Opportunity Zone Pitch Day - March 23rd
A Liquidity Revolution In Venture Capital, With Dave Thornton
Venture capital has historically been a major part of the alternative investment landscape, but it’s an asset class that can be hard to access for individual accredited investors, and their advisors.
Dave Thornton, co-founder of Vested, joins the show to discuss how his company is helping advisors and individual accredited investors to access the VC asset class in unique and diversified way.
Watch On YouTube
- Background on Dave’s career and education, and how he fell into venture capital “by accident.”
- Why venture capital has historically been an opaque asset class that is very challenging to access for all but the largest institutional investors.
- The typical problems faced by many employees at venture-backed startup companies (and how Vested is helping these employees).
- How Vested has created an “index fund-like” product containing upside in VC-backed companies, that is accessible by individual High Net Worth investors, family offices, and independent RIAs.
- How Vested uses machine learning and algorithms to curate the universe of VC-backed companies and find the best ones to invest in.
Featured On This Episode
- Dave Thornton, Vested – Could Index Investing Come to Venture Capital? (The Meb Faber Show)
Today’s Guest: Dave Thornton, Vested
- Vested – Official Website
- Vested – Webpage for Investors
- Vested on LinkedIn
- Dave Thornton on LinkedIn
About The Alternative Investment Podcast
Hosted by WealthChannel co-founder Andy Hagans, The The Alternative Investment Podcast is the #1 alts podcast reaching RIAs, family offices, and High Net Worth investors.
Andy: Welcome to “The Alternative Investment Podcast.” I’m your host, Andy Hagans. Today we’re talking about venture capital. We’re doing a little bit of a mini-series here on the show about venture capital, and I’m really excited for this, because, honestly, it’s a huge space in the alternatives category, but for a lot of reasons that we’re gonna talk about today, it’s more of an opaque space, especially for individual investors. But there are some very unique companies that are honestly revolutionizing this space. So, I’m very excited that joining me today is Dave Thornton, founder of Vested. Dave, welcome to the show.
Dave: Thanks, Andy. Very good to be here. Thank you for having me.
Andy: So, I know we have a lot of ground to cover today, and I wanna start by just saying I love what you’re doing at Vested, because almost every company in the alternative space say, “We’re here to revolutionize alts. We’re here to revolutionize this, we’re here to revolutionize that.” It’s pretty rare that that is actually, you know, true, you know, that the thing that the company’s doing actually kinda lives up to the theory. But when I heard about Vested and I learned how it worked, and it’s kind of unique, so, we’re gonna go into the whole story, I realized that this actually is changing venture capital. But before we go into how the platform works, I’m curious on your background, Dave. How did you get in to the venture capital space? How did you get into the alternatives industry?
Dave: Well, a little bit backwards. I have an all-over-the-place background, which actually does coalesce into what I’m doing at Vested, but it won’t seem that way until I kind of walk through it. So, my undergrad was a joint between the business school of Penn and computer science. So, I could go two directions there. The first job out of school was at Microsoft, and apologies to Dean Perone [SP], who’s still one of the best bosses I’ve ever had, but I did not wanna do software development after spending a little bit of time doing software development. So, I went over to the other side of the joint degree, and I helped set up an internal hedge fund within Citigroup, back when banks were allowed to have internal hedge funds. So, me and a couple traders from one of the best prop trades at Citi at the time built out the same apparatus, but with other people’s money. And I was responsible for writing the trading models and the risk models, and automating as much of the back office stuff, daily production of NAVs, for example, as I could. Went to law school after that. Actually, I completely accidentally timed the Great Financial Crisis perfectly. Went to law school in 2008. And then, after law school, jumped into the entrepreneurial world. So…
Andy: Dave, I gotta stop you.
Dave: Yeah, yeah. Go ahead.
Andy: I know so many entrepreneurs who went to law school, including one, really close to. He’s super successful, smarter than me. He’s made a fortune. It’s funny how many, you know, people I know went to law school and then, like, are immediately, like, “Well, I don’t wanna do that. I don’t wanna practice law.”
Dave: So, I went to law school with the best of intentions. And then about halfway through, so, a year and a half in, I was pretty sure that I didn’t love the people that I was in law school day-to-day with. Like, I had my group of friends, but for the most part, the ethos of raising your hand to have your voice heard, not being data-driven when you’re making your arguments, it kind of killed me, slowly. And that was most of the law students. And so, I…
Andy: I feel like there’s a joke there. But, yeah. Go on.
Dave: No. I’m from a family of lawyers. My brother found a practice that he loves, and I could have overreacted a little bit less to law school, but about halfway through, I kinda decided, in a very entrepreneurial, band-aid-rippy-type way, that I wanted out. So, my then-fiancée, now wife, who had come down to law school, from New York down to D.C. with me, she made me finish. So, I did. I did my best. I very coherently explained a sunk cost to her, and I even mimed, like, lighting 100 grand on fire that we did not have to, but she was having none of it. So, I finished law school, but then no bar and no practice.
Andy: Okay. Fair enough. Okay. So, you went through law school. So, then how did you back into, fall into, venture capital from there?
