102. The Limited Partner, Part 1 (Lindel Eakman)

*Please excuse any errors in the below transcript

Nick: Today we welcome Managing Director of #Foundry Group Next, #Lindel Eakman. #Lindel is a nationally recognized leader in the limited partner community, having successfully managed the private investment program for the 35 billion dollar pool of capital at the #University of Texas Investment Management Company, #UTIMCO. He spent over a decade there where he was responsible for overseeing a portfolio of private equity fund managers, which represented approximately 25% of the endowment assets spread across mandates including venture, growth, buy-out and credit investments in developed and emerging markets. Many folks who talk about LPs are quick to mention #Lindel. And we’re very lucky to have him join us today. #Lindel, thanks so much for coming on.

Lindel: Appreciate that and glad to be here.

Nick: And I know you’ve, you’ve got to say a little disclaimer here that this is not any sort of financial advice. So do you want to get that out of the way?

Lindel: We should do that. The, the SEC has had us register as a advisor. And so because of that we want to clearly say that we are not fund raising today. And per my compliance person’s language, this discussion is solely for informational purposes and not an offer to buy to sell or a solicitation of an offer to buy or sell any security or instrument or to participate in any trading strategy. There, I said it, we’re covered. We’re not raising money, we’re not looking for investors.

Nick: Okay, very good. Very clear. So #Lindel, can we start off with sort of your background and your, you path to becoming a Limited Partner?

Lindel: Sure. Well, I mean, as you said in the intro, and thanks for that, I come from a more diverse background where I looked at all private asset classes. And I was able with this last jump to join some great partners in focusing on venture capital. For me, having been at #UTIMCO for a decade, I saw a lot of ways to make money and I saw a lot of fun and interesting ways to invest around the world really. But for me, the most fun, the most interesting, and oh by the way, the highest returns, came through venture capital. And it was really I, I think a function of my relative youth when I took over the portfolio, and also just my natural interests growing up with an Apple II computer and playing in chat rooms that really led me, you know, building a website with true html back in the early 90s, that led me back to this area of investment and got me excited about it. My best networks were in venture. And for me to be able to make the jump to focus solely on venture has been a real luxury in, in the first year it’s been a lot of fun.

Nick: Great. Can you tell us a little bit more about what you’re doing at #Foundry Group and what you’re focused on with #Foundry Group Next?

Lindel: Sure, thanks. There’s a running joke in the partnership that, that I’m the new guy and I may forever be the new guy with, with much hazing involved. #Seth, #Seth Levine was the new guy until I came along. And, and so he’s glad to have me. But, you know, when I looked at, at my career opportunities and all the different things that I could do with my time, thinking about the strategy that we ended up focusing on at #Foundry Group Next, it was that I questioned whether LP co-investment made sense. Depending on who you were specially or whether a stand alone fund to funds made sense. And then when I started having these conversations, you know, my partners were some of the best investors around, had proven themselves in early and in growth investing through their own funds. They had also personally invested in funds with really great success. And it came to all of us in conversations mostly friendly to start with and giving me advice on, on what to do next, that we could combine those things. And so that’s what we did. We raised a fund that does a couple of different things. We think it’s a differentiated model because we’d lead with direct investments, using my partner’s #Brad, #Jason, #Seth and #Ryan as the leads, participate on boards, put together proactive rounds with companies. That’s not that different, in that we have a, a fund to do that. Our fund invests both in #Foundry Group early stage companies, so like an opportunity fund that many others might have, but 25% of our fund is also reserved to invest in companies coming out of the last 25% of our fund, which is a fund to funds model. There we’re investing in a sleeve of early stage managers that will deliver investment opportunities similar to the co-investor model but with us leading them and being a lead investor in those. We felt like that was a differentiated model, happily LPs and entrepreneurs have agreed. So we raised a fund relatively quickly. And we’re really happy to be able to give back to the ecosystem across the stages. You know, in the early stage, you know, with the seed managers and the micro VC managers, the pre seed managers, with, in the early stage with our own #Foundry Group early stage fund investing in other funds that we like to co-invest with. And now with the, in the growth stage with this vehicle that gives us another mandate to participate.

Nick: So what are some of the ways that you, you are differentiated at #Foundry? How are you getting a leg up on, on others or how are you getting sort of a better advantage with this new model?

Lindel: You know, I would, I would say exactly what we’re looking for in funds. And I think that’s, you know, that’s the area of probably the most interest for listeners here is how do LPs think about funds for us? We focus in our early stage, and that means a seed or pre seed or really Series A, could be to have some exposure there. We want to support new and emerging managers. We also want to support our friends that we’re already close with and, and draw them closer into our network. And that’s generally going to be sub a hundred million dollar funds. It’s technology focused, it’s North America. You know, I have invested across the world. I, I would recognize there are a couple of great opportunities in Europe and particularly in Berlin and London that are interesting to us. We’ve invested in China, it was great. You know, from now my seat in Boulder, not Texas anymore, it’s difficult to invest in some of those foreign markets. So we’re focused on North America to begin with. We like the small funds where we can be helpful to them. And, and I think differentiated in a couple of ways. I bring an institutional LP perspective that many of these small funds may not already have to start with. But I also bring the experience of, of my partners, you know, in an experienced GP perspective. And we help to really help our fund investments grow their own business in a sense. Thinking of investing in them and helping them grow their own business. Whether it’s thinking about portfolio strategy, it’s or it’s a tactical situation with the portfolio company, or it’s, it’s fund raising, or it’s practicing for your annual meeting, we feel like we can bring some advice and some experience to them. And hopefully it’s, they, they see that it’s helpful and, and differentiated in sort of the fund investing model. The second piece of the, of the pie is, is the direct investments. And where we have that friendly fund relationship, where we have the perspective of years of investing experience from the direct side. If I’m doing my job correctly, I am working with the underlying GPs to find those companies for us to participate in earlier, and in fact, before other growth investors might see it and before other VCs might be aware of it, because we have been an investor in their funds.

