David Clark: Lessons from 32 Years of Fund Investing - Why Exits Will Be Larger | E1131

Intro (00:00:00)

• There is a prevailing narrative that billion-dollar funds cannot generate fund returns.
• However, data shows that 45 investments have returned a billion dollars to a single fund and were also fund returners.
• To assess future fund returns, it is important to compare current fund sizes with exit sizes in 10 to 15 years.

Introduction to Venture Capital Insights (00:00:23)

• David Clark has been an LP for 32 years, all with Vanap.
• He became an LP by chance after seeing an advertisement in the Oxford Times.
• Clark's interest in VC grew after seeing the emergence of dot com companies and the impact of new technologies on society.

Beginning a Career in LP & VC Perspectives (00:03:17)

• Being an LP requires understanding what you're good at and focusing on that.
• It's impossible to distinguish good managers from average managers when everyone looks good.
• Having experience in the industry helps in recognizing cycles and avoiding mistakes.
• It's not necessary to invest in every great manager, but all the managers you invest in should be great.
• It's important to understand your lane and be comfortable in it, recognizing that it can still produce the expected performance.
• Sometimes it's better to wait for a better opportunity to invest in a top-tier manager.
• Fund of funds don't suffer from the denominator effect, so they can invest when traditional LPs are struggling.

The Art of Spotting Great Managers in VC (00:07:07)

• Venture capital is an industry where 1% of the exits generate the bulk of the returns.
• The same investors tend to be involved in these successful companies.
• Rather than searching for undiscovered managers, it's better to focus on accessing the best-known names in the industry.
• The most successful venture capital firms often have multi-billion dollar AUMs, which can make it difficult for them to achieve a 5x net fund.
• Over 50% of funds raised between 2000 and 2014 had not returned 1x capital after 10 years.
• Only 6.6% of funds generated a 3x net DPI, and only 2.6% generated a 5x DPI.
• This means that only one in 50 funds is capable of generating a 5x fund.

Adapting to Changes & Evaluating the Illiquidity Premium (00:10:10)

• Venture capital can massively outperform the NASDAQ and S&P if it consistently compounds at the top quartile.
• However, the increasing size of venture capital funds makes it harder to achieve high returns.
• The speaker's firm has seen a net multiple back to them of around 3.5x on a blended basis from their mature funds.
• Less than 3% of their funds have shown a TVPI of less than 1x, even during economic downturns.
• There have been 45 investments that have returned a billion dollars to a single fund, mostly in the last seven or eight years.
• The majority of these billion-dollar outcomes were multiples of a billion dollars.
• Fund sizes today should be compared with exit sizes in 10 to 15 years, as that's when the companies will become liquid.
• Technology outcomes are likely to get bigger over the next 15 years.

Venture Valuations & Market Dynamics Post-COVID (00:13:57)

• Technology is becoming more important and capturing a larger share of the economic pie.
• Market sizes for the winners in technology are getting bigger.
• Multiples on individual companies' earnings or revenues will fluctuate, but the markets they play in and the share of the economic pie that technology captures will increase.
• Exits will get larger directionally.
• Incumbents today have managed to have multiple iterations of their products.
• It is difficult for incumbents to innovate and disrupt their own business models.
• Incumbents face challenges and there's no guarantee they will continue to hold dominant positions, especially as new technology paradigms emerge.
• Blockchain and crypto, if they emerge as dominant technology paradigms in conjunction with AI, could significantly impact incumbents.

Navigating Data Effects & AI in the VC Landscape (00:18:19)

• The shift to cloud computing has given established companies significant advantages, but they may eventually be disrupted by companies with different technology approaches.
• Liquidity in venture capital is crucial, and successful managers understand industry dynamics and capture value during short periods of liquidity generation.
• Consistent investing across every vintage, regardless of market timing, is essential for investors to capture liquidity opportunities.
• Increased regulatory scrutiny of big tech companies' acquisitions may make it harder for the M&A market to operate at scale, emphasizing the importance of building independent, durable, and sustainable businesses.
• The concentration of returns in venture capital is likely to become even smaller as a result of these factors, with fewer companies accounting for the majority of performance in the future.
• It's crucial to back managers who can identify, win, and work with these companies.
• Knowing when to exit investments is essential.

Liquidity in Venture: Strategies and Market Concerns (00:23:19)

• David Clark, a seasoned venture capitalist, emphasizes the significance of selecting managers who can consistently identify top-performing companies, irrespective of geographic location or industry sector.
• In recent years, there has been a shift in allocation from China to Europe and the US, as investors seek exposure to the best managers and companies.
• The primary objective of venture capital investors is to achieve optimal risk-adjusted returns, focusing on the output and performance of managers rather than their specific processes.
• Clark's firm's last net new fund was in 2018, addressing concerns about the lack of recent new investments.
• Small funds tend to outperform larger funds, and Clark is interested in understanding the reasons behind this and learning from their strategies.
• Clark is also intrigued by the concept of investing in a large number of new fund managers and exploring the potential benefits of such an approach.

Venture Capital on a Global Scale: Europe and Beyond (00:28:20)

• The investment decision-making process is the product of venture capital.
• Sustaining great returns and what makes a firm great is the process that leads to the outputs.
• It is difficult to know if an investment process is better than another, but one can understand the quality of one's thinking and how they create environments of safety.
• There is no single right way to do venture capital, make decisions, structure a partnership, or have a successful VC background.
• Trying to predict the key determinants of success in venture capital has not been successful.
• Long-term data from LPs is needed to determine successful strategies.
• The feedback loop in venture capital is long, and most LPs will not be in the same job when the feedback comes.
• Venture capital is a power-law industry, and there are new strategies that have not been done before.