Dave: So, in a sense, I jumped into the startup world, and the startup world is the world of venture capital, from one angle. So, in the first business that I started, we did a number of very cool things, and I could probably talk for too long about all of them, none of which are really related to Vested except this one. From my time at the old Citi hedge fund, we ended up building an illiquid asset pricing model, a subsequent version of which is currently algo-trading a $300 million book at a big, brand-name bank right now. So, put a pin in that, because that comes back to Vested in a second.
Shortly after that business, we left Manhattan and came down to South Florida, where most of the grandparents were, because we had kids of a certain age, and we needed as much help as we could get. And I started and sold a healthcare analytics company. And in the process of being the CEO, issuing stock options to the employees, and then ultimately watching the stock options manifest in the acquisition, I gave my employees some pretty bad advice from a tax perspective. I knew that going stock-for-stock in a private company acquisition was tax-free, but I didn’t appreciate that the mechanical option to exercise on the way to going stock-for-stock was not tax-free.
Andy: A taxable event.
Dave: So, I…it worked out perfectly for the people that it most harmed. But in that year, there was a “Price is Right” problem, where people got stuck with a tax bill. And I kind of just had this moment where I was like, “All right. If somebody with my background is screwing up employee stock options, I’m sure most employees are screwing up employee stock options.” And that’s the basic thesis for Vested, is that startup employees have this very valuable asset, and they don’t really know what to do with it. They don’t tend to think about it the right way, or they think about it the right way, but in a hurry under distress. And so, Vested was begun with the idea that startup employees should know more about their equity, so that when it comes time, they can do something smart with it. So, that’s the long path to Vested. And then Vested itself has a couple paths within it that have led us to the fund product that we produce right now.
Andy: Sure. And, you know, it’s interesting that you mentioned kind of the genesis story of Vested, because now I’m thinking… Because you’re talking about you’re an entrepreneur, you build a startup, then you end up exiting it, successful exit, and almost definitionally, anytime you do that the first time, you’re learning as you go. You’ve never done it before. And then afterwards, you’re like, “Oh, wow. I know so much now that I didn’t know at the beginning.” And that’s literally the same thesis why we started AltsDb. You know, different lessons, different angle, but it’s just like, we sold a company to private equity, and we did it a couple times, Jimmy and I, and afterwards, we’re like, “What’s going on here with this private equity? Why are we selling businesses? We should be buying.” Anyway… So, it’s just funny because there’s so much of that kind of knowledge. It’s like, “I’m a computer programmer, I’m working at Google, or I’m working at whatever, tech startup, the Google of 2020, and I have these stock options that are worth a lot, but I’ve never done this before. I’ve never worked for a company that IPOed before.” You know, and then you have all of this portfolio concentration risk. Actually, it’s even worse than that. I have the illiquid asset, highly concentrated in this company that I also work for.
Dave: Yeah, yeah. That you spend 8 to 16 hours a day working at. Like, you are as levered to this company as you possibly can be.
Andy: That’s absolutely right. So, I kind of know where, I can see where the puck is heading here. So, Dave, I’ll actually punt this to you. I wanna talk about the venture capital industry, but maybe we should go a little further then, how Vested is helping these employees who are working at startups. Because you talked about, you kind of did this transaction, you had this successful exit, but you made mistakes, which we all do in our first transaction. I mean, literally, every person does. So, but you learn from that, and it kinda made you realize there’s a need to provide liquidity, or even valuation, or probably all kinds of services…
Dave: All kinds of stuff, yeah.
Andy: …to folks working at these startups.
Dave: I think the first thing is just understanding what it is that you own. So, startups tend to be cash-constrained relative to the Googles and the Facebooks, now Metas of the world. And so they under-comp in cash and they over-comp in stock options. And stock options are not stock. It’s, like, the very first thing that people don’t typically understand when they’re getting their equity grant. So, one, understand that these are stock options. They tend to vest over time. They’re not all yours right now. You have to stay for a while, especially towards the end of your first vesting cycle, which is usually gonna be your most meaningful grant. Should you wanna leave the company, should you consider your tour of duty tied to, like, your first vesting schedule, you will inevitably run into the fact that 95%, maybe more, of startups require that you exercise your options within 90 days of leaving. Which is just a brutal, and very distressing situation, all of which comes from the fact that most people don’t appreciate that they had to buy their stock in the first place, that stock options are not stock.
So, we started out with just a whole bunch of educational content about the difference between stock and stock options, about the various types of stock options, about all the taxable issues associated with stock options. We also built a couple cool tools. So, one was an employee stock option fairness calculator, that kind of helps you think about your grant relative to other similarly-situated employees. So, it kind of, like, helps you negotiate on day negative one. We built a, kind of, a way to track your grants over time. So, not just, like, hitting vesting cliffs, but also understanding the value of your stock, or the underlying stock at the company, and things are happening, like new rounds are getting raised or competitors are doing things. We built an outcome simulator, which is one of the earliest tools that got used quite a lot, which is just a tool that helps you dream big. If your company exits for a billion dollars, like, what’s it worth to you? And those were kind of the, the content and the tools were what we had initially armed the employees with, to just be a little bit smarter on day 300 than they were on day 1.
