20VC: Semil Shah | The Twenty Minute VC Podcast (Transcript)
On how to raise an institutional venture fund, why LPs mostly have reserve allocation theory wrong & why IPOs and acquisitions are severely constrained.
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20VC: Semil Shah on how to raise an institutional venture fund, why LPs mostly have reserve allocation theory wrong & why IPOs and acquisitions are severely constrained | The Twenty Minute VC Podcast (Transcript)
Length: 28 mins
Harry Stebbings: Welcome back to The Twenty Minute VC with me, Harry Stebbings. I'm always very excited for the start of a new week of shows, and if you are too, then you can find more for me behind the scenes on Snapchat @hstebbings, who two Bs. It would be great to see you there.
But to the show today, and a very special one for me, as I welcome a friend and phenomenal player in our ecosystem. This is a man who, quite literally, has written his way into the business of venture capital to now having raised his fourth and latest fund with institutional capital, I hasten to add. Yes, I'm delighted to welcome Semil Shah to the hot seat today. Now, Semil is the founder of Haystack, an early stage investment firm with a star-studded portfolio, including the likes of Instatcart, Doordash, Giphy, OpenDoor, and ManagedbyQ, just to name a few. Semil's also a venture partner at GGV Capital, one of the leading multi-stage funds and, in the past, he's been a consultant to the likes of Kleiner Perkins, DFJ, General Catalyst and more. If that wasn't enough, Semil's also enjoyed an extensive career in media, having been a contributor for both TechCrunch and The Harvard Business Review. Due to all of this, it really is no wonder that Semil is known for being on the speed dial of some of the industry's most respected VC's, with the likes of Marc Andreessen naming him one of his "55 Unknown Rockstars in Tech."
Enough of these dulcet British tones, I'm now thrilled to hand over to my main man, Semil Shah, founder at Haystack.
Semil, it's such a pleasure to have you on the show today. I'm so excited for this one, a second timer. What can I say? Thank you so much for joining me today, Semil.
Semil Shah: Thanks for making the time, Harry.
HS: Not at all, I've been looking forward to this. I want to start with, for those that maybe didn't hear the first episode, how did you make your way into the world of early-stage venture? Let's start with that.
SS: I was working at startups and also writing on my blog and I had been using Twitter for five years at that point already, so I knew the medium really well. It just so happened, I can't really explain why, a lot of people in the startup ecosystemÔøΩ investors, other reporters, other people at startupsÔøΩ would start reading and citing and sharing my work publicly or privately and it kind of snowballed to the point where a lot of investors would reach out to me. That snowballed into meeting a lot of investors, and that kind of snowballed into a couple of them hiring me as a consultant to moonlight with them while I was working at startups. Actually, it was a lot of VCs that put meÔøΩ They wouldn't hire me, but they would put me in business with a little small fund and I got very, very lucky in that first fund. I think things started to accumulate from there.
HS: I would disagree on the luck there. I think it would be hard work and talent. I do want to carve up the interview today into three differing segments. First, an element of causation on why do managers want to institutionalize their capital base? You spoke about your small fund there, which you've very successfully institutionalized now. Then a discussion on the strategy required to prepare for this raise, and then finish on the wise lessons you learned throughout the process. How does that sound?
SS: It sounds great. You're a pro at this, Harry, so let's go.
HS: Starting on the why, we've often heard small is beautiful, it's easier to return small funds than large, yet more and more desire for institutional capital. Why do seed managers want to introduce this element into their LP base? Let's start with that.
SS: Let's unpack that in no particular order. I think one is it's a thing people do, so you just kind of feel like you should do it. There's a little bit of, "Let me just go try that." I think that's number one. Number two, there's a little bit of branding associated with it, which is not a lot of people get it and so you could be perceived, by other LPs and your peer managers, as being potentially maybe a little bit higher quality, having a more stable capital behind you, somebody who, "Lets co-invest with this person because they're going to have capital behind them." I think, three, people who are going through these fund raise, it's very episodic when you're going with individuals or small families. And even though there's a bit of a process and a bit of formality and it takes, obviously, a lot of time, for the most part, when the institutions come with you, they'll stay with you and think of you in a 10-year lens almost. That's kind of nice too where you can start concentrating your relationship energy with a few folks and say, "How do I help them? How do I share deals with them? How do I think of people that they may want to hire or whatever that relationship may flourish into?"
