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Capital Formation and the LP / GP Relationship (with Altimeter’s Meghan Reynolds)

LP Show Episode

January 8, 2023
January 8, 2023

We sit down with Altimeter Capital’s head of Capital Formation Meghan Reynolds (who previously was TPG’s global co-head of Capital Formation for 10 years) to talk about everything that goes into the LP - GP relationship at venture funds. We cover how (and why) to think strategically about Capital Formation, why it should be about so much more the just investor relations / fundraising, and also why and how it’s going to change dramatically over the next decade. This was a GREAT conversation, and very relevant for GPs, LPs, and also company founders and employees heading into 2023 and post zero-interest-rate capital markets.

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We finally did it. After five years and over 100 episodes, we decided to formalize the answer to Acquired’s most frequently asked question: “what are the best acquisitions of all time?” Here it is: The Acquired Top Ten. You can listen to the full episode (above, which includes honorable mentions), or read our quick blog post below.

Note: we ranked the list by our estimate of absolute dollar return to the acquirer. We could have used ROI multiple or annualized return, but we decided the ultimate yardstick of success should be the absolute dollar amount added to the parent company’s enterprise value. Afterall, you can’t eat IRR! For more on our methodology, please see the notes at the end of this post. And for all our trademark Acquired editorial and discussion tune in to the full episode above!

10. Marvel

Purchase Price: $4.2 billion, 2009

Estimated Current Contribution to Market Cap: $20.5 billion

Absolute Dollar Return: $16.3 billion

Back in 2009, Marvel Studios was recently formed, most of its movie rights were leased out, and the prevailing wisdom was that Marvel was just some old comic book IP company that only nerds cared about. Since then, Marvel Cinematic Universe films have grossed $22.5b in total box office receipts (including the single biggest movie of all-time), for an average of $2.2b annually. Disney earns about two dollars in parks and merchandise revenue for every one dollar earned from films (discussed on our Disney, Plus episode). Therefore we estimate Marvel generates about $6.75b in annual revenue for Disney, or nearly 10% of all the company’s revenue. Not bad for a set of nerdy comic book franchises…

Marvel
Season 1, Episode 26
LP Show
1/5/2016
January 8, 2023

9. Google Maps (Where2, Keyhole, ZipDash)

Total Purchase Price: $70 million (estimated), 2004

Estimated Current Contribution to Market Cap: $16.9 billion

Absolute Dollar Return: $16.8 billion

Morgan Stanley estimated that Google Maps generated $2.95b in revenue in 2019. Although that’s small compared to Google’s overall revenue of $160b+, it still accounts for over $16b in market cap by our calculations. Ironically the majority of Maps’ usage (and presumably revenue) comes from mobile, which grew out of by far the smallest of the 3 acquisitions, ZipDash. Tiny yet mighty!

Google Maps
Season 5, Episode 3
LP Show
8/28/2019
January 8, 2023

8. ESPN

Total Purchase Price: $188 million (by ABC), 1984

Estimated Current Contribution to Market Cap: $31.2 billion

Absolute Dollar Return: $31.0 billion

ABC’s 1984 acquisition of ESPN is heavyweight champion and still undisputed G.O.A.T. of media acquisitions.With an estimated $10.3B in 2018 revenue, ESPN’s value has compounded annually within ABC/Disney at >15% for an astounding THIRTY-FIVE YEARS. Single-handedly responsible for one of the greatest business model innovations in history with the advent of cable carriage fees, ESPN proves Albert Einstein’s famous statement that “Compound interest is the eighth wonder of the world.”

ESPN
Season 4, Episode 1
LP Show
1/28/2019
January 8, 2023

7. PayPal

Total Purchase Price: $1.5 billion, 2002

Value Realized at Spinoff: $47.1 billion

Absolute Dollar Return: $45.6 billion

Who would have thought facilitating payments for Beanie Baby trades could be so lucrative? The only acquisition on our list whose value we can precisely measure, eBay spun off PayPal into a stand-alone public company in July 2015. Its value at the time? A cool 31x what eBay paid in 2002.

PayPal
Season 1, Episode 11
LP Show
5/8/2016
January 8, 2023

6. Booking.com

Total Purchase Price: $135 million, 2005

Estimated Current Contribution to Market Cap: $49.9 billion

Absolute Dollar Return: $49.8 billion

Remember the Priceline Negotiator? Boy did he get himself a screaming deal on this one. This purchase might have ranked even higher if Booking Holdings’ stock (Priceline even renamed the whole company after this acquisition!) weren’t down ~20% due to COVID-19 fears when we did the analysis. We also took a conservative approach, using only the (massive) $10.8b in annual revenue from the company’s “Agency Revenues” segment as Booking.com’s contribution — there is likely more revenue in other segments that’s also attributable to Booking.com, though we can’t be sure how much.

Booking.com (with Jetsetter & Room 77 CEO Drew Patterson)
Season 1, Episode 41
LP Show
6/25/2017
January 8, 2023

5. NeXT

Total Purchase Price: $429 million, 1997

Estimated Current Contribution to Market Cap: $63.0 billion

Absolute Dollar Return: $62.6 billion

How do you put a value on Steve Jobs? Turns out we didn’t have to! NeXTSTEP, NeXT’s operating system, underpins all of Apple’s modern operating systems today: MacOS, iOS, WatchOS, and beyond. Literally every dollar of Apple’s $260b in annual revenue comes from NeXT roots, and from Steve wiping the product slate clean upon his return. With the acquisition being necessary but not sufficient to create Apple’s $1.4 trillion market cap today, we conservatively attributed 5% of Apple to this purchase.

NeXT
Season 1, Episode 23
LP Show
10/23/2016
January 8, 2023

4. Android

Total Purchase Price: $50 million, 2005

Estimated Current Contribution to Market Cap: $72 billion

Absolute Dollar Return: $72 billion

Speaking of operating system acquisitions, NeXT was great, but on a pure value basis Android beats it. We took Google Play Store revenues (where Google’s 30% cut is worth about $7.7b) and added the dollar amount we estimate Google saves in Traffic Acquisition Costs by owning default search on Android ($4.8b), to reach an estimated annual revenue contribution to Google of $12.5b from the diminutive robot OS. Android also takes the award for largest ROI multiple: >1400x. Yep, you can’t eat IRR, but that’s a figure VCs only dream of.

Android
Season 1, Episode 20
LP Show
9/16/2016
January 8, 2023

3. YouTube

Total Purchase Price: $1.65 billion, 2006

Estimated Current Contribution to Market Cap: $86.2 billion

Absolute Dollar Return: $84.5 billion

We admit it, we screwed up on our first episode covering YouTube: there’s no way this deal was a “C”.  With Google recently reporting YouTube revenues for the first time ($15b — almost 10% of Google’s revenue!), it’s clear this acquisition was a juggernaut. It’s past-time for an Acquired revisit.

That said, while YouTube as the world’s second-highest-traffic search engine (second-only to their parent company!) grosses $15b, much of that revenue (over 50%?) gets paid out to creators, and YouTube’s hosting and bandwidth costs are significant. But we’ll leave the debate over the division’s profitability to the podcast.

YouTube
Season 1, Episode 7
LP Show
2/3/2016
January 8, 2023

2. DoubleClick

Total Purchase Price: $3.1 billion, 2007

Estimated Current Contribution to Market Cap: $126.4 billion

Absolute Dollar Return: $123.3 billion

A dark horse rides into second place! The only acquisition on this list not-yet covered on Acquired (to be remedied very soon), this deal was far, far more important than most people realize. Effectively extending Google’s advertising reach from just its own properties to the entire internet, DoubleClick and its associated products generated over $20b in revenue within Google last year. Given what we now know about the nature of competition in internet advertising services, it’s unlikely governments and antitrust authorities would allow another deal like this again, much like #1 on our list...