Andy: Yeah. And it’s interesting, because if you think about what they own, it’s options, not equity, but an interest, let’s say, in a private, you know, fast-growing private company. It’s the type of investment that would normally be owned by a family office or an ultra-high-net-worth investor, someone who’s very sophisticated, has the ability to, you know, deploy a million here, a million there, and not worry about it, have all these private illiquid investments, because they know how to manage it, they know how to be diversified. Whereas if you’re this employee, you’re getting this one random… It’s not random, but it kind of is, you know, and mathematically, it is, right? Because we know that most venture-backed companies don’t have successful outcomes, but then a few have very, very successful outcomes. You know, whatever…is it a power law? What’s the mathematical…? [crosstalk 00:12:07]
Dave: Yeah, it’s commonly referred to as the power [crosstalk 00:12:08]
Andy: Yeah, sure. Okay. So, the need for education, and there’s information asymmetry here, right?
Andy: And a lot of the founders of these types of companies, like, if I go out and start another company tomorrow, and grow that to exit, that’ll be my fifth startup that I can grow to… Like, I’ve done it before. It’s not my first rodeo. I kind of know what to expect. Every time you do it, it’s a little different. Versus if you’re an employee, and you’re not an entrepreneur, and you haven’t been down this process, you know, kind of like what you’re implying. You don’t even know what your options are worth. And even, honestly, even calculating them, at a certain exit, like, if we exit for 500 million bucks, what is this option worth? Even that can actually be super hard. Like, I’ve been in situations where, like, three finance nerds with pocket protectors are trying to figure it out, and they can’t even figure it out. I’m like, “Well, how the heck do you want me to figure it out,” you know?
Dave: It’s hard, because the investors that come in at the various rounds all tend to have different terms, some of which are antagonistic to each other, almost all of which are antagonistic to the common stock, and, like, figuring out how it all fits together at a presumed X of valuation is something where, at a minimum, you need to have all the information to start getting out, you know, moving into your pocket protector and getting your calculator out. And so most startup employees don’t have any of the relevant information, so they couldn’t do the calculations even if they wanted.
Andy: Let’s put a pin in that, [crosstalk 00:13:41]? So, we have this kind of issue with employees at these venture-backed companies. They have options. If they leave the job, they may have, be in a liquidity crunch to exercise them or whatever. There may or may not be a secondary market. All these problems that they’re facing. I wanna put a pin in that, and now zoom out to the investor side of things. So, at “The Alternative Investment Podcast,” we cover all alts, right? So, a big part of that’s real estate, private equity. Venture capital is a huge category, but traditionally, venture capital, it’s been kind of the playground of the ultra-wealthy and institutional investors, right? So, like, a lot of private equity real estate funds, for sure, they’ll say, if you wanna be an LP, you can write a check for a million bucks. Or a lot of them, certainly $250,000, and increasingly, there are private equity real estate funds where you can invest $100,000, sometimes even $50,000, if you’re an accredited investor. So, honestly, at almost any end of the spectrum of accredited investor, from high net worth to very high net worth to ultra-high net worth, family office, you can invest in private equity. There’s plenty of different offerings. With venture capital, that’s not really the case, is it?
Dave: No. It’s becoming more of the case as time marches on and shops like us are trying to put out products that make it more accessible, but it has definitely not historically been the case. I mean, so, you’ve got some venture capital funds that are closed to new investment. So, Sequoia is an example, where they’ve been closed to all but their early LPs for a long time. You’ve got other venture capital funds that are now so big that it’s not worth it for them to take small checks and attempt to do fundraising and all the hand-to-hand combat that is associated with it. So, like, you’ll see minimums like $10 million, just to get in the door.
There’s also, separately from being able to get in, in the first place, even if you had the wherewithal, there’s the risk associated with getting in. So, a stat I’m sure you’ve heard before, but last funds’ top-quartile venture managers only tend to be next funds’ top-quartile venture managers 49% of the time, which is worse than a coin flip. That should be shocking. And so, there’s a significant amount of risk that you take in any one fund, in any one vintage, even if you can get in. And these portfolios that are getting created by a single fund and a single vintage tend to have, like, 15 to 40 positions. Which feels like a lot, but most of them are going to zero. And it’s not a lot.
Andy: So, this is a space, just based on what you’ve told me so far, I either need to be CalPERS, like, literally CalPERS, I need to be a giant institutional pension fund, or maybe one step down from that, but…because I need to be able to write, you know, a $1 million, a $5 million, a $10 million check, but I need to be able to do that to 5 or 7 or 10 funds, in each vintage. And then I need to do it vintage after vintage. So, that’s not even, like, a shared family office. That’s a huge family office, or…
Dave: You’ve gotta be able to take risk, is the short version. And that is directly related to how much capital you might be able to deploy into the asset class.
