending business, high yields, high margins, et cetera.

• 25:17Ted Seides?

  And what's another example of an unpriced asset?

• 25:20Speaker 02

  Examples that I've talked about in the past and are illustrative of the type of stuff we're becoming fascinated by are how do you underwrite an Airbnb account? Airbnb accounts, for example, have terminal value. You know, I have a friend who nets. Four hundred K a month, just hosting, he has like six properties and he has a bunch of employees and they clean the properties, they manage the accounts. And if you look at his profile online, his reviews are really strong. And if you were to go stay in whatever city he was in, the end of the day, the way you pick an Airbnb account to stay with. You're looking at the reviews, you're looking at the pictures, you're looking at where it shows up on the page. So he's built a digital asset with equity value, but he would never be able to sell that business because no one's in the business of buying Airbnb accounts. And we think that the Airbnb ecosystem will end up much like the traditional hotel ecosystem.

• 26:06Speaker 02

  Where you have property owners, you have property managers and you have brands. You're going to start going to an Airbnb host and come out of the shower and see a towel with a little logo on it. That's a logo that you recognize. And I think that that's a really, really powerful thing.

• 26:19Ted Seides?

  It is incredible insight that there's an asset that no one's thought about and priced. What are you doing with that?

• 26:24Speaker 02

  Right now, we're really, really focused on businesses that we're in, but it's indicative of the type of stuff we'll probably get into one day down the line. If we ever feel like the market opportunity is there, but we feel like we're structurally in a place that we could underwrite that asset better than other people from traditional finance. One of the things that we've newly become enamored with is again, sort of illiquidity in the venture market. And so we have a portfolio company called SecFi. And what they do is they lend against the stock options of private company employees. So if you're an employee who's been in a business for a really long time, first of all, you want to exercise your options early if you're able to, because you get capital gain tax instead of ordinary income at the IPO. So it's immediately a product that's healthy for employees because now they're getting a tax advantage.

• 27:10Speaker 02

  You can also get a really, really high return and a high yield on those products because banks have provided liquidity to founders all the time with PGs. But there's no one who's really been serving employee twenty through two thousand. The company's playing a technology product that allows us to do that. And again, we think it's an unpriced asset. We think it's something that's new, you know, it's a new credit-ish type product. And that's being invented by technology that's allowed them to observe a previously unobservable data point. And then we think that we can get an outsized return because of it. Those are the types of things that we've become really obsessed with.

• 27:38Ted Seides?

  How do you find these kind of unique opportunities?

• 27:41Speaker 02

  We now have. Over 180 LPs and these people or institutions are usually people who are getting pitched themselves. They are entrepreneurs, they're former heads of banks, they're former heads of private equity firms, they own sports teams, they are VCs. And so a lot of them are pitched, see things that don't fit their sort of investment criteria. But because it's weird or it's different and they send it to us, we're like the home of misfit toys now for a lot of these people. As long as they're high yielding misfit toys. The other way we do it is other venture capital firms send us deals. So in traditional venture capital, most VC firms who lead deals won't share their best deals with other VC firms who lead deals.

• 28:20Speaker 02

  Cause there really can like only be one. For us though, because we offer something differentiated, because we're helping founders build their product. A lot of the best VC firms in New York or the Valley, et cetera, send founders to us when they like the founder and like the idea, but the company is still pre-product. And so that's become another way that we see deals that we think is really high quality. And when we think about deal flow in general, we think that there's actually this really hard dichotomy that people have to fix. And it says follows. Series A investing is a B to B business. You're investing in a company that's already a company. Seed investing is a B to C business. You're investing in a person that's about to start a company. B to B businesses can rely on sales, but B to C businesses have to rely on marketing. People have to know about you so that they can come to you.

• 29:05Speaker 02

  It's much harder to play offense as a seed investor. And the reason that's such a challenge is because seed investors often have less management fees than series A investors. But they're trying to play a more expensive marketing game. And so you have a business model where the marketing part is just totally broken. And so you have all these growth hacky things like blogging and a website and a Twitter account. And like all these VCs are trying to become personally famous because it's a cheaper way than spending marketing dollars. Our solution has been to turn our little pre-seed seed business into a B to B business. And the way we do that is trying to imitate what our lending business do, which is go through proprietary distribution channels. And we found that other VC firms who send us their best deals because we offer something different.

• 29:48Speaker 02

  And raising capital from LPs who can be value add in our PCs themselves, or angel investors themselves, et cetera, can end up leading to really high quality and high quantity deal flow. The other thing I'll add to that just briefly is being in different asset classes gives us a certain level of expertise that other people don't have. The fact that we have a crypto fund lets us see most of the best blockchain investments. The fact that we have a lending fund lets us see most of the best lending investments. The amount of times that a venture capitalist will email me and say, hey, here's a lending business. We like it, but we can't do the equity unless you guys do the debt. Do you want to do both? That's a great scenario for us. The lending business helps the venture business. The crypto business helps the venture business and the venture business helps the lending business.