1. Instagram

Purchase Price: $1 billion, 2012

Estimated Current Contribution to Market Cap: $153 billion

Absolute Dollar Return: $152 billion

Source: SportsNation

When it comes to G.O.A.T. status, if ESPN is M&A’s Lebron, Insta is its MJ. No offense to ESPN/Lebron, but we’ll probably never see another acquisition that’s so unquestionably dominant across every dimension of the M&A game as Facebook’s 2012 purchase of Instagram. Reported by Bloomberg to be doing $20B of revenue annually now within Facebook (up from ~$0 just eight years ago), Instagram takes the Acquired crown by a mile. And unlike YouTube, Facebook keeps nearly all of that $20b for itself! At risk of stretching the MJ analogy too far, given the circumstances at the time of the deal — Facebook’s “missing” of mobile and existential questions surrounding its ill-fated IPO — buying Instagram was Facebook’s equivalent of Jordan’s Game 6. Whether this deal was ultimately good or bad for the world at-large is another question, but there’s no doubt Instagram goes down in history as the greatest acquisition of all-time.

Instagram
Season 1, Episode 2
LP Show
10/31/2015
January 8, 2023

The Acquired Top Ten data, in full.

Methodology and Notes:

  • In order to count for our list, acquisitions must be at least a majority stake in the target company (otherwise it’s just an investment). Naspers’ investment in Tencent and Softbank/Yahoo’s investment in Alibaba are disqualified for this reason.
  • We considered all historical acquisitions — not just technology companies — but may have overlooked some in areas that we know less well. If you have any examples you think we missed ping us on Slack or email at: acquiredfm@gmail.com
  • We used revenue multiples to estimate the current value of the acquired company, multiplying its current estimated revenue by the market cap-to-revenue multiple of the parent company’s stock. We recognize this analysis is flawed (cashflow/profit multiples are better, at least for mature companies), but given the opacity of most companies’ business unit reporting, this was the only way to apply a consistent and straightforward approach to each deal.
  • All underlying assumptions are based on public financial disclosures unless stated otherwise. If we made an assumption not disclosed by the parent company, we linked to the source of the reported assumption.
  • This ranking represents a point in time in history, March 2, 2020. It is obviously subject to change going forward from both future and past acquisition performance, as well as fluctuating stock prices.
  • We have five honorable mentions that didn’t make our Top Ten list. Tune into the full episode to hear them!

Sponsor:

  • Thanks to Silicon Valley Bank for being our banner sponsor for Acquired Season 6. You can learn more about SVB here: https://www.svb.com/next
  • Thank you as well to Wilson Sonsini - You can learn more about WSGR at: https://www.wsgr.com/

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Transcript: (disclaimer: may contain unintentionally confusing, inaccurate and/or amusing transcription errors)

Ben: Meghan Reynolds, welcome to the Acquired LP Show.

Meghan: Thank you. It's such a pleasure to be here.

Ben: It's great to have you. It's fun to do this. We talked about it almost a year ago at this point. We got to hang out all through the Altimeter Investor Day, chatted about it then, and here we are 10 months later actually making it happen.

Meghan: I'm so glad it finally came together.

Ben: Listeners, for those of you who are not familiar with Meghan and her pretty prolific tweets, we call this the Acquired LP Show, but most of the time, we're not actually talking about the interface between venture firms and their limited partners.

Meghan spends all of her time thinking about the interface between VC private equity, capital management of all sorts, and the owners of capitals, the limited partners. She is currently at Altimeter, which is a $10 billion assets under-management firm.

Of course, we had Brad on the show. It's interesting looking back across the three chapters of her career. Starting in 2000, she joined Goldman Sachs, stayed for nine years, and got to watch basically the growth of private equity and venture from this cottage industry to what it is today. Over her tenure there, it went from about $8 billion in assets to $40 billion in assets in private markets. All at Goldman.

Chapter two, she joined TPG in 2010, was at the firm while it grew from about $40 billion in assets to about $120 billion, and was co-running fundraising globally. Think about the insights gleaned if you are running the fundraising practice for a firm like TPG and then, of course, doing a very similar thing in a very different way at Altimeter today.

Meghan, we are lucky to have you and learn from all your insights.

Meghan: I'm so happy to be here. It feels appropriate that we're talking LPs on the LP Show finally only four years into this journey. When did you start?

Ben: Acquired is seven years old, but the LP Show is maybe 2018-ish.

Meghan: I went back, and it looked like the LP Show started around 2018.

Ben: I saw you subscribe this morning. Thank you so much for doing that.

Meghan: I paid my fee.

David: It's our growth strategy for the LP program, we have people on the show.

Ben: Meghan, I wanted to maybe start with a high-level overview. Let me state the obvious first. When a startup raises capital from a venture capitalist, it's not that person's money. A little bit is that person's money, but most of it is raised from LPs.

Can you talk to us a little bit about what different shapes that can take? What types of LPs invest in venture firms and private equity?

Meghan: I think pointing this out and starting here is really important because it's a piece of the industry that's missed so often. One of the surprising things about me starting to talk about LPs on Twitter is how many founders have subscribed to and commented on what I'm doing because it's this black box that actually, the ownership of the company is through an entity that has underlying ownership for some really important causes and people. It's creating returns that are so critical to our economy more broadly.

The underlying LPS really takes two forms. I would say there are largely high net-worth individuals, and then institutions. In institutions, I think people have a tendency and venture to think of endowments and foundations.

The history was that it started with Harvard, Yale, and the Ivy League institutions, but it's so much more broad than that today. Where the growth is coming from in the industry is actually not on the endowment-foundation side but the sovereign wealth funds, public pension plans, corporate pension plans, healthcare balance sheets, and corporate balance sheets more broadly.

It's really important to know and understand the differences between each of those types of organizations, who they represent in their underlying constituents, the advisors and the counterparties, and all of the pieces that come together to bring that capital to bear in a venture capital fund and then ultimately into a company.

David: Even obviously, the difference between a university endowment and a public pension fund. What they need from their capital, the returns they need on what timelines, their distribution, their consumption of the capital, the public reporting requirements, and the nature of the people who manage the capital are completely different, and yet to founders at least and even many VCs, they think it all looks the same.

Meghan: They think it all looks the same. One of the things that are missing in the industry and one of the things that I spend all of my days thinking about is that translation of not just who gave us capital but who is involved in the bringing of that capital to bear and having a lot of empathy for the allocators in what is required of them and from them in the allocation to a venture fund.

If you're investing on behalf of a public plan and you have exposure to something that your pensioners may be sensitive about, you need information and you need to be responsive to what your investment committee is focused on.

You have boards, investment committees, teams, and underlying constituents. All of that is really important to the people that are making the decisions to invest in your fund. We haven't done a very good job as an industry of spending time knowing your customer and operating with empathy—which involves transparency and lots of different factors that we can talk about—but I hope that the industry is evolving today.

One of the reasons I'm excited to be now on the venture side of things is I think that venture has the longest way to go and really starting to translate that.

Ben: It's funny. We opened the episode by talking about you getting to witness venture and private equity going from a cottage industry to a more industrialized professional capital allocation—but it's a lot more professionalized than it was in 2002.

David: It's not yet what I assume you experienced and helped build at Goldman and at TPG.