Andy: So, basically, the whole asset class, if you’re not among the world’s largest family offices, it’s almost been closed off to individual investors. Doesn’t matter, accredited, very high net worth, doesn’t matter. Realistically, you’re pretty much locked out. Is that fair to say? Historically?
Dave: Yeah, and even if you’re not locked out, you’re definitely locked out from the places that you would otherwise wanna be. So, like, you can find your local VC managers, but now you’ve gotta learn how to diligence them and figure out what the difference is between them and the Bessemers and the Kleiners of the world. And so, like, you’re definitely locked out from the top tier most of the time, and maybe locked out from the second tier, based on kind of who will pick up the phone for you.
Andy: And emerging managers, it must be said, sometimes they’re gonna have really good ROI, really high returns, but, to your point, you have to diligence them, and then [crosstalk 00:18:13]
Dave: Yeah, you have to be able to separate the wheat from the chaff, and it’s a chicken or egg problem. If you’ve never been a VC, and you’ve never gone through that process, like, how would you know how to pick amongst your local 5 or 10 managers?
Andy: So, okay. We’ve done a good job, I think, of talking about two problems, right? The one problem that employees face in venture-backed startups, where a lot of their comp is weighted towards these options, and they may be in a liquidity crunch, or have a hard time valuing them or whatever. The other problem we’ve identified, this is an opaque asset class, this is very hard for even high-net-worth investors to access. So, Dave, I’m throwing you a fastball down the plate, to describe what your platform does. Because we were talking before we were recording. I was like, “This is so interesting, because it doesn’t solve one problem. It actually solves both problems.”
Dave: Yeah. And as we were also talking before the recording, if I told you that we started out to solve the second problem, I’d be lying. So, it’s kind of important to understand what the evolution of Vested was, from the educational content platform to the fund management platform that it is today, and how we monetize today. So, out of our initial user base, of all the folks that had shown up for the free content and the free tools, we started to feel this steady drumbeat of people that were asking us for money. And at the time, it was like, “What is going on? We very clearly, very explicitly do not provide money for this stuff. Like, why would you think it’s a reasonable question to ask us?” And we started looking at it, and it was entirely folks who were in that 90-day post-termination exercise window that I mentioned, where they left a job for whatever reason. They’re going to grad school, Google poached them, maybe there was a small layoff, and all of a sudden, they found out, for the first time, usually, that they had 90 days within which, if they didn’t find the money to both buy their stock and pay the related option exercise taxes, they were gonna lose the primary form of their compensation for the last, on average, three years.
So, these folks were coming to us, and then we looked a little bit harder, and we were like, “There’s gotta be a market for this.” And we found out that there was a market for a select, small set of people in this position. So, if you are the SVP of Stripe, leaving after a 5-year tenure, and you have, like, a $2 million to $5 million option funding need, there are 4 or 5 shops that’ll fight over that deal. But, if you were the mid-level customer success rep at Stripe, that left on the same day, and you needed, like, $45,000, nobody cares and nobody will give you the time of day. Similarly, if you were leaving an earlier or a mid-stage company, the kind of companies that are just hard to diligence as an outsider, because they haven’t done enough in the world yet, nobody will give you the time of day.
So, we put two and two together. We were like, “All right. Smaller-ticket option funding needs, and everybody leaving early and mid-stage companies, that’s probably 99% of startup employees by count.” There aren’t too many senior execs at Stripe. And what we ended up realizing was we could probably support them, and be the only liquidity provider, help solve their problem and help them own most of their shares at great prices. Because you tend to be able to get great prices when you are the only liquidity provider in a market. And we ended up building a fund product that is kind of like the anti-VC fund product, except for the fact that it provides an incredible entree to the asset class, which is, rather than trying to be one of those winner-picking machines, and, per the 49% number, not everybody… People think VCs are winner-pickers. I have read a lot on this, and I don’t think most of them are.
We were instead going to get rid of the companies that have clear red flags, but try to support the employees from the remainder of the companies. Do it little bits at a time, $45,000 at a time, $80,000 at a time, and at the kind of discounts that allow us to feel comfortable deploying that capital. And we’ve effectively created kind of like a VC index fund. We’re helping employees from companies across all stages and all sectors, and it’s an index fund at a discount, because all of the positions that we’re putting on come from the attendant distress that I was just describing. And this particular fund product is kind of like the most risk-adjusted way to dip a toe into the asset class. Like, we had a $25 million fund previously that had 250 positions in it. No more than 1% concentration in any one name. You can kind of write one check, get exposure to the hypothetical median of the VC asset class, and kind of call it a day for your asset allocation, so, that’s the way in which…
Andy: Well, it could theoretically be better than that though, in the sense that… And I wanna talk about the discount. I think that’s an important component here. And I wanna be clear, because, I mean, you know, I don’t know, like, what percent discount it is, or, you know, because a lot of times, when you value something, when you have a valuation, the context is super important. Is it a retail price? Is it a wholesale price? Do you have time to, you know, wait, and receive a maximum price, or, you know, rush, you need to sell this tomorrow? So, I think, as you said, when you’re the only liquidity provider in town, or even just the easiest, right? It’s interesting. Totally different markets, but, you know, cash for gold or whatever, there are so many different markets where people will just say, “You know what? I have this asset. I need liquidity quickly. I know that I’ll get a discount from this liquidity provider, but I need the convenience, I need the speed, I need the reliability of knowing that I can trust the buyer on the other side to say what they’re gonna do.”