Obviously, if somebody's out there as a new manager and they happen to be friends with or from, let's say, a family that's doing really well that has a small pool of capital or they have access to a couple of corporations and a good relationship, all the capital is the same in a sense. It's just a matter of does the manager have a relationship with the capital source and if not, then how do you go pick the different capital sources and which ones are most stable? Even though this is my first institutional fund, I have raised and deployed three non-institutional funds already, and so I was continuously raising and deploying all of those funds, had a lot of VCs put me in business, some LPs, as individuals, put me in business. A lot of entrepreneurs put me in business, a lot of my founders invested in my fund. I wouldn't have been able to start without that and I think that's why people go for it, because you can start to build up those relationships and concentrate them.
HS: I'm intrigued because you said about capital source selection and then, just there, with the building relationships. How do you think about the relationship building with the institutional LPs and when is really the right time to start?
SS: Let me answer that in reverse. I think a lot of people I'm meeting today are raising their first fund ever and they want an intro to MIT and Notre Dame. What they don't realize is Notre Dame may not have invested in a new fund in about two years, considered one of the most selective university endowments out there, and MIT, they haven't invested in a fund that is below 140 million, which was a stretch for them. First of all, they're not going to invest in a small fund right off the bat and, second of all, they're expecting the risk associated with that new fund raise to be outsourced to other LPs. I think that's the first mistake people make is, "I'm just going to go and go right to the top." The people at the top have hundreds of millions allocated to the best VCs in the world. It's not even worth their time to consider it.
HS: What's the time to go and meet them just to ingratiate them and start the relationship even for fund two and three?
SS: I think so, but I think it depends on how they're introduced to you. Probably the best way, and you've probably heard this before, if somebody that they know respects says, "You should meet Sally," or, "John has sent us four deals this year and we did two of them," they say, "Okay, let's go put this person on our radar." But I think trying to go and do that and gin it up where there's no natural connection or introduction is a little bit of misplaced energy.
HS: I do get you. I do want to shift to your fund raise, though, and very successful fund raise, so huge congratulations, first, on that.
SS: Thank you. I don't personally think of it as an accomplishment. I'm a more now consumed with the paranoia of how to deploy it properly.
HS: I think that's always a good sign. But I do want to unpick some of the elements that you've said before. If we start on timing, you said before that you wish you'd pre-marketed for six months, not the two to three that you did. I have to ask, first, what does pre-marketing really mean and entail in your eyes?
SS: The analogy I use here is that let's say you, as a fund manager, your fund is a motion picture that you're going to put into theaters. You're going to create a trailer for it, or maybe a couple of trailers, so that people, in a few minutes, can consumeÔøΩ People are talking about the Star Wars trailer today and you're going to want to just talk to people like you might talk to your friend and say, "When are we going to go and see that Star Wars movie?" Or, "What happened in that little scene?" Or, "They left us a little cliffhanger here." I think people just need time, especially LPs, to just think, "Great. I met you in March and I know you're going to start fundraising in January. It would be great to talk to you in the fall," and just keep a record of that. I know I had written six months in the post that I wrote; I'd probably say even longer.
The pre-marketing is just a casual reminder, the casual, "Here's what I'm doing," the casual, "What do you think about this? Do you have any feedback?" It's not about materials, it's not about setting up a formal meeting. Everything is the opposite of formal, but it's very intentional.
HS: Can I ask, how open is one in these conversations? Do you say, "I'm thinking about raising a $50 million fund and we're going to be focused on ML, integrating soon into enterprise software," or is it for less specific?
SS: I can only say what I did, which is just be super open and look for feedback and try to triangulate. I don't know what other people do, but to me, it just seems like, in this day and age, it just doesn't make sense toÔøΩ
SS: Yeah. I think it just makes sense to be open and then see who you click with. A lot of people give great feedback and you just have to go figure out, from all the feedback, where the true North is.
HS: How did you go about that thought process regarding what to take on board from the LP feedback and implement and then what to maybe discard, with difficulty, I'm sure?
SS: I took a lot of notes. I'm still surprised that both entrepreneurs and VCs, when they're meeting their perspective LPs and VCs, don't take notes, so I took notes. I kept refining, I kept showing them a page that we could just draw on together, and then kept refining that work. I would say, in terms of discarding, some LPs will have religion around something where, if after a while, you still don't believe it from your own experience, I think it's okay to discard it. You have to figure out if somebody has religion around something because a lot of themÔøΩ Some LPs are very close to our market and some LPs are this is one of a hundred things they look at in terms of types of assets or types of investments, so you have to take that with a grain of salt. Obviously, if somebody is an LP and helps start a great micro fund of funds and is also a direct investor in 10 different funds, then you know they probably have really good feedback that, no matter how harsh it is, you've got to listen to it versus somebody who's managing $1 trillion where they're looking at private equity, they're looking at real estate and all of this other stuff. They most likely probably don't know the minutia of what you deal with on a day-to-day basis.