Meghan: Yeah. TPG, for example, you would think that when I joined TPG at $40 billion in assets that they had figured it out and that the buyout industry—since it had been operating at such a large scale coming right through the financial crisis—clearly, the infrastructure had been laid to efficiently and effectively raise capital and service investors, but it was actually not the case at all.

I joined TPG in 2010. Our what we called capital formation or fundraising practice had four people. I was probably higher number six or seven, and three of us had joined that month. There was very little communication, transparency, proactive marketing, and brand building. All these things that we should talk about on what is actually included in capital formation, none of that infrastructure was laid. That was actually the case for other firms that were growing and building at the same time like KKR and Blackstone. We are all evolving those practices at the same time.

David: At that moment in time—let's take TPG as a snapshot—how many funds were there, how many different vehicles, and how many LPs across those vehicles?

Meghan: They had raised TPG Capital funds six, which was a $20 billion fund. Two years before that, fund five had been a $15 billion fund. They had TPG Growth and TPG Biotech.

Ben: So it wasn't all buyouts at this point.

Meghan: It was not all buyouts, but we had not yet grown. The objective and why we now had to grow our team was because we wanted to build a real estate and credit practice and build on the TPG Growth franchise with a view toward impact and all the things that we ended up building fairly successfully.

Now, looking back, that seems very logical, but in 2010, we were still in the teeth of the financial crisis. TPG had faced some severe performance declines (luckily) temporarily in the financial crisis with some of the large buyout deals like WaMu, Caesars, and TXU. There were some marks on the track record that investors were reeling from.

Ben: And in particular, why this is an issue is in the buyout industry, a firm like TPG would take a company private, buy it, and then, of course, when something like 2008 happens, that company's profitability isn't nearly what all of the forecasts that it was going to be, so servicing the debt required to do the leveraged buyout becomes very difficult.

That's when you get yourself into this downward spiral if you're a buyout firm that just bought an asset. You expected a predictable set of cash flows, but because of the macroeconomic shift, now you don't experience those cash flows. Is that how that happens?

Meghan: Exactly right. It turns out that a lot of those deals ended up being not great but okay. There are levers that you can pull in operational efficiencies and refinancing over time, and the track record ended up shifting. But at that moment in 2010, our fifth fund was marked at $0.50 on the dollar and ended up being around 2X. The sixth fund had a lot of dry powder, but the first deal on the fund was WaMu, which went to zero.

The question is how do you build $40 billion in assets with four people? That's because performance had been amazing. I talked about this because it's what's happened in venture. Performance had been amazing at the same time that investors were increasing allocations to the asset class. Institutional investors were accepting that private equity needed to be a meaningful part of their portfolio less than it is today. In most places, we're growing from 5% to 8%, but if you're CalPERS and have $300 billion in assets, that's a lot of money flowing into the industry.

Performance had been great. You didn't need to have great communication and a lot of servicing because so much capital was flowing in. The macroeconomic picture shifts, there are black marks on your track record, underlying constituents are angry, and you need to work really, really hard to get the trust back of your investors in order to grow going forward. That requires people.

David: And you have a strategic plan to grow and add all these additional products.

Meghan: Right. Because the market has shifted and now it's really interesting to build credit. Talent had become available because of disruptions at firms. Dynamics in banks' regulatory changes were meaning that private market teams within banks could no longer operate as they had been, so those folks were becoming available.

Downturns create great opportunities. You need capital for that. That's hard when your capital base is really upset because not only had your performance suffered, but you didn't communicate well.

There's such an analogy at play with what's happening in venture today. We just had massive increases in allocations to venture, we just had a 10-year run of incredible performance, and capital flowed very readily into the asset class, which fueled the growth of mega-firms, fueled emerging managers and teams, and now the macroeconomic picture has shifted, interest rates rise, growth assets fall, and investors are pissed and need to know what's going on.

David: And almost no firms have capital formation and LP relationship infrastructure in place like you.

Meghan: Exactly. That's what's such a head-scratcher. In capital formation, senior talent is almost always the last piece of the organizational puzzle to be added.

Ben: Makes sense. You basically have the smallest team possible at first. You have one person who's both raising the capital and deploying the capital, and then over time, you start to figure out what functions you need to add. As that person gets stretched too thin and as that person or team—that small general partner team—is focused on triaging the portfolio perhaps, toward the end of a fund, and needs to figure out how to allocate scarce dollars, then you really need someone who's communicating a lot of the hard decisions to the LP base.

Meghan: That's exactly right. You understand why organizations evolve in that way because I think investing is the most core piece of the firm. Firms tend to be founded by people who are investors, not salespeople and relationship managers. Can you imagine having a product without a sales team?

Ben: The right analogy here is sales service and product. The venture investment business is like any other business where you need a product and that product is picking the companies you're going to invest in, and you need a sales arm who's going to go and raise the capital, but you also need service for those customers, clients, and allocators to keep them informed rather than just a quarterly YOLO letter that gets sent out of, hey, here's what we did. No real additional color.

David: Meghan, you said a minute ago that we should talk about what are the elements of a capital formation team. What are the elements? What did you build a TPG?

Ben: Let me ask a dumber question. What is capital formation?

Meghan: Capital formation is the strategy of bringing investors into an investment management organization. It's all of the components that are required to bring them in and service them on an ongoing basis.

The servicing—because of the way that private markets close and funds operate—is that its capital formation is ongoing because you raise the fund, you invest the capital, and then you need new capital. It's not evergreen in nature. Capital needs to be constantly formed in order to service the business because of the structure of the industry.

Ben: The reason capital formation is a virtuous thing for the world is because when you get a bunch of capital in one place, it can act with agency, whereas if all the capital sat desperately with its owners, one, it's not going to find its way efficiently to opportunities.

Two, let's say you're a founder. How are you going to go raise $100 million when there's not a pool of $100 million to raise from? Are you just going to go knock down 150 different doors of individuals, institutions, and pension funds? It wouldn't work. You need to form capital into a pool to allocate efficiently.

Meghan: The industry has evolved to have either internal or outsourced functions in order to do that, but there are some components that are often missing.

What are the components of capital formation? There are two pieces that are well understood, and then the most important piece is less understood.

The first one is IR. People are like, oh, I have a fund and I have an IR person. What is IR? IR is the servicing of your existing investors from an administrative standpoint and from what is required of you in the agreement you make with them when you invest in a fund.

I have to send you a capital call. When I'm making an investment and the money is due from you, I need your contact information to do that. I need to know who and where you are, and I need to give you reporting that I told you I will send to you.

There's an administrative function of IR, and people have a tendency to focus on that which is understandable because these are basic bolts that are required to service the business.

Ben: Often the contractually required components or legally required components.

Meghan: Almost always because when someone is signing up for a fund, you have said that you will provide an annual meeting once a year or you will provide a certain level of quarterly reporting, so you need a team that's going to do that.

The second piece is the fundraising piece of it. I am going out and raising my next fund. I am going to do that either from my existing investors or from prospective investors. I call that the action of campaign management when you're going out to raise a fund.

People can do that with their own teams. There are placement agents out there that can do that very effectively. It takes an incredible amount of time and effort, and it's a draw on massive resources of the firm when you're going out and marketing a fund.

Those are the two pieces that I think are well-understood. We need to service our investors in a legal obligation, and then there's the need to raise a fund at the time that we run out of capital and are almost out of capital. We're going to do that ourselves or hire a placement agent and pay them on a success basis to do that.

this all goes back to someone whose day job and all of their energy is spent knowing and understanding the customer. Having that as a part of your team is really important whether or not you outsource it, whether or not it's internal, and whether it's internal if it's someone that's dedicated like me or someone that's on your team who's going to own it and really make that a part of their mission every day.