And also, I think it has to be said, and, you know, with what your firm does, these small transactions, there’s a fixed cost. There’s, you know, labor, transaction costs that are associated with just servicing and completing smaller transactions. So, what is the discount, though? Because you’re talking about, like, a diversified fund, but I’m thinking, well, it’s, in theory, it could be better than that, because you have the ability to get the diversified fund, which is getting shares at a discount, right?
Dave: Yeah. From a fund returns perspective, it should be quite a bit better than your average heavily-diversified fund, specifically because of the discount. The discount is typically relative to the last price that investors paid. And in this market, if investors paid their last price a year and a half ago, that’s probably too high. So, there’s a bunch of context on every deal, but the most important thing to understand is we’re kind of a secret data machine. We talk to lots of employees, across lots of startups. We have access to the kind of data, at scale, in the VC asset class, that is not readily available to most investors. And as a result, we can do a pretty good job figuring out what a company is worth, what companies are probably going to zero, and taking a discount relative to our expectations.
Andy: Now, Dave, are you licensing that? I’m like, that sounds like a whole other business line for your firm.
Dave: We are going to use it for our own proprietary purposes for as long as the fundamental arbitrage that allows this strategy to be really attractive exists. And at some point, I have no doubt that we are going to flip over, like BlackRock with Aladdin, and start selling it to everybody else. But we’ll see.
Andy: Fair. I appreciate your candor. You’re using your powers for good, not for evil, right? So…
Dave: Yeah, yeah. That’s right. And to your point, on the discount side, we’re helping people own their shares. This is not just quick cash in pocket on the way out of a job that we’re providing. We’re specifically giving them money to buy the shares that represented the biggest form of their compensation in their prior job. And people are holding onto 50%, 70%, 90% of their shares because of the financing that we’re able to provide. And otherwise, they’d be going up in smoke. So, we do think that we’re doing a real service here and that the discount is in service of expanding that service.
Andy: So, okay. You know, I’m more from the investor point of view, right? I’m not working in a tech company, God willing, and I never will, you know, be a software developer. I don’t think I’d be a very good one. So, from the investor point of view, I am an investor. I’m interested in the platform. How does this work? You know, is every investor who comes onto your platform, are they all buying the diversified portfolio? Are there opportunities to select individual investments if you want to? Like, how does it work?
Dave: At the moment, we’re offering a fund product that kind of rolls… Like, we always need money for the next employee. And so we will always have an open fund. The intention for the fund product at the moment is to be a diversified basket of VC at a discount. And so, an investor in that core product will be getting access to the entire portfolio. However, because we’re so diversified, because we have such low concentration limits in any given fund, any time a bigger deal than we can handle in a fund comes in, there are co-invest opportunities. Because if somebody comes in and needs a million dollars from us, and we can only do $250,000, they don’t wanna take $250,000 from us and then go on to somebody else for $750,000. They wanna get their entire deal done in one place. So, for us to have the chance to do the $250,000 into the main fund, we basically need to go to our LPs and our potential co-invest population and say, “We’ve gotta come up with the other $750,000.” So, the main product is the diversified VC, but it kind of comes with free co-invest opportunities that are based on larger deals coming in than we can handle.
Andy: Dave, I have a great idea for you. I’m not even gonna charge you for this golden idea. Well, it reminds me of Warren Buffett, right? Because, you know, Berkshire, they own insurance companies because of the float. Because it’s just, they have this cash cushion, and then they buy these other, you know, capital-intensive businesses. So, it sounds like Vested kind of needs a float. You kind of need that buffer of liquidity, because if someone comes along and says, “You know, I have, you know, $5 million worth of Stripe stock and I’ll sell it to you at a very attractive price,” you don’t wanna be turning them away, or saying, “Well, we’ll take a tranche of $500,000.” You know, you wanna be able to bite off that…
Dave: That whole thing if we can. Yeah.
Andy: So, how do you manage, I guess, the co-investment opportunities, but do you have, like, any issues kind of matching demand for liquidity versus demand from investors? Like, have those been pretty even on both sides of the equation to date? Or do you need one more than the other right now? Like, do you have an excess of one and a scarcity of the other?