• 30:29Speaker 02

  And how the different heritages and cultures actually mesh together to create something really powerful. The rigor of credit helps our venture team and we inherit that rigor. The opportunistic nature of venture and sort of the creativity of venture helps educate our lending business. I'm trying to figure out what crypto does for the others in terms of thought. I guess they're just very volatile and we're all sort of hanging on the table, white knuckled now. You know, I think those cultures bleed together.

• 30:54Ted Seides?

  What's next on the horizon?

• 30:55Speaker 02

  I think that we're still going to continue to see new asset classes get invented. And every time we start to see the early kernels of an asset class getting invented and you start seeing high net worth individuals investing in it because institutions really can't get there yet, or they don't have someone on a desk to do it yet. That's an opportunity. So Chris Dixon has this awesome quote where he says, "The best engineers are doing as hobbies on the weekend will end up being what we all do in the weekday later." I think it's one of those really, really talented angel investors or high net worth investors or family offices are tinkering with something in the back room, but it's taking a lot of their mind share. You know, taking those very, very seriously, knowing that they actually might mature into an asset class that's investable,

• 31:38Speaker 02

  even if it's not investable right now with anything other than a principal's capital.

• 31:42Ted Seides?

  The obvious new emerging asset is crypto. Crypto assets, cryptocurrencies.

• 31:47Speaker 02

  A perfect example of the type of asset class that's newly built on the back of a technology that didn't exist before. And it was directly within our firm's DNA to build a business in the space.

• 31:57Ted Seides?

  What is that business that you guys have built?

• 31:59Speaker 02

  The way it started is an index fund. It's a basket of the top 15 crypto assets weighted by their market cap and rebalanced every two weeks with a flat fee and we don't charge a carry. We're not picking tokens. We have a methodology that we use that, you know, we share with people.

• 32:15Ted Seides?

  What are you including in crypto assets?

• 32:17Speaker 02

  It's the Bitcoins, it's the ethers, it's the ripples, Zcash, Dash, Monero.

• 32:21Ted Seides?

  It's not ICOs, so.

• 32:22Speaker 02

  No, we're not holding ICOs. I can kind of go into thoughts on that in a minute. Our goal is really just to provide diversified exposure, a cheaper product and a more secure product. And as long as we can give our clients and our LPs secure, diversified and inexpensive exposure to the asset class where they feel like they can dip their toe into the water, we feel like we've built a really, really high quality product that doesn't really exist today in the market.

• 32:47Ted Seides?

  Let's dive into some of the details there. You mentioned cap weighted. Why did you think about doing it in a cap weighted way instead of an equal weighted way, particularly when the volatility of the underlying instruments is so high?

• 32:59Speaker 02

  Sure. We felt more comfortable holding the largest sort of crypto assets as the largest percentages of the portfolio because with having a high market capitalization comes security, liquidity, there's more exchanges that trade them or offer them. And so when we looked at sort of the different methodologies, we said, what is going to give us a representative exposure to the asset class as a whole, to what gives us security and what gives us sort of confidence that these have staying power? And market capitalization ended up being a leading indicator that those will likely all be the case. You know, there's a world where 10 years from now, I don't know what's going to be in the index, but Bitcoin likely will. Bitcoin's probably the worst technology of the ones

• 33:41Speaker 02

  in the index. It's probably slower, more expensive, but it's got staying power and people trust it and it's hit some level of network effect that would be very, very difficult to overcome.

• 33:55Ted Seides?

  We're going to take a quick break in the action to tell you about Brookfield. Brookfield invests in the thing behind the thing behind the next big thing. Their focus across infrastructure, energy, real estate, private equity and credit is helping to build the backbone of the global economy. Brookfield combines deep operational expertise with disciplined, long-term investing, uncovering value and partnering alongside clients to shape tomorrow's economy today. Invest in the businesses that shape tomorrow. Learn how you can own what's next at Brookfield.com/own.

• 34:32Speaker 02

  This is not an offer to sell or investment advice. Investing involves risk, including the loss of capital.

• 34:38Ted Seides?

  And now, back to the show.

• 34:42Ted Seides?

  So the notion of a crypto asset, we now are starting to understand, certainly in the institutional world. What's the simple case that you would make why someone wants to have that exposure?

• 34:52Speaker 02

  Sure. So I think it's important to differentiate different crypto assets into different buckets. And so the first one that's probably easiest to understand is Bitcoin or crypto assets as a store of value. And I think that if you were to go down a list of what makes something a good store value, Bitcoin actually holds up fairly well. So the first is volatility, which Bitcoin sucks at, but many of these other store values were very volatile at one point in their history as well. But the second is portability. And Bitcoin is really, really powerful in how portable it really is. I've never tried to cross a border with holding some significant amount of gold, but I can't imagine it's a really fun experience. And the other is acceptability. Like, at the end of the day, people accept Bitcoin. They've ascribed value to it, which has allowed other people to ascribe value to it.