Exploring VC Innovations & Strategic Evolution (00:32:53)

• David Clark, a venture capitalist with 32 years of experience, shares his insights and strategies for successful investing.
• Clark stresses the significance of identifying managers who have successfully found top 1% companies, as they are more likely to repeat that success in the future.
• The critical juncture for evaluating a manager's ability to find top-performing companies is typically at fund three.
• Material ownership and the investor's contribution to the success of the first fund are important factors in assessing managers.
• Clark believes that some venture capitalists add value by understanding when to support and when to challenge founders.
• Clark's firm proactively seeks out managers and builds relationships with them to gain access to investment opportunities.

The Importance of Management and Succession Planning (00:38:11)

• David Clark and his team focus on analyzing the top 1% of companies that have exited or are close to exiting to identify potential investment opportunities.
• They seek lesser-known investors in these companies and gather information through soft referencing among their GPs.
• Despite challenges in being an LP, Clark sees opportunities to invest in top-performing funds by understanding entry points and intercepting managers during difficult periods.
• The lack of liquidity in recent years has affected LPs, but the denominator effect has dissipated.
• Clark prefers to sell public stock positions rather than hold them, as he believes it's not their job to hold public stock for investors.
• He advocates for venture capital firms to distribute profits regularly to investors rather than holding onto them for an extended period.
• Clark believes the best venture capital managers can identify top-performing companies and have the confidence to hold onto them, even during challenging times.

The Economics of VC: Fees, Carries, and Future Returns (00:45:25)

• Nvidia's remarkable growth was driven by the unexpected rise of mobile gaming and artificial intelligence (AI) after its initial public offering (IPO).
• Venture capitalists should consider holding onto companies with promising future prospects, such as Square, which had untapped potential in its Cash App.
• Successful venture capital firms handle succession effectively by setting age limits for partners and creating opportunities for younger talent to contribute fresh perspectives.
• Firms that struggle with succession often have senior partners who overstay their positions, hoard economic benefits, and hinder the growth of junior partners.
• It can be challenging to identify issues within a firm due to conflicting information and the lagging nature of venture capital performance indicators.
• To maintain a healthy firm, it's important to observe the flow of new talent, value the contributions of junior partners, and provide them with opportunities to influence the partnership's behavior and strategic direction.
• Venture capital firms have different approaches to leadership transitions. Some firms, like Excel, have successfully transitioned through multiple generations of leaders, while Sequoia has a unique approach where leaders step aside for the next generation. Foundry Group operates on a different model where they accept that the group will eventually dissolve when its members are done working together.
• The venture capital industry is known for the willingness of successful investors, such as Sequoia's Mike Moritz, to give back and mentor others.

Reflections on Investment Decisions and Mistakes (00:51:23)

• The speaker's firm thoroughly monitors their fund managers' portfolios and conducts a comprehensive diligence process for every investment, including references and a thorough investment recommendation.
• The diligence process aims to identify any potential issues that may have been missed and is not limited to investing in two or three funds from a manager.
• Team issues are the primary reason for not investing in a fund.
• The firm sends internal benchmarks to their managers to compare their performance with peers and works with them to address any lagging areas, such as DPI.
• When declining an investment opportunity, honesty is essential in providing managers with the reasons for the decision, as it allows for better understanding and acceptance.

Adjusting Deployment Timelines & Performance Metrics (00:56:59)

• Time diversification in funds is important, and managers should maintain a three-year investment cycle to ensure accountability for performance.
• Net performance is prioritized over fees and carry, with tiered carry structures reflecting performance.
• Fund sizes are monitored to ensure the potential for returns from a single investment.
• The firm invests in early-stage and growth funds, with a 50/50 allocation between the two.
• Growth funds tend to return distributions earlier than early-stage funds and are more economically sensitive, with valuation and exit size playing a more significant role in growth investments compared to early-stage investments.
• Despite the strong performance of some growth funds, the firm is comfortable with their 50/50 allocation because the best managers can pick the best companies regardless of stage.

The Future of Venture Returns & Fee Sensitivity (01:04:46)

• Existing funds will likely experience more pain due to unrealized losses and potential business failures.
• Loss ratios for early-stage funds are expected to return to historical averages, with around 60% of companies not returning 1X cost.
• There is a significant chasm in valuations between different investors, making it difficult for LPs to assess the true value of their underlying book.
• The venture industry has expanded significantly over the last 30 years, leading to different segments within the industry.
• In segments where capital is a strategic advantage, such as late-stage private rounds, returns may decrease due to increased competition and efficient entry values.
• In other segments, such as seed stage and early-stage investing, where capital may not be a strategic advantage, the craft approach and understanding market potential can still yield excess returns.
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Quick-Fire Round (01:09:35)

• Venture capital investing involves a high degree of uncertainty, but referencing managers in the same sector can provide valuable insights.
• Triangulating information from multiple sources and understanding VC biases is crucial for informed decision-making.
• Direct co-investments by limited partners can optimize returns by focusing on top-performing companies.
• Democratizing venture capital allows everyday investors to access top-tier firms and indices.
• David Clark believes venture capital can significantly outperform other investments over the long term.
• Challenges include accessibility for individuals and broadening the sourcing of general partners.
• Maintaining a specific strategy is essential for consistent performance, and diversity initiatives are encouraged.
• Clark regrets missing an investment opportunity due to pension fund limitations.
• US university endowments show strong venture capital performance, but balancing local support and top-performing managers is challenging.
• Succession planning is crucial for the firm's future, and local investors should choose managers based on performance, not personal connections.
• Genuine discussions and disagreements foster a dynamic and innovative market.