Dave: There is an absolute excess of deal flow right now, and I’m not talking about deal flow of specific sizes, but if people leaving startups is what produces deal flow for us, and right now, even healthy VC-backed companies are laying off 10% to 20% of their workforce with the expectation that they’re not gonna raise in the next couple years, and they need to be able to make it through. So, we have a ton of deal flow piled up, and substantially less, proportionally, capital. Like, a $25 million fund wouldn’t even put a dent in the amount of total…
Andy: Let me stop you right there. And I’m a shark, man. I’m merciless. Does that mean, as an investor, if I invest now into this current fund, I’m potentially getting better value, more of a [crosstalk 00:30:00]
Dave: Yeah, actually. So, it’s a good trade in any environment because there’s an amount of distress that’s created by the folks that are coming to us, where we’re always buying at a pretty good price. However, in the current environment, because of our concentration limits in the fund, maybe before, we might have had zero or one or two or three deals come to us from the ex-employees of a given company. Now we might have 10 at a time, and we can only do 1 or 2 or 3, because we can’t do too much in any given name. And so, the thing that we would do, as a fund manager, we would take our 10 deals, sort by price, do the best 1 or 2 or 3. And so, just to put that into numbers, in the last fund that we ran, we were buying at an average of a 51% discount, and currently, we’re buying at about a 70% discount. And that’s purely a function of the market environment that I just described.
Andy: And that’s a 70% discount to the company’s previous rounds, that they’re…
Dave: Yeah. Typically to the last round. So, that number by itself doesn’t tell you the full story. It’s got a bunch of variability within it. Old rounds, 70% off doesn’t mean much. New rounds, it means a lot, but the average moved quite a bit is the point.
Andy: That’s a pretty substantial discount, because you have to think… Here’s what I’m thinking. Another investor, who is probably smarter than me, or is at least more well-connected…maybe they’re not smarter than me, but they’re somehow managing a giant VC fund with billions of [crosstalk 00:31:32]
Dave: Yeah, well, no matter what, they got access to the company’s management team, which is the one thing that you will never have access to unless you’re an inside investor, so…
Andy: And I know that they just bought at essentially three times what I’m buying at, if it’s a 70%, is, like, if it was a round for $450 million, you know…
Dave: Yeah, you’re effectively buying into common stock at $150 million valuation. So, it’s worth noting from our prior thread that the common stock that we’re getting our exposure to, which is typically what the employees have or have access to, is not worth what preferred stock is worth. It’s usually worth a, call it a 20% to a 30% discount from preferred stock. But we’re still getting it way lower than that. And so your major point holds, which is that we’re buying stuff for lower than the equivalent that you’d expect to buy it at, relative to what some smart VC just paid.
Andy: I understand. So, the common stock that your funds would be holding, par value would be something like 70% or 75% of the previous valuation…
Dave: Yeah. That’s right.
Andy: …because that previous valuation would’ve been basically preferred rounds, series B or whatever, and what we’d be investing is common. But still, then, if there’s a 70% discount, it sounds to me that’s…
Dave: Yeah, there’s still plenty of buffer between what this type of asset is theoretically worth on average and where we’re buying.
Andy: So, walk me through, then, the funds. So, these are diversified funds. I understand there’s a, like, co-GP. There’s these other kind of one-off opportunities, but the diversified funds, those are open for a period of time, and then they’re closed? So, Vested almost has, like, its own vintage, so to speak?
Dave: Yeah, yeah, yeah. We don’t have vintages the way that a traditional VC will have vintages, and those are usually yearly vintages. We’ll actually have more frequent vintages than that, because there’s a lot of deployment to do. So, we might have, if, let’s say we continue to do $25 million funds, we’ll probably be deploying for a handful of months, and then we’ll need to have the next fund started, deploy for a handful of months, the next fund will need to be started. So, it’ll be kind of like a set of rolling funds.
Andy: So, what fund are you on right now?
Dave: It is fund three right now.
Andy: Fund three. Okay. And what about holding period? Because, you know, with all alts, that’s one thing I kind of coach everybody. I love illiquid alts. You know, honestly, there’s more money to be made, ultimately, in illiquid investing than there is in liquid investing, because there’s an illiquidity premium. But you gotta understand the illiquidity, and, as an individual investor, really important that individual investors understand their liquidity needs and each product that they’re investing in. So, how does the liquidity work? Is it a 5-year, 10-year hold?
Dave: So, in our case, it’s a five-year fund. And it’s got a pretty interesting distribution profile on paper, current markets notwithstanding, where, like, all of the exit events are just chilling out for a year and change. But the general idea is we’re not reinvesting with our capital. So, if we put out 250 positions, you’re gonna see 10 or 20 go liquid over the next year, randomly. Like, the company that I sold, 16 months after our seed round, we were opportunistically acquired by one of our vendors. That happens all the time. Nobody writes about it, but, like, the point is, these liquidity events kind of kick themselves off more frequently than you would expect, especially [crosstalk 00:34:57]
Andy: And those are, like, the…can I use a baseball analogy? Those are the singles and the doubles, right? Like, for every…
Dave: And if you’re buying…like, if preferred stock is worth a dollar and we’re buying common stock at 30 cents, and on a good exit, preferred and common exit at the same price, and it exits for $3, like, we just 10X’ed. It doesn’t take much. Like, a single or a double can 10X a position [crosstalk 00:35:21]
Andy: So, Dave, that’s a difference, I guess, also from the preferred, it’s the higher valuation. But that’s also a difference, like, a double, you know, hitting the double, for a fund like yours, that’s awesome, right? Because it’s just like, “We wanna be in the money enough to where the common and preferred, ideally, are both getting that same, you know…
Dave: The same effective.