• 35:35Speaker 02

  And the restaurants we go to will accept Bitcoin before they accept slivers of gold. And I think that there's something really powerful about that. There's also something really powerful about the fact that Bitcoin has become this project where thousands and thousands and maybe millions of the smartest engineers in the world are all working on that project. That in itself creates some sort of ascribed value that people can hold and transact with. So that's like, I think, part of the store value thesis. There's also utility tokens. So people are having ICOs and they're either issuing ICOs at Like securities and really in that case, the issuer, the company is saying, I can raise capital cheaper and not dilute myself. So I should have an ICO. And then there's the other type of ICO that's issuing utility tokens. And some of those utility tokens actually make the platforms they're on better.

• 36:20Speaker 02

  So I'll give an example of one type of utility token that really wouldn't make the platform better. But it's just sort of a way to call the utility token and raise capital cheaper. And then I'll give a mediocre example of a type of utility token that I could imagine actually making the platform better. Let's imagine an e-commerce company said, I'm going to issue an ICO. It's going to be a utility token and you have to use this utility token to shop on my app. For the e-commerce company, it's a good idea. They can raise capital cheaply. They don't have to give up equity. Pretty awesome. But for the customer, like, I don't really know why I'd want to use the token. It's sort of a pain. It's ball tile. I have to take my dollar, turn to the token and transact very quickly. You know, maybe I'm saving a transaction fee marginally, but probably that transaction fee is being captured by the e-commerce company.

• 37:02Speaker 02

  Is the type of example where you can issue a utility token, but it's really only good for one party. Now let's imagine Yelp issued a utility token. That actually could make a lot more sense. And the reason is for every person who reads reviews on Yelp. A very, very, very tiny fraction actually produce reviews, right? There's not a lot of content creators compared to content readers. So what if the only way to read reviews on Yelp was to use tokens? And the only way to get tokens was to either buy them or produce content. You would now have a token that motivated people to produce content. And that'd actually be a really like fascinating thing where the token was better for everyone. It was better for Yelp because now they're able to raise capital or sell something or have something that tokenizes the economics on their platform.

• 37:46Speaker 02

  And it allows the value creators of Yelp, the content creators to share in the economics. And you could sort of make that argument for medium.com. Medium probably has a struggling business model. Like, are they going to produce ads? Are they going to make you pay for the content you read? Or maybe they could have these tokens where every time you write a blog post, you get tokens issued to you and you can use those tokens to read stuff written by other people. And if you don't want to write blogs and you have to buy the tokens. So I think that you're going to start to see the reinvention of business models so long as the tokens that are being issued. Are helpful to both parties, not just to some entrepreneur who's realizing that raising money via an ICO is cheaper, better and faster.

• 38:20Ted Seides?

  The two examples you used, podcasting is an obvious third one, where today the content's free for the reader. So if you have two competitors, you have Yelp and TripAdvisor, and one of them starts to effectively charge through the tokens, the other doesn't, doesn't that dramatically decrease the scale and network effect for the competitor that's trying to charge for the first time?

• 38:42Speaker 02

  I don't know. It depends, right? And you can charge with both money and you can charge by, you know, sort of motivating people to be better participants of the platform. And so I'll just sort of spitball, and these are probably bad ideas, but like, for example, on podcasts, you could get issued tokens for every minute you listen, which means you're a more engaged listener. And so now more people are motivated to have a podcast because they know that the people who listen on Apple's, you know, App Store are more engaged than people who listen through some other medium. And so now you have more people like coming to that platform. So there's ways, I think, to create positive incentives where, sure, you might have less people in the network, but the network might be stronger. And maybe you could capture more economic value via a more tightly wound network of people who are better participants than a loosely bound network with many, many nodes.

• 39:26Ted Seides?

  So now that you've laid out some of the use case that makes a lot of sense, there's an argument that I could make, that this whole crypto world is a bunch of really, really smart programmers trying to capture value for themselves. And it's not yet clear what the use case is. So you have this sort of financial world of looking at this and the technology world that's building it. How does someone in the financial world get comfortable that this is something that they should participate in?

• 39:54Speaker 02

  There's both a positive and a negative spin on it. It's positive that the creators of these networks are the ones who are actually generating the wealth. You know, at the end of the day, the people who made money on the dot com era were like the same people who made money on every other era, which were like the people who capitalized these businesses, held the shares, and as the economic value became greater, like it was the entrepreneurs and the VCs who made the money. And the engineers who actually built all this technology, like Actually are a bunch of people who make reasonably good, low six-figure salaries. But even though they're creating all this value, they're not capturing it. In crypto, because the economics are actually shared with the people who are building the protocols, I do think that it is good that the builders are actually capturing the economic value. The negative spin on that, though, is you have a lot of people who are experts in crypto

• 40:37Speaker 02

  because they've happened to know about it since 2008. So if you're a really hardcore crypto person, you've been involved since 2010, 11. You have six years of your incredibly long experience in the space. And by the way, like, one year's experience isn't necessarily an analog to the next because it's changed so dramatically. And you have a lot of people who have sort of fashioned themselves as hedge fund managers, even though they have never managed capital professionally before. And you'll see a lot of people make a lot of mistakes. And in some cases, they'll be nefarious. And in some cases, it'll be because they're just new at managing capital. You know, one of the examples that I like to give is when we first started looking at the space and we started underwriting different funds. Because when we started investing, part of the reason was because our investors started asking us, "Hey, who should I invest with?"