HS: Absolutely. I think altering it according to the investor is important. If we move a step down the pipe, though, to building the materials, you told me before that you've had a master slide deck and then sliced it into a short email deck. Why did you do this and why do you think that's fundamentally important? Let's start with that.
SS: This is both for entrepreneurs but also investors, VCs raising funds. The deck is going to be passed around. It's going to be passed around to the person you sent it to, their colleagues, their friends, the LPs that they co-invest with, so make it easy for them to pass it around.
HS: Meaning small and light?
SS: Small and light and PDF.
HS: Do you have any concerns over sharing? I get quite a lot of docs send files from entrepreneurs. Is the ever and all the element of concern over the openness of your deck?
SS: I almost don't want to go here because I've been public about why I think it's a bad idea and it's a controversial thing. I guess I would just say forget about entrepreneurs, forget about VCs, forget about this silly little world we're in. If you are going to write to the CMO of Coca-Cola, what are you going to send them in an email? I would answer your question with a question. I think being brief, direct, tactical, with PDF works best.
HS: One thing that is personally interesting, did you always take paper copies to leave behind as well?
SS: I didn't. The thing I did, as maybe a corollary to that, is I would always have an iPad with me and I would always have not the deck, but very specific slides as images in a folder. By the way, the reason I would email the deck, I never hardly use a deck in person, but what I would do is let's say we're talking about something and something comes up around deal sourcing, I would pull up my iPad and just the act of pulling out the iPad and then sharing it with the person is a lot more social and conversational than having a slide projected somewhere or having it on your laptop. I found that to be very useful. I also put all of those images on my iPhone as well, so I would really literally run up to a person at a cocktail party, after an event and they would say, "What's going on?" or, "How is your fund two or three working out? Boom, literally in a folder on my iPhotos, I would just show them. Sometimes I would even text it to them.
HS: So you don't prefer the pitch to have it in front of you? Do you think it distracts from the narrative and the conversational element?
SS: Part of the reason I love podcasts is I am an audio learner, I'm a conversational learner. I converse by nature; I want to get to know the other person and I hope they want to get to know me. I kind of feel like the email deck is the way you get the meeting, but you close it with your persona, your conversation, your personality.
HS: If you were, then, to perform, say, an 80/20 analysis on the materials themselves, were there core elements that you found the LPs that you spoke to about in the process, were there core elements that they were always drawn to?
SS: Yeah, and I try to do tell this out in the post a little bit. They certainly want to know previous performance and the basic numbers. They want to know, fund by fund, where things are tracking. They want to understand deal sourcing. They want to understand check size, like what check size are you? What ownership are you getting? How are you moving up or down that level? They want to understand who else you're co-investing with, who's following your deals. In this world, we don't have results yet, so everything people look at are proxies for real results and the proxies in the seed are who follows your deals, how much money is put it behind those deals, can you continually do that? Can you intercept the good deals? The problem with all that, that we're going to go through probably in the next three or four years, is those may not be correlated with results.
HS: Absolutely true. Can I ask one thing with regards to the check size? Before, with smaller funds without institutional LPs, it was a smaller ticket size for you. How do you think about scaling up and getting the placement in those incredibly hot rounds with the larger ticket size?
SS: When I mentioned I'm consumed with paranoia now, that is 80% of it. It's a TBD, maybe that will be podcast number three, but I'm going through that mental exercise right now. I would say I would drill down, the most sophisticated LPs I talked to, this was the number one question, their number one concern, and it was the absolute number one thing to key in on, which is I guess you can put 25 or 100 or 250K in this company and you got lucky. How are you going to consistently put $750 to $1 million in a great company? And when you ask that question of a manager, including myself, the universe of people where people would feel comfortable with that is pretty small.
HS: For sure, absolutely. I am interested in another element, though, being the second picking decision and how the larger fund size changes that. How did the larger fund size change your approach to reserves?
SS: Again, we're laying the groundwork for podcast number three, Harry.
HS: This is just presale.