David: We've talked about the two basic building blocks. What's the third piece?

Meghan: The third is what I would call product management. That's looking at the portfolio or the fund that you're managing with the lens of what you need in terms of capital and what your customers need from you.

I say that it's actually part of the investment process. It's part of the exiting process. It's looking at everything that you're doing with the lens of how would our investors think about that? Are we delivering on what we marketed and promised to investors as we manage the portfolio?

I include in this the thinking and preemptive thinking about fundraising, strategy, timing, fund size, and portfolio construction.

David: There's actually a whole strategic alignment that needs to happen here. If you're a very basic early-stage venture fund or you're like, I'm going to be a $250 million fund and I'm going to lead series A's, maybe there's less thinking that needs to happen here. But if you're an organization like TPG or Altimeter with multiple products and multiple different types of investors, I totally see what you mean here. There's a lot of strategic thinking that has to happen.

Meghan: This comes to some firms very naturally, but I'd argue it's really important for the $250 million series-A fund as well.

For example, you've got an opportunity to back your healthcare fund, you see a great opportunity to invest in a company that's mental-health-related, and there's prescription of benzodiazepines involved. Incredible economic model, incredible growth, and we should make this investment. How would our investors think about this? What are the headline risks involved in this investment? Is this in line with the strategy? We were mainly in traditional healthcare. Is this on the edge?

The fun part for me in this role has really been the integration. Some of the biggest value that I've provided is the integration into the investing process to say, let's think about how our investors respond to this, not just the market and whether this is a good investment opportunity. It's most relevant and has been most relevant as it relates to exits.

I think that often, GPs have this view of maximize carry and maximize capital, and the best GPs are really thinking about what do our investors need in terms of liquidity?

There have been extreme examples of this more recently with people holding on to public positions longer than investors might want them to. You can debate it. Different investors want different things, so it's really understanding your base and being plugged into that throughout the whole cycle.

David: Like the Sequoia fund and moving to that structure, whatever you think about that decision. Whether that was a good economic decision and a good capital management decision in a vacuum, across a broad set of LPs, some people might like it and some people might really not like it for their own very specific reasons.

Meghan: Yes. That's the thing. Different people want different things. It's just who is making it their data job to fully understand that and bring that to bear as we make decisions. It all goes back to knowing your customer.

Ben: It's been really interesting to me just as I learn more about this world that everyone is definitely seeking returns. In the upside scenario, sure, all that matters is did you make the most money for me that you could possibly make, Mr. or Mrs. Manager? But in the downside scenario, what matters is were you investing in the things that you told me you were going to invest in? Did you do the amount of diligence that I expected of you? Did you do the amount of reporting that I expected of you?

A lot of this stuff is really around if this investment is not the greatest investment in the world or this fund is not the best fund in the world, am I doing right by you on everything else that I said I was going to do?

I was talking with a founder the other day. We were negotiating a term sheet. I was saying, look, you should think about all the downside stuff associated with the construction of this board, the rights, and preferences of the investors because everybody starts a relationship thinking, this is never going to get contentious. But the reason why you have all of this stuff in place is when it gets contentious, it gets thorny, or the outcome isn't good, do we have all the right (in this case) protective provisions?

In what you're talking about, are investment products being executed the way that you said you were going to execute them so you can continue to have a 20-year, 30-year, or 40-year relationship between an owner of capital and a manager when everything's not rosy? Because we do go through cycles.

Meghan: Absolutely. I think that when things go wrong, it all comes out in the wash. That's a very obvious statement, but when returns are great, no one's asking any questions. No one's asking, did that investment make sense? Was that in line with your strategy? Did you do the diligence you needed to do?

Ben: You told me you were a low risk investor, but you ended up being an incredibly high-risk sliver of my portfolio. You made me a lot of money, the DPI is there, and you've wired the money out. Oops, okay, you're fine.

Meghan: There's a lot of forgiveness in return. That actually gets to the last piece of my explanation of what capital formation is. This has been very long.

It's relationship management. There's the product management, which I think happens within the walls of your investment committee and investment process. Then, there's relationship management. How are you managing and what are you providing to your investors on an ongoing basis beyond returns? Beyond returns is what is required of you legally. It means different things to different people and different people have different objectives, but it's so important.

I give Brad a lot of credit. He talks about this all the time. Our investors are with us because they want returns, but they also want transparency and insights. The returns are given. The returns are just the baseline expectation.

There are so many options out there for people to deploy their capital. Chances are if they're investing with you, they want something beyond that. There's a trust factor, transparency factor, and intelligence that exists within your organization. How do they get to leverage that knowledge sharing? Some of it is deal flow and co-investment.

David: That's a huge part of that. Especially as the dollar sizes of the funds go up, there's co-investment. They also have public equities arms, there's more to the relationship, and there are more returns for them to be had on their capital beyond just the returns that you as a firm are providing them.

Meghan: Absolutely. With 10,000 firms in the market this year, chances are they're going to look for folks that can provide all of those things. Whatever is important to them, they're looking at you across a number of different measures. It's really, really important that you land the plane on those things that they expect. Often, it's not totally clear and directly communicated what the expectations are in the relationship, so you need to understand it, especially when returns are poor.

I actually believe that relationships are made when the performance is poor and how you act and how you operate when everything isn't rosy. Some of that is through alpha. You actually outperform when the market is bad, but if things went bad, how did you communicate? Were you delivering more?

That's what makes people stick with you over many, many cycles. Not necessarily from my own experience. Put the firms that I've worked for aside, but you see many examples in the market where firms have had fairly mediocre returns but have managed to continually raise.

I would argue that it's because of the way they manage their relationships. That creates loyalty beyond because if it was just based on investment measures, many firms would be out of business.

David: We've talked a lot here about the neutral to downside scenarios and why capital formation, relationship management, and product management are so important there too.

There is also a huge upside to it too, especially at a firm like TPG or Altimeter where you're in a growth mindset. You're adding products and strategically want to do things on the investing front that require different types of capital than maybe you've had historically. Can you talk a little bit about that aspect of it too?

Meghan: Yes. It's a great addition to that part of the role. It's important to think about that because a lot of firms, as they've grown, have done that not just because they perpetually grow the size of their base, but they've raised additional strategies, new strategies, and other asset classes.

These big multiproduct firms are everywhere now. Even very small firms have done it. We've got a core fund and now we're going to have an opportunistic fund. Almost everybody now has multiple vehicles unless you're just starting out. If you were 10 years into your evolution, you've got multiple products, I would bet. If you nail the product piece and the relationship management piece, that is what creates the opportunity to get strategic new capital when you want to do flexible things.

Intimacy of relationship, trust, and a deep knowledge of how you're operating time and time again that capital does not come from new investors almost never comes from some new prospect that you've developed a relationship. It almost always comes from your existing base.

At TPG, as we expanded asset classes, 80% of that capital came from existing investors in our platform. There are challenges as you grow to think about investor concentration and how you're bringing in new investors versus existing, but if you're managing well—and we have examples of this at Altimeter—you've got deep relationships. You can be tactical and strategic and see new strategies and businesses in really exciting ways. That goes to show the benefit of that day-to-day nurturing that's necessary for firms that truly want to be institutions of scale and nature.

Ben: How do you deal with the situation where an allocator tells you, this is the type of investment I'm looking for either in duration, access to liquidity, or risk-reward trade-off?