• 41:22Speaker 02

  And when we started underwriting funds that we wanted to partner with, we'd look at their fund documents and we realized that in some cases, they were just broken or wouldn't work. So let's imagine you were a fund and you were holding mostly mature tokens or securities. And then part of it was ICOs, as you alluded to. If someone wanted to redeem their account or their NAV, a lot of these funds were allowing them to redeem their entire NAV within 90 days, not just their liquid NAV. And so next thing you knew, every time someone redeemed, the fund got less and less liquid and it would create a run on the bank. And so far, that hasn't mattered because the market's been really good. Eventually, that is going to matter. And you're going to have a lot of managers who have never experienced something like that.

• 42:04Speaker 02

  And they're going to throw up gates, either prematurely or too late, because that's sort of their secret weapon. And their lawyers told them, "Well, worst case scenario, you can throw up a gate at manager discretion." But like, the mechanics of how the money moves in and out aren't really well-defined. So we felt like there wasn't a lot of institutionalization, even the docs of these funds, how they were managed, how things were communicated to their investors. And there are these great prognostications of what does the future of distributed networks look like? But there wasn't a lot of sophistication around how to manage capital in a safe institutional way that someone like an endowment or a large family office could feel like, "These men or women are taking care of my assets." Some of the docs, we see things like we self-custody. I will do everything in the world to not self custody. Should I like sit in my office with $30 million of Bitcoin like and private keys like in a safe?

• 42:49Speaker 02

  No, because people are gonna like, that'd be like incredibly unsafe thing to do. I'm in New York, people could find out about that and like, I've met the guy who does security at the bottom of my building. He seems relatively nice, but he's not like the biggest genius I've ever met.

• 43:01Ted Seides?

  You mentioned that you don't invest in ICOs.

• 43:04Speaker 02

  Correct.

• 43:05Ted Seides?

  Why?

• 43:05Speaker 02

  Because we think that most of the ICOs today are entrepreneurs raising money via an ICO because it's cheaper than equity and not because they actually think the ICO is going to help the economics of the business. I know why the ICOs are better for the entrepreneurs and in most cases, I don't understand why the ICOs are better for the investors. The only case that I can really imagine where an ICO makes sense is they have these pre-sales and pre-sales are basically when your close friends and family or people who are influential in the industry are offered the tokens at a 70% discount to what they'll be sold at, at the regular sale. And you can look at it and say, well, there's X amount of demand for the tokens. I'm allowed to get in earlier, I'm going to get a discount and the company is building validation of their business because someone, you know, a firm like Covevent who has a crypto fund is in, so that like is a stamp of approval.

• 43:50Speaker 02

  And I know that I can sell it to the next person. And that just sounds icky, you know?

• 43:55Ted Seides?

  Why is your fool game for sure?

• 43:56Speaker 02

  Yeah, and I can't really understand what the true economic value of these tokens will be. I think one day we're going to have ICOs that won't be companies that are just white papers that are pre-product. It'll only be for growth equity companies that use their raised equity rounds of financing first. And then once they got to some critical mass, could raise a token that would then increase the network effects of their business and increase their barriers to entry.

• 44:17Ted Seides?

  So the notion would be that an ICO would be kind of a value added later round of financing as opposed to what it is today?

• 44:23Speaker 02

  Like Reddit. Reddit would be a great candidate for an ICO because they have real economic value in the business. You can understand why the content creators or content contributors on the platform should be issued tokens later. And you can imagine that people would want to either create content to read more content or buy tokens to then increase the business model of Reddit and then also have more access to longer threads or more threads.

• 44:45Ted Seides?

  What will an institutional crypto investment fund look like?

• 44:50Speaker 02

  You'd underwrite it very similarly to any. Any other fund, it'll be high levels of security, they'll use top tier vendors, it'll be a management team that's knowledgeable about the space and has managed capital before. It'll be people who probably err on the side of caution, like Bitcoin probably has enough upside, or the more mature crypto assets probably have enough upside. You probably don't have to go too far down the risk curve to like get real alpha in your portfolio. So it'll probably be people who are a little bit more methodical in the beginning. And then what they won't be is, you know, I think there's this early wave of managers who said, I was really in early in crypto, so I know all the people who matter. That'll become really commoditized. There just aren't that many people who matter in crypto. It's actually really easy to get to know all of them. It won't be like in venture where you can say, I just have this proprietary network and I'm going to use that.

• 45:34Speaker 02

  And I think there's a lot of, by the way, analogies of the evolution of managers of crypto funds and the managers of VC funds generally. Venture investing traditionally has just been a less sophisticated asset class. You have this blunt tool and you use this tool to buy equity in startups. And everyone charges more or less the same management fees. Everyone more or less decided that seed round should be done at like a five pre to a 10 pre. Right? Like basically with no specific reason. And every single VC fund claims to have the same cost of capital, right? Like every single VC fund is supposed to produce a 3X return. Regardless of the year, regardless of the management team, regardless of the strategy. And I think that's completely ridiculous. And the reality is you have some firms that are really, really top tier and have been in the top tier for a long time.