SS: I don't know. I think that what I can say, as it reads relates to reserves, is people will ask you, "What have you reserved in the past?" and so I showed them my philosophy around reserving, which I'll go into. In fund one, I didn't know what reserves were at all. People would ask me, as I was finishing the fund, "What's your reserve policy?" and I literally was like, "I don't know what you're talking about." In fund two, what I did was I put a third of the fund across four companies and I bulked up just to show that I could write a bigger check and follow. And then in fund three, which I just finished, I did quite a bit of one to one following and then I put 12% of the fund into just two companies. So that would be the first point I would make, is you have to show a history of showing the ability to scale check size properly. You don't want to veer off too much because people know, if you go from 250 to a million to 5 million, unless you're an incredible investor, if you veer off that strategy, you're probably going to get into trouble.
The second point I will make is, now looking forward, the LPs will say, "What's your reserve policy?" and, here, I have a slightly controversial view, which is I think the majority of LPs have taken the history of how VCs, institutional VCs, AB and C reserve and bolted that onto seed, whereas I think seed is a completely different asset class. They'll come into the meeting and say, "I think you should do a two to one reserve and put all your stuff into A." The problem with that is a lot of your deals may not go into A and if the good ones do, you may not have access.
HS: How do you feel, then, the new asset class of seeds reserves actually looks?
SS: I can only give you my opinion and I don't know if it's right, but I think let's look at Benchmark. Benchmark has been on the record as saying when they strike with an investment, they try to get all of their ownership upfront and either maintain or ride it out. I think early-stage investors have to do the same thing. I think a few can and will be really good at investing in a lot of things and then pouncing on the things that are working, but most people won't have enough bandwidth to manage that.
HS: Absolutely, I completely agree. I do want to, before we dive into the lessons learned, though, from the raise that you said there from three, two specific elements that intrigued me with regards to one of your posts was you said about the time in the raise and you said a very specific raise date. How do you mentally think about the raise date, potentially not getting to it, and your thoughts around why it's important to do that. Mike Maples actually told me the same thing.
SS: I think, only in retrospect, which I mentioned in the post, the three things that I committed to for myself turned out to be helpful, but I was doing that to just control my own brain and my own mental health, if you will. I told people I was going to stick within a range, I wouldn't take a dollar more than the top end of that range. I told people I was going to budget six months and I told people that it's okay to say no; I'm going to still have money to continue investing. That kind of gave me piece of, "This is just what I'm going to allot to this and let it go after that." Again, I got very lucky at the very tail end of it, so we could really be having a very different conversation right now. I chose for myself that it was taking so much time and so much of my mental RAM, if you will, that I couldn't afford to do more.
HS: Speaking of doing more, I'm also intrigued, you said you weren't willing to go over a dollar on the high end. What's the thesis behind that?
SS: The thesis is, and I think this is also going to be maybe we can start off podcast number three with this one.
HS: I don't want more money.
SS: I am of the paranoid belief that, in any vehicle, if you have over $40 million, you have to be so laser-focused on ownership, regardless of how many GPs you have, in order to have a really good fund. I think we have exited this period where companies are on steroids with capital and growing at immense rates. That's just not going to happen in the next three years again. So, in order to play that fund well, you have to operate like a Homebrew, where you're doing five to eight deals per year and really focusing on ownership and I didn't want to make that promise to LPs. I'm certainly going to be taking a lot more about it, but I don't want to be leaving every deal, I don't want to be committed to every deal for that amount of dollars right now. I felt like that would be, going back to what we were saying before, veering off the glide path I'm on.
HS: You said about the steroids there for the companies and the capital steroids that they're on at the moment. How do you see the market evolving from today?
SS: I'm going to write a post on this soon, which is how early investors have to change their stripes in order to get liquidity. I think that if you and I invest in a company now, what are the chances that it's going to go public? It's lower than before because now there's 4000 fewer publicly listed companies on the NASDAQ and New York Stock Exchange than there were 20 years ago. On top of that, obviously, seeing the best Internet and tech companies that are cash-rich, they're not buying startups in the same way that they used to. So the two tenants of the VC business model, getting out through IPO or acquisition, are severely constrained. This is something that people just don't talk about; I don't know why. I think every early-stage manager, myself included, yourself included, we're going to have to get really good at understanding of how to sell in secondaries and when.
HS: Can I ask, why do you think that it is, because it is a slightly taboo topic, why do you think it is a slightly taboo and how do you see the secondary market playing out with the need for liquidity at seed?