You know that what you're offering is not quite that, but it's close enough that you can say, sure, let's do it. That can land a big check for you—$50 million–$100 million—if it's eyeball-able. Have you ever seen that go wrong? How do you handle situations where you're like, gosh, we are so close to a fit, but it's not quite exactly what you're looking for in your portfolio?

Meghan: When there's a large check in play, chances are you're going to want to do that. No matter what size you are, if someone's going to strike you with a $100 million check, chances are you're going to want that capital in your base. I think that being flexible and strategic around how you're thinking about your products is really helpful.

Sometimes, people have blinders on like we need to fit everybody in the box of this fund. Especially right now where so many people are raising and they haven't finished raising, they just want to get everybody into these little boxes of funds.

I always say where are the strategic angles? Maybe find someone who wants a piece of what you're doing and structure around that. Maybe find someone where you fit a need, or at least mostly fit a need.

I think being flexible and considering that for large checks is helpful to a business. You get into trouble when what they're looking for doesn't actually tie to what you're doing or the opportunity set in hand because the capital is not going to get deployed, or it's going to get half deployed and it's not going to turn out well for anybody. I will say be flexible in structuring the product if it actually ties to what you're doing and the deal flow at hand.

David: This makes me think about a firm back earlier in my venture career that I did a number of co-investments with. I won't say the name of the firm, a well-known firm that to my mind did super well. I was very impressed watching it.

They were one of the largest capital-under-management venture firms out there. Their LP base was a little different though. They had a lot of sovereigns in the LP base, especially at that time 10 years ago. It was very different.

What I saw them do time and time again was bring those sovereign LPs in as direct co-investors into deals which also was non-traditional at the time. I wonder if this is maybe a good example of what you're talking about of, hey, we got hundreds of millions of dollars into our funds out of these LPs. They also wanted more, so we were able to do something to give them more and fit them into the box.

Meghan: They're looking for weighted capital that's weighted toward a certain opportunity set. Can you do that through co-investment and maybe structure some economics that makes it worth your while but also creates a blend of exposure that makes sense for the program?

I think the large mega-funds have done that very well, particularly those that were more buyout driven and are now multiproduct. Building strategic partnerships for large pools of capital that are flexible either through economics or strategy to suit needs has led to a lot of growth.

That's where you have to have some sophistication around capital formation to say, not only is this doable or does this match our deal flow, but will this upset other LPs? Are there conflicts of interest? Is this going to create issues if our existing LPs find out about this because you've got a guaranteed co-invest or some other special separate account?

Some of the things that have come to mind are when we structured a lot of different creative things at TPG. We created new products. A lot of the new products were actually seeded with ideas that were solutions for things that investors wanted but also happened to be deal flow that we were seeing in the market.

The way that you can accomplish it is through really, really good communication with your investors if you're creating a new product, you're doing something special, and you've got some separate account from a large state pension plan who specifically wants exposure to clean energy. I'm making this up, but clean energy is a portion of our strategy. You've got a large state pension plan that's looking to build that exposure in a thematic way. We have something that can suit their needs.

How do we do that without pissing off our existing investors? You do that through going to your existing investors, creating reporting requirements around it, and creating a cadence of sharing of information so that people understand that someone's not getting something that otherwise would have gone to a fund and that there are no conflicts.

Time and time again, I've seen these creative structures come into being and be successful through great communication and transparency standards with your existing base that's not involved in those new accounts.

Ben: It's about finding the daylight. If some new LP, big check, or big opportunity for the firm to grow comes in and says, I want something and it first hits you, you're like, oh, that something is going to really bother our existing base because that sounds like some kind of more favorable deal than they all get. It's about finding that daylight of what is the middle ground between the thing that you want where you're still happy, but through communication, structure, or whatever, I can also keep all the other investors that we work with happy?

Meghan: That's exactly right. Leveraging relationship management and having a really good direct dialogue with decision-makers and people that matter is important. Leveraging bodies like your advisory committee. In venture, I've heard time and time again that people make these comments about their advisory committee. Oh, we have one but we've never met with them. Oh, they insisted—they call them LPACs (LP Advisory Committee)—on being on our LPACs. But fine, that's a gift.

If you're not leveraging your LPAC, you're doing something wrong because those are your largest, most strategic investors that you can be engaging in the organization and strategy of your business. Not in a way that you have to be defensive and not in a way that they have deep requirements but in a way that you can learn and have deeper touch points. When you want to do something new, they'll understand where it's coming from or why it will benefit your business.

David: To your point, in your lived experience, 80% of the capital for new initiatives, new funds, and new strategies comes from your existing base. You'd be really dumb not to be engaged with your LPAC.

Ben: Every LPAC meeting is an opportunity to instill more confidence. That can be with bad news or good news. It's one of these things where people think VCs move slow because they take months to make a decision. LPs take years to make a decision, so the opportunity to continue to add those positive data points over time with the most likely people to allocate more capital to you in the future is a no-brainer.

Meghan: It's a no-brainer, but people don't do it. It's amazing to me. Jim Coulter is one of the founders of TPG who was an incredible builder but really a relationship manager. If you really look at the founders of some of the big firms that ultimately became big, public, multiproduct organizations like TPG, Blackstone, KKR, and Carlyle, those firms are led by great relationship management and brand builders that started as great investors, but they spend so much time building relationships.

I always put that back. Why Brad and I really bonded is he knew the investment quality at Altimeter was phenomenal, but when we were coming on, it's like, we could be doing more to really nurture relationships, not because we need to be in a big multiproduct firm but because that's how you become a great firm. You can't just do it with great investing. I think that's what some of the greats from the '90s that built incredible firms really learned early.

Jim said to me once, we are at such an incredible privilege in doing what we do because we are one industry that has an opportunity to directly touch our customers every day if we wanted to. We can pick up the phone and call so and so at the state pension plan that's invested in us or the head of the Notre Dame endowment. You can pick up the phone, call them, and learn from them on a daily basis. How many products out there can you really do that? When you think about it, how many industries really allow you to do that?

Ben: Or would want to talk to you on a daily basis. Most of the time, of all the things that I'm a customer of, please don't call me. But if I've entrusted you with a big portion of my capital, please do call me. I'd love more real-time insights all the time.

David: If Jim Coulter calls the CIO of Notre Dame, that person is for sure going to take that call.

Meghan: Yeah, and Jim is going to learn from it. You're going to understand what's going on in the industry and what's important to them. You're learning about competitive dynamics that you would otherwise not know because they're invested in lots of GPs, and you're learning what people believe makes great products. I think it's a really unique and special element of our industry that not many people take advantage of.

David: It's surprising to me to hear you say that the mega shops in the buyout industry had not yet professionalized and up-leveled to this point when you started in 2010, and now obviously they have.

When you joined Altimeter recently coming into venture, Brad obviously gets this, but the industry does not. But I would suspect that venture is not even anywhere near where buyout was in 2010 in terms of sophistication and professionalization around this.

Meghan: I would think they're probably in the same spot. I think venture right now is probably where buyout was in 2010. In 2010, I would bet that 20% of the firms had dedicated people in fundraising capital formation roles. Maybe 15%. By 2015, 100% of the firm's middle-market on up dedicated people managing fundraising investor relations strategy or they outsourced it.

David: You mean senior people. I think a lot of firms in venture will have somebody who is like, oh, yeah, you keep the CRM [...] piece.

Meghan: They have IR. Lots of people have IR, but I'm talking about making a strategic senior role. A hundred percent of buyout firms today that are $500 million above have someone senior whether or not they're an investor that takes on that role 80% of their time or someone is doing it. That's probably 10% or 15% of venture firms today and probably the largest. They might not look like someone like me, but it might be a senior principal or partner that is really spending their time doing that.

