White lies, half-truths, and verbal sparring
A peek inside the world of investors
The worlds of venture capital and private equity create fascinating attempts at sales. The conversation that follows takes you behind the curtain to see what's involved. First, some background.
The characters
Character 1, we'll call him VC Joe. He works in venture capital (VC), which is the business of investing in early-stage businesses (e.g. Facebook in 2005). He does this on the technology side.
Character 2, we'll call him PE Ram. He works in private equity (PE), which is largely acquiring mid-stage businesses and then growing them (e.g. what Mitt Romney used to do at Bain Capital). PE Ram does this on the physical side, so non-technology.
*I use male names because only a dismal 20% of VC/PE firms have even one female partner.
The context
Both VC Joe and PE Ram work in industry X, though VC Joe on the technology side and PE Ram on the physical side. VC Joe used to work in private equity.
PE Ram set up the call with VC Joe because VC Joe may know one of the owners of a business PE Ram wants to buy.
VC Joe accepted the call request presumably because VC Joe wants PE Ram's businesses to use the services of VC Joe's investments.
My running commentary on the conversation in italics throughout. VC Joe in regular font. PE Ram in bold.
Hey, it's great to hear from you PE Ram. I'm glad you reached out.
Yes, it's great to see you VC Joe. Remember the last time we saw each other? Must have been years ago...
blah blah introductions blah blah...
Shall I give you a brief overview of where we're at?
Um, of course, yeah, sure.
We're up to 40-odd locations with over 45,000 customers. We just closed on a new business in North America and about to close on a new business in Asia. So, being pretty aggressive right now. We've switched to digital provisions of the service and the feedback has been amazing. We are growing amid COVID-19. Of course, we want to wait until September for things to settle down, but we're still active on the hunt for businesses to buy. Are you doing any physical investing?
Decent opening serve. Pretty standard company pitch. Trying your best to sound optimistic in the face of COVID uncertainty. PE Ram's expecting to hear 'No' and then move on to the intro ask.
Actually, things are a bit different for me since we last met. Can I give you a little background from my side on what's happened in the last few years?
First curveball. PE Ram wasn't expecting to hear a pitch from VC Joe...let's see where this goes.
So, as you probably remember, I was in PE in this industry focused on everything in the industry, both physical and digital. A couple of years ago, I decided to focus more on the digital front with a couple of my business school classmates. Together, we started by raising this fund focused exclusively on technology in this industry and it's been growing fantastically. We just closed on our third fund, which was oversubscribed and we had to hard cap because of all the interest. Great interest around the board. Investors like X, like Y, and even like Z. And now, between all of the funds that we manage, we are the largest investor in the world focused exclusively on this space.
A few things to note here. Note that VC Joe establishes his credibility on the digital front immediately, not saying he moved into this space but rather was already doing it (even if it was less than 10% of VC Joe’s previous role). Then, VC Joe also only highlights one shift (physical to digital) without highlighting the other (moving from private equity to venture capital). Private equity tends to view venture capital with an air of superiority, due to two feelings.
A feeling that VCs are driven more by hype than their underlying fundamentals
A feeling that VC is more akin to gambling due to the more volatile strategy of seeking 'home run' investments that can justify a bunch of mistakes.
So VC Joe deftly avoids mentioning the VC shift. Now, notice the use of 'we' to describe activities for the company he works for, but actions that preceded his joining the company. I find that interesting. Not sure it's negative but interesting. Closed on their third fund sounds very past-tense, doesn't it? And that last fact is technically true - but ignores the fact that several investors have made investments in this industry far larger than their funds, but these investors don't focus exclusively on that sector. So, by saying "of investors focused exclusively on this space", VC Joe artificially designs the parameters to make the fact true. Again, not passing judgment, just noting. Anyways, VC Joe's not done and he continues...
Actually, maybe I can talk to you about some of our investments. This is private stuff, but I'm happy to share it with you as I think you'll find it super interesting. Much more interesting than what we've just discussed. Again, this is stuff we only share with our LPs (those who have invested in their fund) but I think you'll find it relevant.
PE Ram's meeting request has been hijacked. Instead of asking for the intro he wants, PE Ram is now listening to 20 minutes of VC Joe walking through his tech investments. It's quite a return of serve. I’m impressed. VC Joe proceeds to show a report on the satisfaction amongst consumers using the various tech products he's invested in.
Now, this is our proprietary outcomes report, which some of our investors like even more than the financial metrics. Of course, the financial metrics are great. But these show the true potential of the business. I'll give you a high-level flyover of all the companies, and then you can tell me if any of them sound like you want to double-click on to go deeper.