SS: It's taboo because it's reality and how I see it playing out is that, if you're so lucky to have a company, if Stebbings Capital invests in a company that literally goes from a 3 million cap to a $600 million valuation in that round where there's some secondary, you really have to work those handles and probably sell half of your position because when else would you have the chance to do so? Compound that with the fact of, if you have too much money in the pooled vehicle, you may not be able to do that because you need to keep riding that horse.
HS: I do want to finish, though, before we move into a quickfire on I have selected some of my key questions from the raises. Talk to me about broader, more micro tips that you particularly learned during the campaign and if there are any that really stuck out to you.
SS: I saw this in your notes. I guess I would just say one thing, which I touched on before, which is when I raised my first second fund, I just went to people I knew, like founders I've backed, VCs that I've worked for, and would literally be collecting 10K checks, 25K checks. Still took some 10K checks on this one from people that I know. I see a lot of people just going right to Notre DameÔøΩ I'm picking on Notre Dame because I think they're just one of the best groups out there. Everybody is not like Ken Griffey Jr. Or Kobe Bryant; you're not going straight from high school to the pros. So I just laugh inside a little bit when I hear that because I feel like you have to go through that step first. That would be my one learning I would pass on.
HS: I do want to move into a quick fire, though, my favorite of any interview. I say a short statement and, as you know, you give me your immediate thoughts, 60 seconds per one. Are you ready? Are you strapped in, Semil?
SS: I'm ready to go.
HS: Let's start. Your favorite book and why. What must I be reading?
SS: I was very nervous because I know you always ask this question and I used to be a voracious reader but, once I started this fund and then have kids, I do not read books, but I voraciously listen to podcasts, so that's my answer.
HS: Let's do placement agents. Good, bad, what are your thoughts?
SS: I would just follow the interview you just did with Samir at First Republic. If you're an early or unproven fund, early-stage manager, smaller fund, it just doesn't make sense. I think you have to build those relationships on your own. I think if you have been lucky enough to build up a franchise and you have oversubscription and you've returned capital across funds, you're going to have an IR team and you're probably going to work with some agents from the banks because they're going to come to you.
HS: Talk to me, what is the element that you learned the most from this fund raise personally?
SS: That some people simply will wait for you to raise an institutional fund before taking you seriously because they don't think you can raise it.
HS: Is that tough to accept?
SS: No, it totally makes sense. It's the same analogy of why doesn't Benchmark do angel and seed investing? Because they're smart. They outsource that risk.
HS: Your blog is one of my favorites. Tell me, what are your favorite blogs or newsletters?
SS: This is going to be clich‚àö¬©, but I will be wrestling with some issue and I will go back into the ABC Catalog or a bookmark from Fred and I almost feel like Fred is mentoring me through his blog.
HS: I do Google searches with, "SomethingÔøΩ AVC."
SS: Yeah. I think that, in a world where I think it is an apprenticeship business, that has sort of changed. I almost feel like I'll read a post of his from 2012 and say, "What would Fred do here?" Clich‚àö¬©, but it's the truth.
HS: Which first-time fund manager has executed best in raising from your experience?
SS: Meaning they had never invested before or they had never had their own fund before?
HS: They had never had their own fund before.
SS: I will give a shout out to three people. I think the way Homebrew just builds relationships with anybody, including how they set up their LPs, is a master class of just being a pro. I think that's sort of an obvious one. I think someone I co-invest with often, Avidan Ross and Kane at Root, these guys are so in deep in what they do and it's so infectious that I think LPs are just are drawn to them because of that infectiousness, their love for what they do. And then someone who I am lucky that mentored to me a lot, the founders at Lux Capital. Everybody knows Lux now and they've been oversubscribed many times, but literally, for 10 years or plus had a really hard time raising funds.
HS: Absolutely, I love Josh.
SS: I think it takes a long time to go. So I would answer your question with three little shout outs there.
HS: Absolutely love that. Let's finish on your most recent publicly announced investment and why you said yes, Semil. What is it?
SS: The last one that I announced was Ironclad. This is a good one to talk about. Ironclad was a YC company, did it about a year ago, they just raised series A from Steve Loughlin at Accel. The reason I'm excited about it is it's a very good example of the type of investment I want to make, which is investing in a specific person. Jason, one of the co-founders of Ironclad, in the first five minutes that I met him, he just blew me away. He was a corporate trained lawyer, I think he actually went to Notre Dame, and got so frustrated with some e