Andy: …same deal on exit. But you don’t need a unicorn. Because when you’re buying in at a discount, and you’re diversified, there’s already inherently good economics. So, if you can just consistently hit enough singles and doubles, it’s…
Dave: Yeah. If all we did was hit singles, this would be a 3X fund. Like, there’s still plenty of froth in the market, and some companies are gonna go to zero that weren’t in our, you know, training set, because the training set came from the good times, as we were preparing for the trade. But, like, really, your point is right on. We don’t need home runs. We will benefit from home runs, because we’re playing in the same asset class that VCs tend to play in, and it’s a power law asset class, where Facebooks are 1000Xs, but if all we had was a series of singles, our products would perform very well.
Andy: So, you mentioned that it’s kind of like an index fund, but, you know, it’s the Russell 1000 or whatever, but that you’re also weeding out, almost like you’re weeding out some pink sheets, some penny stocks. You know, some kind of shady listings here. So, let’s talk about that. So, you’re not necessarily diligencing everything like an actual VC firm would, right? But you’re kind of doing something in between.
Dave: Yeah, we’re doing something in between. We’re doing a thorough job with, and it’s a very data-driven and automated thorough job, but the big thing that we’re not doing, because how could we possibly, given how many hours there are in a day, is sitting down with each company’s management team and having a conversation, and kind of assessing the quality of the leadership of the early-stage companies. However…
Andy: Because we’re about to buy $40,000 worth of stock options, so…
Dave: Right. Yeah. They’re not gonna give us the time. We’re not gonna spend the time. But we do have a whole bunch of other machinery for weeding out, you know, the biggest problem-type companies. So, we have access to financial performance data for about 75% of the VC asset class. It’s really easy to ask basic questions from that data. Like, is this company profitable? Did their revenue grow last quarter? And we’ve built a pricing model around some of that data.
Andy: Could we use, like, some kind of non-traditional algorithm to find out if all the employees are, if there’s, like, a smoothie bar and a bunch of foosball machines? No, I’m kidding. I’m kidding.
Dave: It’s a non-traditional algorithm, called “that company loses money.”
Andy: Yes. Exactly. No, go on. Go on.
Dave: So, we’ve also taken a look at financing trajectory and financing terms. So, this is basic stuff, like is the company…
Andy: Well, this is so interesting to me. This is almost like machine learning due diligence. It’s kind of like the human being who’s trying to qualitatively judge. There’s probably just an algorithm and a set of metrics that can do just as good of a job, if not better, at spotting the startup that’s gonna be bankrupt in 24 months.
Dave: I think that really, really good, thoughtful investors are likely to always do a little bit better with the same underlying dataset than a machine learning algorithm is going to do. But, like, literally, we’re using a machine learning algorithm, like the… When I mentioned in that first startup that we built in a liquid asset pricing model, that’s algo trading right now, we’ve built the pricing model with the data feeds that I’m gonna finish describing to you, and it’s doing the same thing.
Andy: Well, Dave, let me push back on that just a little. I mean, you know a lot more about venture capital than I do, but, you know, we were talking about managed futures in liquid alts on the show with Andrew Beer. And so, his point was, with these algorithms, you know, they’ll kind of play the odds, kind of stupidly. Like, they’re like a dumb computer, right? Like, they have a lot of computing power, but they’re dumb. And I’m thinking even a really smart analyst, a really smart investor, we can all get, I don’t wanna say hoodwinked, but, like, you can meet a founder and be like, “I love her. She’s fantastic. I have to get in on that deal just because…” So, I feel like those human things, they can definitely help. Like, Warren Buffett is smarter than the Warren Buffett computer version of Warren Buffett. So, there are exceptions, but I think just as often, if not more often, human beings fall into human traps, you know?
Dave: I do definitely agree with that. And the downside of meeting with the management team is exactly what you’re saying. You’ll pattern-match, without meaning to, against the founders that you’ve seen and loved before, and you’ll say, “This is the same type of founder,” and then you’ll write a check maybe a little bit quicker than you would’ve, or at a bigger size than you would’ve. So, I agree with that. My caveat was more around, like, really good, thoughtful investors, that are not as prone to those biases, that have seen, like, all the terrible things that can happen.
Andy: Sorry. No, I’m not…trying not to laugh, but I’m like, “Oh, the really good VC, who’s not prone to biases.” Maybe that’s Sequoia Capital. You know, there’s probably… But biases, I mean, they’re a fact of life, right?
Dave: No, you’re right. And especially with the FTX debacle, there’s a bunch of soul-searching going on, even amongst the most thoughtful VCs that I know.
Andy: Good, good.
Dave: So, yeah, financing trajectory, financing terms, investor quality. Interestingly, all of this stuff coalesces into a portfolio where 62% of our positions are backed by what everybody would agree are top-tier VCs.
Andy: Now, is this chicken or the egg? Because sometimes I wonder, when you’re backed by a Sequoia Capital, or you’re backed by, you know, one of these top firms, of course they maybe saw something in your company, right, that they really liked, but maybe they’re also opening doors for you, or maybe some of their relationships or some of their even strategic guidance is helping you succeed.