• 46:19Speaker 02

  Such that they should have a lower cost of capital. Like if first round capital told me that net to me, I'll get 2X my capital. And some other firm said, I'll give you 4X net your capital, I'll still trust first round and give them my capital at 2X. Just like in traditional lending, like you'll give Ares capital at a really, really low cost of capital because it's Ares. And you know, they're not going to like go out of business one day. Whereas you'll find some small specialty lender and you'll expect a higher yield for your trouble, the hassle, the extra diligence.

• 46:47Ted Seides?

  So if you took that to the next step, one possible outcome is something that we see commonly in asset management, which is the first round capitals of the world. Raise more and more money because they can, because they deserve to. They can then put that money into the same. Businesses at higher valuations because the required way to return is less.

• 47:06Speaker 02

  First round's done a really good job of staying disciplined with fund size and so has Union Square Ventures and Benchmark and a few of the others. But I think the way it'll translate to is you'll start to see those firms be able to invest at higher valuations into the companies because again, their LPs will stick with them and they'll be willing to tolerate lower returns. First round's a bad analogy because their returns are so outsized, but I do think in 10 to 15 to 20 years, that's where the market will evolve. And if you're one of these firms with a really established LP base, you've produced strong returns consistently for a long time, you will be able to produce less good returns than other firms. And that translates to being able to invest in a company at a higher valuation and still doing your job.

• 47:46Speaker 02

  And if I have to invest in a company and I require 3X and another firm requires 2X, they will beat me on deals because they can invest at some significantly higher valuation because they're in my market with a better product. That is a really, really powerful thing. And I do think that level of sophistication and that level of granularity will eventually come to venture capital.

• 48:07Ted Seides?

  And where is it today? Because if you look at the venture capital world, there definitely is a notion of a first-tier venture capital firm. Those firms have the supply of as much investor capital as they would like to take. They also themselves are fabulously wealthy and could invest as much of their own capital as they want. Are you seeing that in the pricing of deals today?

• 48:28Speaker 02

  No, not really. And I think it surprises me a bit. I mean, maybe Andreessen Horowitz a little bit, right? Like, they just have so much capital or they probably have some level of confidence that they'll be able to continue to raise more capital. And I don't think it's consciously going into their thought process, but maybe subconsciously of look like if we return, you know, 1.5X, 2X the money, we're probably still going to be able to raise another fund. And so we're playing a different game than everyone else is. But, you know, I think that a lot of people in venture capital, for better or worse, view it as an art, you know, and they like view their IRR as like their multiple invested capital as like the holy grail. And I think it's like a massive sense of pride. Or what's happening is many of them are becoming so good and so wealthy that they're becoming such a large percentage of their own fund. They're thinking less about the fees and the AUM than they are about what are the generated returns. Overall and what is my IRR?

• 49:13Speaker 02

  So I don't know. I think it'll just sort of depend on the manager, the manager's background, the manager's motivations, and what ways they're trying to earn their economics. But it's just something that we're sort of fascinated by and are a little confused of why it stayed so static.

• 49:26Ted Seides?

  Yeah, there hasn't been that much price differentiation as a business strategy.

• 49:30Speaker 02

  And what's crazy is also you have the same expected cost of capital, just like regardless of the vertical. If you're raising an AI fund, you still have to return 3X. If you're raising a fund that like invests in mobile apps, it's 3X. Like, sure, they both have like lines of code at the DNA of each company, but like they're incredibly different companies and they probably require different return profiles. It's something that's never made sense to me.

• 49:53Ted Seides?

  And how should an allocator, looking at the landscape, try to address that notion? Because it makes a lot of sense, right? These are different companies, they're different investment strategies. They should have different, the cost of capital for the GP is the same thing as required rate of return for the investor.

• 50:08Speaker 02

  I do not envy allocators, right? Because you're sitting there and like, I don't think that the cost of capital of the allocators is just based on what they think they can get in the market. It's probably what they've been told by somebody else. So like, this is what you have to return for me at the end of the year. And so they're sitting there and thinking, well, this is what I can get out of one basket. This is what I can get out of the next basket. And as they start to get to venture capital, in some cases, this is like the thing that might save the portfolio. Or they really need that outsized return because there's not really yields anywhere else. One of the things that just blows my mind is everyone complains about how overvalued venture capital deals are. It's just because the whole world's overvalued. A couple of years ago, everyone was like, venture capital is in a bubble. I was like, no, it just happens that like no one can get a return anywhere else. So they're putting their capital into venture, hoping for like a hail Mary. But if they get a 2X, it's probably fine, given the market.