I think it's evolving really quickly and you're seeing it happen in real-time with the way that communication is working. There have been some high-profile bankruptcies, fallouts, and fraud in the last couple of months very recently where there are major portfolio issues. The thing that I'm witnessing and observing is the quality of the communications, how rapid communications are coming out from investment firms, and quick responses on webinars and letters. We all see it.

I think those are signs of a rapid evolution in the appreciation for what you need to be providing your investors, and I think that that will make it happen really quickly because people will realize that you need to have preparation for that. To just scramble, get that information, and turn those cogs when things go wrong is really hard and needs to happen fast, so you need to have some sort of infrastructure around that and the nature of relationships that you can get to. Get to folks when you need to get to them.

Ben: It's interesting. By not having this capability in-house, people have a shadow risk in the organization that they don't realize exists because if something goes dramatically wrong in the portfolio and they don't have the resources on the team to quickly make all the calls, develop a response plan, and communicate well, then that can take down a firm. That can be it. It's like wandering around on the streets with a big family with no life insurance.

Meghan: I completely agree. The number one rule for me in investor relations is no surprises. Do not let something hit the press. Your investors cannot learn of it from the press. Get to them first or get to them at the same time, whatever you need to do. The easiest way to piss off one of your investors is to have them read something good or bad in the news and not have heard from you directly about that.

Ben: And of course, sometimes, you're finding out as a GP something about one of your companies from the press, which is them failing to communicate with you as an investor and there's nothing you can do, but you can at least try to communicate with your investors and say, hey, I learned from this in the press too and I'm working on it.

Meghan: People are understanding of that. Sometimes, it needs to happen in real-time, but if you just have the mindset of no surprises (good or bad) and if you're only achieving it with your top 10 investors, that's okay too. It's just the mindset of what investors need from you.

Seeing this evolve in different organizations, it's actually not just investors. There's an organization and strategy piece of institutionalized firms that you've got your companies, investors, and employees. If you can manage communication while those three parties have an infrastructure for communicating with those three groups, then I think that you're managing your institution very well.

I've seen organizations send emails out to investors about changes in organizations, and the employees have no idea. It happens more than you think. Or you're communicating with your companies about something that's going on about a transition of a team member when your investors don't know yet.

That creates surprise. Avoid surprise, try to communicate, and keep those three sets of constituents in mind.

David: I'm so glad you brought up companies too as another critical constituent of a venture firm and investment organization. Thinking about it now, I don't see any way that the same trajectory doesn't happen in venture over the next couple of years. That happened with buyouts because as capitals flowed into the industry, firms have gotten bigger. Obviously, LPs need this now because they have so much larger commitments at stake and there are different types of capital.

But companies and firms, we talked about this with Brad a lot. So many venture firms are now lifecycle capital providers. If your main investor is XYZ big venture firm, lifecycle capital provider and you're a founder, you're a company, and then you see some bad news in the press, you're like, oh, crap, is XYZ firm going to be here for my next round? These are really important perceptions and relationships.

Meghan: Very important. It's going to continue to be an issue over the next couple of years as we work through the macroeconomic cycle, not just because of performance challenges that certain firms will have, but team changes and turnover is something that really has a tendency to create a ton of dissonance with LPs and founders.

David: My board member just left.

Meghan: Or somebody I knew. This is a people business. The communication around team evolution is something that I've seen people get very wrong time and time again. You need to be super mindful of it. Everybody will face this because it's when the cycle turns that young people make decisions about their career or people just have to make decisions around I've done this for long enough. People have a tendency to stick around when everything's up to the right.

Ben: When we were first kicking things off, you mentioned that there are two types of investors that are the primary investors in funds. You talked a lot about institutional investors. What is the other type?

Meghan: The other type would be individuals. Institutions, meaning you are investing on behalf of underlying constituents. There's an underlying principle that it’s not you and you’re managing capital on behalf of someone else or something.

The other pieces are largely high-net-worth individuals and family offices. This is one of the biggest growth areas in the market because private market allocations have been very small for high-net-worth individuals overall.

Everyone talks about family offices, so we have this perception that they're a big piece of the overall pool, but if you actually look at the percent of wealthy families that are allocated to private markets, venture, and private equity, mostly, it's very small or it represents a very, very small percentage of their overall portfolio.

In some of their sophisticated family offices and the many billion-dollar families, that's not the case, but if you think about the potential allocation for wealthy families, it's massive.

I think I read a Hamilton Lane stat which was that just a 1% move to private markets from the broad base of what's considered to be high-net-worth families would create a trillion-dollar move in private markets.

It's a massive opportunity. You're seeing a lot of people—meaning advisors, banks, and therefore sophisticated firms—focus on how do I tap into that part of the market.

Ben: That's because today, the high-net-worth individuals and families primarily own public stocks, bonds, and real estate.

Meghan: Yes.

Ben: It's interesting that endowments and sovereigns have way more exposure to private companies than the high-net-worth individuals do.

Meghan: I think Brad has talked about this. It's not just high-net-worth individuals, but it's also retail. Can you solve a retail product for private markets? No one's really done it successfully because of how you manage liquidity, how you trade it, secondary markets, and things like that, but this broad group of individuals has missed all of the returns of the last 20 years. They've missed the best returning asset classes for 20 years,

David: Especially post-Sarbanes-Oxley as we were chatting a little bit about before we started recording with Enron and all that, the returns have aggregated to private markets over the last 20 years.

Meghan: Whether or not you believe that will continue to persist, which I think many people believe it will, how do you provide access to that and let individuals find a way to efficiently get capital deployed into private market firms? I think that this will fuel an incredible amount of growth but also create unique challenges for liquidity, servicing a long tail of investors, aggregation vehicles, and things that are necessary in order to facilitate that.

It will be an interesting thing to watch. I would keep an eye on public advisors. There are private market advisors like Hamilton Lane and StepStone as an example. They started as advisors to institutional investors as institutional investors grew allocations. They're phenomenal and do an incredible job of advising and helping facilitate institutional investors' large and small allocations to private market firms. Now, they're very focused on retail and high-net-worth. I think that that's a leading edge and something to watch for what kind of vehicles are created.

Ben: If you think about your average, big, successful university endowment, average big successful pension fund, and average big successful sovereign wealth fund, how do their allocations break down between public markets, PE, VC, and that sort of thing just so people have some vague notions of that?

Meghan: Large endowment—to totally generalize—have been investing in private markets since the '80s. Since the beginning, they are allocation to alternatives. Private markets are probably 40%-plus, really high, and it's mature. They've generally had a stable of managers that's probably anywhere between 50 and 75 funds, which has varied over time. They've done secondary sales, they've cleaned up, and a lot of people have consolidated the number of managers they want to support.

David: But importantly, they're up the J curve on the asset class because when you start in private markets, no matter who you invest in and how good those funds are, you're illiquid for a long time and you're just putting money in. But once you have a stable of long-term relationships, now you're putting money into new funds but getting money out of old funds.

Meghan: Exactly. There are challenges because everyone's managing their allocation to private markets based on a model and expectations of capital going in over time and capital coming out, and now we're in a period of time where there's less liquidity coming out of the portfolio. In addition, your public market values have come way down.

The combination of public market values coming down and liquidity not coming out of your portfolio creates something that people know of as the denominator effect, which is now the overall portfolio value has come down. But because liquidity is not coming out of your private markets portfolio, your private markets portfolio value has not come down. Or because private markets tend to get marked down on a slower pace, you are over-allocated. You have too much exposure. That is very extreme for the endowment community today.