Dave: I might be biased, but I want that to be true, at least. Like, I don’t think it’s true in the later stages. I think in the later stages, the companies that are doing really well know how to run themselves, and they can open their own doors. But, like, I’ve been an early-stage startup creature for most of my startup existence, and I kind of like the idea that there are a handful of folks out there in the world that can open the right doors, and there are good VCs. But yeah, for the most part, I’m a little bit skeptical on exactly how much of a flywheel that is.
Andy: That’s fair. That’s very fair. Okay. Okay. So, right now, is there one fund open right now, or two funds open right now?
Dave: We’re trying to make it so that there’s only ever one fund open, so that we don’t have, like, allocation policy-type problems.
Andy: And the platform is, from the investor side, it’s for accredited investors only. Is that right?
Dave: Yeah, that’s right. Accredited and up right now. And we’re gonna do everything we can to democratize it further, but at the moment, accredited and up.
Andy: Well, even bringing it to accredited and up is already, you know, democratizing it. And what is the minimum investment on the platform?
Dave: So, what we need is actually an average ticket size of $250,000. If we got a million-dollar ticket and we got 5 more $100,000 tickets, that’s fine. We’ve set our stated minimum at $250,000, but that’s only because most people write to whatever the minimum is, and that’s kind of a way of enforcing the average that we need. But $250,000 is the minimum. As long as our average ticket size for a group of investors is $250,000, we can take smaller tickets.
Andy: Understood. So, if you’re interested, you have $235k burning a hole in your pocket, send Dave an email. He might be able to help you out. No, but, I mean, that’s a very typical minimum for private equity funds. So, I get it. And if you think about the diversification in your fund, that’s… You know, because the thing is, $100,000 minimum into one thing, versus $250,000 into something more diversified. Yeah, I think that bears thinking about, because this is potentially, for an investor, a way to get exposure to this asset class that is one and done, and I think that’s… I mean, I guess you have to talk your book or I wouldn’t respect you, Dave, but is there anything even else out there that’s like this, where you can write one check and get diversified exposure to VC?
Dave: There are a small set of VC fund-of-funds that are diversified enough. Like, they invest in managers across all stages and sectors, and they offer a product that can get you close, I think. But the product itself comes with other drawbacks. For example, they’re paying preferred prices, and we’re not. On a look-through basis, a lot of the managers end up investing in the same companies. And so there’s more inherent concentration there. And then, the VC fund-of-funds tend to have two layers of fees, whereas we have one.
Andy: I was gonna say, I’m paying 2 and 20 on my 2 and 20, or whatever.
Andy: So, yeah, that’s pretty painful. And those probably tend to have pretty high minimums, I would think, anyway, even if you are getting diversified.
Dave: Yeah. And just like the other comment that we were talking, when we were going on the thread about access, it’s not that easy to get into a VC fund-of-funds. If you’re a financial advisor, and an independent financial advisor in particular that doesn’t have access to the VC fund-of-funds that a bank will put together, you’ve gotta be on a platform where those VC fund-of-funds are, and I think there’s only one on one of the major distribution platforms that I’m aware of. It’s just not that easy to find.
Andy: So, this is truly unique. And that’s what I love about this show, “The Alternative Investment Podcast,” is, I mean, I truly do love all alternatives, and I think that alternatives are the best way to protect and grow wealth. But there’s a lot of change going on right now, and, you know, certain asset classes, and this is one of them, where, if I fast-forward, and think what is venture capital going to look like a decade from now, I’m firmly convinced it’s gonna look pretty different, and there’s gonna be, you know, a much more diverse capital base. And, I mean, I think that’s a great thing. So, Dave…
Andy: …I can’t thank you enough for coming on the show, you know, kind of giving us a crash course in venture capital, but also talking about the real-world problems that Vested is solving. You know, obviously it’s helping improve people’s lives who are exiting these companies. But I also just think, for independent RIAs, for high-net-worth, very high-net-worth, ultra-wealthy investors, individual investors, this is just a really cool investment offering. So, that being said, where can our audience of high-net-worth investors and advisors go to learn more about Vested?
Dave: So, the custodial platforms that custody most of the private funds, we’re on most of them. Schwab, TD Ameritrade, Fidelity, Pershing, and a couple others. I don’t know how good the searchability on those various platforms are. So, there’s always an alternative to come directly to us. The email to use is gonna be [email protected] And I will make sure that anybody who comes in from your podcast goes down to our sales team directly.
Andy: Awesome. And I’ll be sure to also link to y’all’s website in our show notes. I’m also gonna link to another podcast that you recorded with Meb Faber. Meb Faber, he’s a friend of the show, and that was awesome content. Like, I heard that and I was just hooked. I was like, “I gotta get these guys on my show.” So, thanks again. I’ll make sure to put all these links on the show notes, including that podcast, including your website. You have a separate page for investors, and I’ll also include your LinkedIn page. Those are always available at altsdb.com/podcast. Dave, thanks again for coming on the show today.
Dave: Thank you, Andy. I appreciate it.