• 50:54Speaker 02

  And so it probably made sense that assets got, became more valued. I think that if you're a capital allocator, you should probably say, what do I really need on my venture portfolio? And depending on what I need out of the venture portfolio, I have to figure out where on the risk spectrum I'm willing to be. And if all I need is a 2X on the portfolio, you should go to an established firm that's been around for a long time and has billions of dollars under management because they have the highest certainty of getting you there. If you're sitting there and thinking, wow, you know, this is like, I need a 5X here. You probably should put your money into really small funds that have the greatest chance of an outsized return relative to AUM and are going after sort of frontier markets, whether it's Internet of Things, or AI, or blockchain technology, et cetera. As an allocator, I have a really hard time, by the way, investing in blockchain funds,

• 51:39Speaker 02

  because I can meet a lot of people who talk shit about Bitcoin, and I can't meet a lot of people who are haters on the blockchain. So that's probably already been priced in. But, you know, I think a lot of it comes down to, again, what do you need to get out of your venture portfolio and allocating per that. And every time a venture manager approaches you and says, "I'm going to return a 3X in a portfolio," you should ask, "Why? Is it because you built a model and kept changing the numbers until it got to 3X? Or is it because from a ground-up perspective, you actually think, based on the other deals you've done in the past, you have some likelihood of getting to some other outcome?" I think that the investors have gotten fooled by a bunch of firms that sort of made it their mandate to try and co-invest with those top-tier funds. So, you know, as a VC manager,

• 52:22Speaker 02

  you know that you raise initial capital, and then in two years, when you go to raise new capital, your LPs are going to look at the following things. What percent of your companies went to zero? What percent of your companies raised follow-on rounds and earned you a markup? And who did you co-invest with? And the problem is, you know, you're going to have some zeros. You're not going to have a ton of markups within two years, because if you're investing, let's call it, eight deals a year, so on year two, you've invested in 16 companies, half of your companies haven't even had the chance to raise a follow-on round. And of the other eight companies, let's call it, two have failed, two are still, you know, haven't raised a round, and then four have raised markup. So now you're at a portfolio of 16 companies. You kind of look like an idiot, because two of the companies

• 53:06Speaker 02

  have already failed, and only four of them have even raised step-ups or follow-on rounds. And so the only KPI that you can really brag about is who you co-invested with. And everyone agrees with this notion that there's certain top-tier funds, and there's power law, and you have to be in those funds. And the next best thing is to invest in the funds that co-invest with those funds. And so everyone was trying to squeeze these, like, really tiny checks into rounds that were being led by first round, or led by, I would say, Sequoia, but, you know, they usually take the whole So led by these top tier firms, I think it was a regression to the mean. You know, there's negative selection bias in any of those deals that you can actually get into unless you can really explain it. So I think that as an LP, what you should really be doing is take that as a indicator of their network and who they know and who they can co-invest with.

• 53:48Speaker 02

  It's a useful data point, but don't use it as your driving thesis. It's about underwriting a manager who you believe their thesis and their sort of methodology of thought aligns with your own. It's a manager that you believe you can back for three funds. Because if they're good, it may be the first fund and maybe the second fund or maybe the third fund that makes it. Right. There have been stories of many, many funds that, you know, their LPs were losing faith and then finally they hit Facebook. Right. So it's picking a manager that you believe in their way of thinking, where the founders that they work with believe that that VC was the most helpful to them. Where they have tangible ways of creating an unfair advantage when getting into a deal, whether it's a low valuation or a new way of sourcing deals or a vertical expertise.

• 54:31Speaker 02

  And then they have some tangible way of producing an outcome that isn't random. Where do you play in the spectrum of venture investing? It's hard to say where you play because it's constantly moving. You know, and even the nomenclature of venture capital doesn't make any sense anymore. And the reason for that is as follows. So in 2011 and 2012, everyone in the world raised a seed fund. And what happened was those people were either really good or really bad. Cause that's how venture works, right? There's not a lot of mediocre venture funds. The people who are bad couldn't raise new funds and the people who were good raised larger funds. However, if you're an LP and you invested in a seed investor and the seed investor did well and wanted to raise a new fund, you would want that seed investor to keep being a seed investor.

• 55:13Speaker 02

  And knowing that, the managers basically raised more capital and said, yep, I promise to do the same thing. But the reality is they didn't. Their check sizes increased, they started looking for more traction, the companies they were investing in. And there was this article written called the Series A Crunch, which everyone was assuming, okay, it's going to get really hard to raise Series A rounds now because those people have moved upstream. So everyone went from being a seed investor to doing what Series A used to be. And there was a time, I think it was in 2014 or 2015, where there were six deals in all of New York that were at a million dollars in size or under, that had an institutional seed investor in them. And remember, seed rounds used to be like $500,000 to $1 million, and they were scrapped together.

• 55:54Speaker 02

  You'd have first round in for 250K and soft tech in for 100K and someone else for 50K, and you had all these super angels. And even if you look at the New York market, there really aren't super angels anymore. You know, a super angel used to be defined as someone who would write 10 to 20 checks a year, 25, 50K, 100K at a time. Those people either ran out of their money or became really, really good venture capitalists, and they work at the VC funds we all idolize today. So there's became this huge gap in the market where no one was professionally investing these smaller rounds. And so then you have this new term called pre-seed investing. And pre-seed investing is really what super angels used to be or what seed investors used to be, and that's more or less where we play. And what's the time horizon for these investments? It's getting longer and it's a problem.