I have a tendency to work with new funds. It's something that I love to do. Groups have come to me and just asked me for advice as they're starting or as their fundraising. It's my hobby. Sadly, I'm a very boring person. They say, oh, we're going to call the endowment. I'm like, don't bother. Not now. They're maybe adding one or two managers a year, and they're over-allocated. It is a waste of time.

Ben: It's interesting that the numerator effect happens slowly where all the returns seem to be coming from the early-stage venture, so we should be allocating more there because multiples in the public markets are really high. It's hard to imagine that performing well. Every year, we allocate up to 16%, 17%, and 18% going to venture funds.

But the denominator effect happens really fast. When the total portfolio value drops because the public markets dropped overnight, even though private markets aren't changing their marks yet, suddenly, you're like, wait, I just went from 20% to 36% allocated to venture funds. What?

Meghan: That becomes particularly problematic if you are an institution that has firm policies around permitted allocation ranges. Now, there are dynamics in 2008 where that became very extreme. There were a lot of organizations that had permitted guidelines, and they had to do secondary sales of their private market portfolios.

A lot of that changed. This cycle, you're not seeing that happen as much because people recognize the nature of the denominator effect. Selling the assets at the wrong time is not the solution. Policies have changed within institutional investors. This is all the maturity of how the asset class has matured over 20–30 years.

David: To your point in the beginning of this, this is all on the institutional side. Retail and high net worth, none of this.

Meghan: It's challenging. We started with endowments and foundations. If you think about a pension fund, that usually looks like somewhere around 10%–15% would be private markets, and then there's a breakdown between typically venture growth and buyout. The endowments have a tendency to look for more ballast of a higher venture allocation.

In insurance, you see a lot of large firms that have dedicated capital formation and people building expertise in insurance because insurance obviously has a huge capital base that is return-seeking capital. Their allocation to private markets tends to be very, very small. It could be 5% or less, but they're talking about very, very large dollars. That has the potential also to increase over time.

Again, watch where people are adding fundraising professionals. That's where the growth is going to come from. I'd say insurance is one to watch. Then, on the high-net-worth side, very, very small in terms of percent allocations, but the challenge is around when you're newer to the asset class, there's less understanding and then also more challenges around liquidity.

David: Do you think that the aggregation of retail and high-net-worth dollars into private markets will come from firms building that capability in-house? Do you think it'll come from intermediaries like advisors and other aggregators whether StepStone and Hamilton Lane move in this direction? Or a combination of both?

Meghan: I think it's a combination of both. Very large firms will build expertise in-house. The mega-firms have 50-plus people doing this. That's largely those buyout-driven firms that I mentioned before, but it's increasingly venture firms.

I've seen that a couple of very large multiproduct venture firms recently have job postings that they're going to hire 30 fundraising-oriented professionals to be geographic- and channel-focused. That's what happens. They're going to hire people that are exclusively focused on high net worth, insurance, or other channels.

Then, I think the advisory community is really important. Whether it's what banks are doing internally, there are unique firms like [...] Capital, or there are other firms out there that are building platforms so that IRAs and others allocate as one. In particular, they're developing products and ways to tap into this broad RIA community or wealth advisors so that you can have access.

We didn't talk about consultants and fund-to-funds. The role that they play in this whole ecosystem is really important. Also, similar to what I said about LPACs, in the last five years, VC firms don't like LPACs and they roll their eyes at consultants. The reason that they do that is because those groups ask for lots of information. They tend to be groups that want access to your data, want to do due diligence, and require a lot of ongoing servicing. It turns out the reason that they do that is they are fiduciaries themselves and they have underlying investors that require information.

Ben: This is one of those areas where you have to be flexible because you're saying, this could be a great partner for us and this could be a great capital to add to our platform under management, but man, it is going to add additional work for us as a team versus these five high-net-worth individuals who previously were our only investors and didn't care what we did. Now, we're taking on someone's capital who also has fiduciary responsibility upstream. They have requirements they've promised and therefore are going to enforce on us.

Meghan: I think it's very short-sighted of organizations to take the road of easy when it comes to capital because you need to think in a more sophisticated way about what can provide you scalable capital as you seek to grow and what is the sophisticated capital because the sophisticated capital will be stickier if you do well. It will be allocating throughout cycles and serve you well as you grow.

Maybe it's because I grew up at Goldman and they're a fund-to-fund and advisory business, but certainly, over time, I've seen the efficiency. Not the strain that advisors in front of us can put on an organization because of the information that they require but the efficiency of raising capital because they tend to be very sophisticated allocators, they have a broader group of clients that they're aggregating underneath, they can move in scale, they can move quickly, and they can be great co-investment partners for deals that are more complicated because they are very well resourced themselves.

I'm a big fan of understanding that landscape. In general. I think it's great practice. If you're managing a fund, you want to have a diversified investor base. Your customer base should not be concentrated and it should represent the broader ecosystem of allocators because each of those different types of allocators will face challenges at different times and you won't get strained if you've got a good practice of diversified investors.

David: Would you put Cambridge Associates in this bucket? The amount of capital that they advise is enormous.

Meghan: Yeah. Cambridge Associates, AXIA, Hamilton Lane, StepStone, Pathway, Cliffwater, and the list goes on are advising endowments and foundations, sovereign wealth plans, pension plans, as well as wealthy individuals, high-net-worth family offices, and things like that. They are advising the broader universe.

Sometimes, the mistake that people make and take for granted is they think that they can market to an endowment or they can call on a pension plan and will be able to get a commitment from them. What people don't appreciate is that you also need to have their advisor on their side. You need to have an ongoing relationship with the consultants and any advisors that they rely on for decision-making so that you're taking into account everybody that's involved in decision-making.

David: It's so enterprise sales. Capital formation is enterprise sales. It's what VCs advise their enterprise companies all the time that they should probably do it themselves.

Ben: We've got a good primer on capital formation. We're sitting here on December 1st 2022 recording this. Over the last few months, you've had some great learnings you've made public on Twitter from conversations that you've had with LPs. I'm curious to dive into some of those. Whether you've already tweeted it or not, what interesting conversations have you had with LPs recently where you've noticed a pattern forming?

Meghan: It's a really interesting time in LP land. It's great. I love these moments because it's when all the learning and all the opportunities happen to upgrade your relationships because when things become turbulent, you have an opportunity at hand to get to know people better and understand what they need. They need very little, as I said earlier, when things are great.

I'm trying to have a lot of conversations, and Twitter has been an interesting exercise, but for me, it really forced me to distill the nature of the conversations that I'm having without peace starting about nine months ago. We're sitting here in December. I guess it really started about a year ago. It was really before the public markets had cracked.

You felt it happening on the LP side already. There was so much anxiousness around portfolio exposures, risk in the portfolio, pace at which things were happening, and fundraising pacing.

The LPs are a great leading indicator of where bubbles and excesses are in the market. A lot of the things I was hearing and what I was putting out on Twitter a year ago or nine months ago is around the pace at which people were raising and deploying capital and the stress that that was putting on LPs because there's a limit to how much LPs can actually continue to invest. There is a limit to allocations.

The pacing of which people were deploying and raising was well-outpacing the capital actually coming back, and LPs were feeling that and very stressed about it.

Then, we move into the new year and into Ukraine, inflation, and different cracks in the market. That's where you start hearing, we need to understand exposures. When things go wrong, the LP motion is I need to understand where I have exposure to this immediately. What is the second derivative? Not only that I want to first understand first derivative exposure, but then I need to understand second derivative exposure.