VC Joe proceeds for 20 minutes, going through a 1-minute elevator pitch that seems to demonstrate deep knowledge of each unique company's situation and pathway to success. For a sector where 3 out of 4 investments fail, it sure is interesting that it sounds like all of their investments are on a very successful trajectory. I know some of these investments are pigs, but even I can hardly see through the thick coating of lipstick VC Joe is applying all over them. On one company, PE Ram interrupts.
Actually, in 2002, I looked at investing in a company like that, company XYZ.
Note: Company XYZ is known industry-wide as a giant failure.
Oh, that's interesting. Yes, that was at a different time. Of course, that was never going to work. There wasn't broadband access then, so it was dead on arrival. Now, we're in a completely different world these days and this product is completely integrated within it.
Quite a quick rebuttal from VC Joe. It sounds good, but it's not true. That particular space within technology is full of numerous failures, both before and after the widespread proliferation of broadband access. VC Joe’s company might be on a different trajectory, but widespread broadband access won't be the reason why.
Look, that sounds really interesting. Any chance you could send me that outcomes report? I can pass this on to our operations team and see if any of these are products that our investments might want to adopt. By the way, on your next fund, will you still be looking only at technology or maybe doing some physical investing as well?
Better than nothing for VC Joe. He gets PE Ram’s big physical business in the space to look through his entire portfolio of investments to see if any are useful. Not bad for a random inbound meeting request.
Sure, I'll send that over right now. I think that will be great and your team will find many of these pretty interesting. As far as our fund, no we are exclusively going to invest in technology businesses. They might have a physical presence, but they will always be technology-first in terms of their differentiators within the market.
Ah, I see. Hm - well do you still know PE Ryan? I think you might know him and would love to talk to him about the company MNO.
You can see VC Joe's face drop as he realizes the conversation has shifted back to PE Ram's request. VC Joe has what he wanted and you can tell. There's a noticeable change in his tone and interest level as he replies.
Oh, yeah, sure....I'll shoot you an intro to him. Just send me a separate email that I can forward on for the intro for context.
Well, it was great talking to you. By the way, does your fund accept individual investors?
DING DING DING DING! We have a bite, folks. VC Joe's reaction when he hears PE Ram say this is like Christmas has come early. He remembers that PE Ram comes from wealth and may be able to invest in his fund personally. Looks like that sales pitch on his portfolio companies paid off in even bigger ways for VC Joe.
Oh, yes, it's interesting, we do! For our fund, we had $X m in hard commitments so we did a first close, but we're actually still finalizing our second close of the fund. We're not really looking for money anymore, but rather people like you, PE Ram, who have the type of experience that we can call on. And we do call the people that invest in us. And actually, I know we talked a lot about the outcomes, but we're a top-quartile fund as measured by company ABC. And being sector-specific gives us an information advantage and a win-rate advantage. In fact, 97% of our terms sheets (offers to invest in a company) are wins. The 1 time we didn't win - someone else decided to pay 1.5x as much to invest and we didn't feel it was worth it to match. Oh, and we've done the analysis - 94% of our portfolio is COVID-neutral or COVID-tailwind. 72% is COVID-tailwind. So we are positioned really well.
Wow, don't get me started on this one. So, first, sounds like VC Joe's third fund is no longer closed? That past tense VC Joe used earlier to describe this third fund now seems like much more of a white lie. And only taking investors with experience? BS. VC Joe is looking for anything green. And that top-quartile fund? That's what you call unrealized returns, which exist on paper. Until those investments reach a size where someone might buy them, there's no actual returns for the fund. That win-rate for term sheets? Another technical truth, as investors will often do everything possible to get a term sheet fully agreed and accepted BEFORE it is formally presented. It's like asking your friend to make sure a girl likes you before you ask her out, and only asking her out once he has 100% confirmed that she's going to say yes. Yes, you technically have a 100% hit rate on girls you ask out, but it feels like that's not true in any real sense. Last, are you kidding me with the COVID stats? I think the one thing we can all agree on is that we still don't know what the fuck COVID is going to mean for society and various aspects of the economy. To speak with such precision about the companies that will benefit or not from COVID is crazy to me. Well, anyway, let's wrap up this conversation.
Thanks a lot VC Joe. That sounds interesting - send that PPM (the document about investing in VC Joe's fund) and I'll take a look. It was good catching up with you. I'll send you that email now.
I'm not sure I have a broader point about this conversation. But, to me, it exemplifies something essential about this industry and how many of these professionals can create value. I'll leave you with these facts: The financial services sector accounts for 7% of US GDP and there's $7 trillion invested in the alternative investment sector.