• 56:38Speaker 02

  What's happening is you had a lot of the people who came into these seed funds, they were family offices or high net worth individuals who could afford to commit 250K to $500,000 into a fund, which was less than any Series A or larger fund was willing to accept. And this was their first ability to really invest in venture capital. The problem, though, is those people are less tolerant of severe illiquidity. And severe illiquidity is exactly what we have today. And that's getting worse and worse as Series A and growth funds are getting bigger and bigger. And now we have the SoftBank Vision Fund, which is like the replacement of the IPO, right? Like, the goal used to be, I want to IPO my company. And now the like, the goal is, I want Masasan to like, give me more money than anyone could ever imagine. So it's bad and it's getting worse.

• 57:23Speaker 02

  And so what happened is, a lot of these seed investors are going to their LPs and basically saying, "Sorry, it'll get better later." And I think that's a really bad answer. I think the answer has to be, the market changed, so we're going to change our strategy with it. I know at CoVenture, so we have a deal. The company's raising another round, it's going to be a very oversubscribed round. And at the new marking, it's going to be something like a 30, 40X return for us, which will be great. What we're doing is we're setting up an SPV. We're allowing our investors from past portfolio to either sell their position into the SPV or hold on to the company by rebuying into the SPV at no price. It's giving them the optionality and liquidity. And by the way, that deal will like two and a half X the whole, you know, fund.

• 58:05Speaker 02

  We're giving them the ability to create liquidity, even in a world where traditional liquidity doesn't exist. We're evolving our market or our model because the world that we live in is different than it used to be. We're not just going out to our investors and saying, sorry, I know your NAV is overallocated to venture. There's nothing we can do about it. I bet you, you start seeing that from other firms as well. The other thing that we're really conscious of is with illiquidity also becomes more complicated capital stacks. So it really sucks to be a seed investor. If you have Series C preferred equity, you might be really, really far down the cap stack. And if you look at how these VC funds are holding their positions, they're really not taking that into account. The term valuation is broken, right? We basically take, let's take the price of the most senior security and ascribe that

• 58:49Speaker 02

  to the price of every other security, regardless of the structure and call the cumulative number, the value, which is like totally bullshit. And so as a seed investor, you're sitting there thinking, oh my God, like these preferred shares on top of me not only have liquidation preferences, but they have ratchets and they're participating preferred and they have some sort of like guaranteed return. And you suddenly realize that you are sort of at the whim of the market. You have no control. You can't make the company sell and your LPs have to be sitting there thinking, you know, I know I'm marked up on paper, but I don't know if that's actually real or not. And I don't know if I'm going to get out from under this.

• 59:22Ted Seides?

  And so the notion is when the company goes to do another round, you can then clean up the capital stack.

• 59:28Speaker 02

  Yeah, you can either clean up the capital stack. Our job as really early stage investors is not to decide if a company is worth 500 million or 700 million. Our job is to help the company prove customer value, gain product market fit, build an initial sales team, scale the initial sales team and build early signs of a barrier to entry that'll indicate the business will be around for a very long time and produce economic value for its shareholders over the long run. But once we've helped a company get to escape velocity. Our fund that we put capital into was not mandated with being a growth investor. So why are we underwriting in rounds that we really shouldn't be participating in? And if there's an opportunity for us to produce an outsized return and liquidity event for our investors, it is our responsibility to do that.

• 1:00:12Speaker 02

  And I think that a lot of seed investors got it in their head that, you know, only unicorns matter. And once a company is a unicorn, they're looking at how much they're worth on paper and thinking, wow, they just do another 2X step up, how much, you know, it's a lot of FOMO that's inappropriate.

• 1:00:27Ted Seides?

  Yeah. All right, Ali, let's turn to some closing questions. What was your favorite sports moment? Could be either as a participant or as a fan.

• 1:00:34Speaker 02

  Because we're like on a podcast that's about investing. I'll talk about my greatest sports moment was a false positive. We were playing this guy, he was on Royal High School. And he was a really, really top prospect. He ended up getting drafted in the second round. And one of the guys on our team was also like a top 100 prospect. And so both of them are getting drafted really early. So every scout in Southern California was at the game. And the guy was pitching like 92 to 96, which was a big deal in high school. And I hit a ball, like there was a centerfield fence and a small hill and a little path. And then a parking lot and a building, I hit over the building. And everyone thought I was like the best player like ever after watching that one game. And I was actually not nearly as good as they all thought.

• 1:01:15Speaker 02

  And then I ended up getting invited to like all these different showcases and like college campuses and everything else because of that one game, which by the way, definitely a highlight for me. It was amazing, but it was a great false positive. And if I were to try to relate it to investing, you know, like picking a VC who has a one hit wonder might actually not be the right approach of underwriting managers.

• 1:01:34Ted Seides?

  And while we're on it, I just have to ask, like, who are the guys you played with that are playing pro ball now?

• 1:01:38Speaker 02

  So I played on either on travel teams or against like Christian Yelich, Jimmy Sherfy, Trevor Bauer, Mike Montgomery. So Trevor Bauer, Mike Montgomery both played at Hart High School. And like, there was a great like one and two rotation. And seeing them pitch against each other when the Indians were playing the Cubs in the World Series. So they were the two final pitchers of that game. It was like a really surreal experience. And then Christian just got traded to the Brewers. And I think he's going to be playing. Ryan Braun played at Granada High School. He's now moving to first base because Christian's moving to third. And my mom called me, she's like, this is just like in high school where someone would get transferred from a travel team. And they'd have to switch positions, except now they're getting paid millions and millions of dollars to do it. So there was like a Ryan Healy, who's now the three hitter for the A's.