The immediate motion is that if the Ukraine-Russia war happens, where is my exposure? Then, the second thing I need to know is where are potential knock-on effects to that?

It's happening in crypto right now. One thing that GPs take for granted is they think that LPs know what they own. It happens all the time. GPs think, oh, LPs know our portfolio. They know what companies we're invested in. They don't.

David: Especially not if you're not having LPAC meetings.

Meghan: Yeah. If you're not having LPAC meetings, you're assuming LPs know the portfolio companies that you have and what those companies do. If you're an institutional LP with 75 GPs, you probably have 400 funds that are active in your portfolio, which is probably thousands of portfolio companies. It's really hard to know where you have exposure.

David: Even before going full-time on Acquired, I was a professional GP in venture. Now, I'm an LP in many funds including some of my former funds. I see it and I have no idea what these key firms I invested in. And I used to work there. That's just for a small number of funds that I'm an LP in. I can't even imagine it as a professional LP.

Meghan: It's so hard. Something to keep in mind when you're managing relationships is that people need to know what they own and never take for granted that they understand where you're invested, where you have exposure, and where there's a risk. You're hearing a lot of that stress in some of the things I was talking about on Twitter earlier in the year about how LPs need to understand where they have exposures.

Today, it's a lot about the stress in fundraising and the lack of capital that LPs have for new opportunities today because of the impact of the denominator effect, lack of liquidity, and because firms just came back to the market so fast.

Of the things that I tweeted, I think there are two things that got a lot of feedback or engagement. One thing that I tweeted was that what's really hardest for us is that firms raised four-year capital and invested it in two. We didn't size things appropriately. We sized the commitments that you're going to draw down over four years. You drew it down in two, now I don't have more money to give you even if you're great.

The other comment that I had put out on Twitter that got a strong response one way or the other was if you were a firm that had relatively mature capital available during what was the best exit environment of all time—call it 2018–2022—and you failed to return meaningful capital, it's a no-go, nonstarter, and hard no.

I put this out this summer. I think it was the beginning of this conversation around DPI (distributions versus paid-in capital), the ratio of which you've distributed capital versus what you've actually called from people. This recognition that in venture, a lot of paper returns have been created but what actually has gone back to investors is cash on the barrelhead has been very low. The returns have been great. You are clearly going to keep committing. But we're in a world where LPs are focused on, I don't believe your returns right now, so the only thing I can hold on to is did you actually return capital to me? That's what's going to drive my commitments going forward.

Ben: When do you think that the private market marks start to become believable? That this all shakes out where venture firms' private portfolios are worth what they think they're worth?

Meghan: It's going to take a while in my opinion.

Ben: Why is that?

Meghan: There are a few dynamics. One, companies are sitting on a lot of cash and don't need to raise rounds right now.

Davis: There's no impetus to have a mark happen.

Meghan: So many companies are sitting on cash, so there's no forcing function for a mark. That has generally been the valuation policy of venture firms, which is you mark off of a subsequent round. You can argue to auditors that with early-stage capital, we've got plenty of cash. Public comps aren't appropriate.

It comes down to your valuation policy. None of this is Altimeter-specific. I'm just speaking about the generalities of the industry, but I think that dynamic is going to delay write-downs because people don't necessarily mark off of public comps and subsequent rounds are delayed because companies are sitting on a lot of cash.

Ben: Which just tells why that's a reasonable thing. If an early-stage company is doing $100,000 in revenue and they have zero or negative earnings, well, there's no way to apply a P/E multiple off the sector that they're in of public companies. But even if you apply a revenue multiple, throw what used to be 35X on, and now you're throwing a 15X on, that company you invested in is probably not worth $1.5 million. They have more cash than that in the bank. That would be a silly thing to say anyway. There is definitely legitimacy to you can't value early-stage companies like public companies.

Meghan: It's a very challenging thing. Valuation practices are challenging at an early stage which is why you've had this practice of okay, we'll just value off of the subsequent round and what people are willing to pay. Every firm has audited financials at the end of the year, but there is psychology for certain firms around the timing of marks relative to being in the market and sensitivity to take significant markdowns while they're raising capital. There are reasons to justify why you wouldn't mark it down.

I would argue that there's a lot of psychology around how your marks look at a given time when you are raising capital in the market. GPs are not incentivized to just take all the pain now and LPs understand why you're not.

David: They're not going to believe the marks.

Meghan: You have this very difficult period of time when there is going to be a bottoms-up approach to fundraising that happens for all LPs in that we're not just going to accept your high-level benchmarking and high-level performance. When you come to market, we need to understand the operating dynamics of each of your portfolio companies and try to build up what we think that is worth today. Every GP has to be prepared for that.

Ben: In conversations with LPs you've heard, we want the financial statements of all your companies so we can build our own valuation model of your portfolio.

Meghan: It's not that they're asking for their direct financials. It's to help me understand revenue and growth rates. Walk me through your portfolio company by company or at least the value drivers. Help me understand why it's worth what you say it's worth, and then also help me understand what this may be worth in the future.

What are the prospects for this? As an LP, I'm trying to model out what your unrealized returns and what could be expected from that to get a sense of whether what you've been investing more recently would actually translate to 3X-plus returns or top quartile returns in venture.

David: In the beginning of our conversation here, we've currently only called that 15% of the venture industry has professional caliber capital formation and LP relationship capabilities, whether that's in-house, on the GP team, or external. If you don't have that, you're going to have a really tough time having these conversations if you're trying to raise capital going forward, so this is going to be a forcing function for professionalization here.

Meghan: It will be. This is exactly what happened in a buyout. There became a standardization post-GFC of what LPs required when they were underwriting new funds.

Buyout looks a little bit different. It's entry-multiple and leveraged. There are basic stats that you need for your portfolio companies existing and then an understanding of your strategy and where you're focused. I think for most buyout funds, you can build a very standard data room that will cover 95% of what LPs need based on how LPs post-GFC realize they need to understand and underwrite buyout firms.

That's happening in venture today, that in LPs now, there will be a standard set of information that is required by LPs that is much more in-depth than what venture firms provided in the past about their portfolio. They would use the excuse of confidentiality around portfolio. A lot of it was like, oh, it's confidential, but the reality is a lot of venture firms don't have the data. They don't track the data.

By the way, the buyout funds didn't either. They were the systems, and the systems have created another software. This is all coming together. Look, if you talk to one of the great consultants out there, they'll tell you what the data room looks like. You could figure that out today if you wanted to.

I would encourage every VC firm out there to start preparing now to really understand the set of data and set of statistics that LPs and institutional investors will want. Whether or not you're going to raise from institutional investors, you should be prepared to provide institutional quality due diligence if you're a best-in-class firm.

Understand what it looks like, understand what the DBQ looks like, and prepare for it now because it will be standardized in a world where firms are going away and performance suffers. There will be people that emerge from the pack because of the transparency they'll give.

Ben: That is a great, great note to leave us on. Meghan, thank you so much for joining us.

Meghan: This was such a pleasure. I hope that we can continue the conversation. I hope that the audience got some value out of this session.

Ben: Where can people find you on the Internet?

Meghan: On Twitter, @meghankreynolds.

Ben: Great. Listeners, we will put a link to that in the show notes. We'll see you next time.

Meghan: Thanks, guys.

Note: Acquired hosts and guests may hold assets discussed in this episode. This podcast is not investment advice, and is intended for informational and entertainment purposes only. You should do your own research and make your own independent decisions when considering any financial transactions.

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