• 1:02:22Speaker 02

  It's crazy and it's very fun to get to watch them.

• 1:02:24Ted Seides?

  What teaching from your parents has most stayed with you?

• 1:02:27Speaker 02

  I'll give one from my mom and one from my dad. My mom has incredible empathy and actually is like an incredibly concerned person. To the point where like, maybe it's obsessively concerned. And I think that I've inherited that obsessive concern in how I think about lending. Like every day, like I think of a new thing, a new way I can get screwed. Or every day I think, oh man, I said something earlier and I wonder how that person sort of took it. So she has this obsessive concern that I sort of inherited, which I think is actually quite useful. One of the things that my dad said to me, you'll end up realizing that some of your friends spend all their time talking about things. And the other subset of your friends end up spending all their time talking about ideas. And it's a lot more productive to spend your time around friends who talk about ideas as opposed to specific things.

• 1:03:10Ted Seides?

  What information do you read that you get a lot out of that other people might not know about?

• 1:03:15Speaker 02

  The two filters of what I read, I try to read stuff where the agenda setting is democratic. And where I'm paying for the content. So I'll explain both of those things. So Facebook ends up being just sort of this kitchen sink of stuff that you already agree with. Because it's trying to help reaffirm stuff that it knows that you're interested in and provide it to you. Whereas Twitter, one of my favorite things is I follow people and try to make sure that if I'm following 50% Republicans, I'm also following 50% Democrats. If I'm following people who work in tech, I'm also following people who work in arts and finance and healthcare and everything else. So by creating sort of a democratic feed or a democratic agenda setting. I try my best to sort of get different disciplines of information. Because I think it's a lot easier to know something different than more of the same.

• 1:03:57Speaker 02

  And I always try to make sure that I'm paying for the content or I'm going through a paywall. And the reason is that's how I know the content that I'm reading is meant for me. So if I'm reading something that's free, it means that I am the product that's being sold to advertisers. And the content I'm reading is just a marketing tool to attract me to the website. I think it's really important. Important that I know that the writer is concerned about how I feel and the quality of the content that I'm receiving because it's most likely to be accurate. I love things like The New Yorker where they essentially treat their writers like authors of books, where they give them the budget ahead of time, let them spend the amount of time they need to doing the research without feeling like they have to like get a B and like post it within an hour. I think it just leads to higher quality content.

• 1:04:36Ted Seides?

  What life lesson have you learned that you wish you knew a lot earlier in your life?

• 1:04:41Speaker 02

  I've definitely started wading in more cautiously. So I grew up as an only child. And I think because of that, I grew up only arguing with people who were fairly rational and who had my best interests at heart. So I too often want to, you know, sort of be optimistic about the other person's fairness and their ability to reason. The other thing, though, that I've started doing to try to understand people better is, so now I've taken the practice of when we hire people or when we're even investing in a company, I try to read their favorite book. And the reason is people's favorite protagonists from a book is often someone they either aspire to be like or empathize with. And so you can end up learning a lot about a person and having this sort of emotional connection with them if you read their favorite book because you learn a lot about the protagonist who ends up being

• 1:05:26Speaker 02

  someone that they're attached to in some way or another.

• 1:05:27Ted Seides?

  This is going to be a tough one for you because it's a long way off. But if you were in your waning days, sitting in a rocking chair, what advice would you give yourself today?

• 1:05:36Speaker 02

  Be patient. You know, I think that it's really easy to get out of the gate and start looking at the people next to you and saying, am I farther along than they are or behind them? And life is incredibly random. And so just because someone who you think that you're equally intelligent or someone you think you have equal ability to is getting ahead of you because the life events that have been around them for some irrational reason have been more opportunistic, doesn't mean that you should then stretch on your risk profile to try to catch up. So it's a lot of competing with yourself as opposed to looking neck and neck at the people next to you and not stretching out the risk curve or doing things like we spend every day thinking, okay, we're going to be around for 50 to 100 to 1,000 years. I don't know how fast we will grow. I have some sort of idea, but we're never going to sort of chase growth because we feel like

• 1:06:21Speaker 02

  we're in a race against other people. You know, at the end of the day, we're like fiduciaries to people's savings. And I think that like playing, playing your own race with other managers as opposed to just sort of like, you know, continuing to grind and do sort of the things that you're supposed to be doing each day is hopefully I don't have to have given myself that advice. Hopefully we think about it now.

• 1:06:39Ted Seides?

  Great. Ali, thanks so much.

• 1:06:41Speaker 02

  Yeah, thank you.

• 1:06:43Ted Seides?

  Thanks for listening to the show. To learn more, hop on our website at capitalallocators.com, where you can join our mailing list, access past shows, learn about our gatherings, and sign up for premium content, including podcast transcripts, my investment portfolio, and a lot more. Have a good one, and see you next time.