Nick: Great. So how did the transition from Texas to Colorado go? I know, I know the culture in Colorado is pretty unique and it is in Texas as well?

Lindel: Well, I would say I’m a proud Texan, which is something you don’t say very loudly in Colorado. We, I, I’ve had family appear in Boulder for, you know, since the 1970s. And so I’ve been coming up here to Boulder. And I would argue that Austin and Boulder have a more similar culture than any other two cities in Texas and Colorado. So relatively easy transition so far. And glad to have the family up here in getting settled with me.

Nick: Awesome. Well, as you know clearly, today we’re talking about the Limited Partner or the LP. And we have discussed LPs in bits and pieces many times before on the program here. But for those listening to the program for the first time, can you start off with the simple definition of Limited Partner?

Lindel: Well, I think there’s, there’s probably a legal definition and, and given that I’m not an attorney I won’t provide that one. Although I’ll try and simplify it a little bit to represent that it’s not just in the venture industry or the private equity industry or real estate. This is a model that’s been around well since before I was born, much longer than I’ve been alive. It’s when an, a limited partner is, it’s a capital provider that invests usually with other capital providers. It’s in a pooled vehicle. So several different people will invest together in a vehicle that is actively managed by the general partner. In this case we’re talking about venture capital and venture capitalist firms. There’s a certain set of terms and agreements. We call it the Limited Partnership Agreement or the LPA, where the limited partners don’t have active participation, but they do limit their capital at risk to the invested or the committed amount. Like I said the industry evolved a lot over time but the limited nature gives the GP discretion and in return the LP receives limited liability. And that’s, that’s the model that much of the industry has settled on. There are often people trying to come up with new models and with new structures. And I’ve always listened attentively, but I’d say 98 -99% of the industry follows that limited partner model.

Nick: Got it. So most people think of LPs in sort of two groups. We think of the, the institutional LPs like the endowments and the pension funds that you do have a lot of experience with, and then we think about sort of retail LPs. So those individuals of high net worth that are making commitments to venture funds. Can you talk about some of the, the large strategic differences between some of these groups of, of LPs?

Lindel: Well, you know, I, I mean, I’d say capital can come from anywhere. I mean, the most common is actually, you know, individuals or family offices. I think, you know, institutions are recognized because of their, their size. They could write a big cheque. Generally they have a long term nature depending on which type of capital it might be. There’s a usually a commitment to the asset class, and that usually has a staff. Sometimes it may not be a big enough staff, but it’s a staff that has a, a, a charge to invest in the asset class. Yeah I think, I think appraised for, you know, consistency in their long term nature, endowments or foundations get a lot of press because an endowment or a foundation often have a, a time horizon in, in perpetuity. So, you know, they’re investing, they’re playing the really really long game. You know, pensions often will have a longer term horizon. You get public pensions which we hear a lot about in the news today. Increasingly private pensions are going away but they’re still large sources of capital, you know, for the industry, you got insurance companies. And then you have collective vehicles such as OCIOs which is an outsourced CIO institution that effectively likes, acts like an outsourced endowment staff. And you might have an OCIO that gathers up some smaller institutional moneys and, and delivers the benefits of scale and the cost savings  of scale by having one staff. Those have been something that have really grown since I came in the industry. Then of course you have fund to funds. And fund to funds, I would say they’re, they’re looked down upon historically, largely due to capital uncertainty and frankly under-performance, and, and, you know, in a lot of cases. But I would tell you that, that I don’t think they should be because they are the ones most committed to your asset class as a GP. They’re the ones that are most aligned, and usually they attract people that have the most experience because they have a different compensation structure than many other public entities that I just named.

Nick: It almost sounds like some of these institutional LPs are well positioned for an asset class like, like venture because their horizons are, are in perpetuity for a lot of these funds. And venture is traditionally very long time horizons with low liquidity. Is that why you find, you may find a higher percentage of allocation of portfolios in these institutional investors toward private equity and toward venture than you’ll find elsewhere?

Lindel: Well, you know, there’s, there’s actually a lot of downside that comes with, with some of these, these same ideas. So they’re appraised for size and consistency or time horizon, they are a dedicated staff. But you know, there are, there are challenges too. There are gatekeepers, which I’m sure you’ve experienced, you know, would be they consultant or be they service providers. There are slow decisions. Generally there’s a, there’s a longer process. And maybe multiple levels of process. I would say that the incentives are generally wrong for staff at some of these places. And that they end up attracting a, a very risk averse type of person when maybe they would better off taking more risk. So they do come with challenges, yes. They write big dollars but actually if you look at a percentage of their portfolio, and it, this is totally generalizing, but it’s very low. Whereas you might find an individual who’s willing to take more risk, right or wrong, and you’ll, or a family office that’s willing to take more risk and have a higher percentage of their assets, you know, over their whole balance sheet in venture or a perceived riskier asset class like venture.

Nick: Yeah. Speaking of that, what, what would one expect when they look at the, the portfolio breakdown of percentages to different asset classes including venture of a, a big pension fund for instance?

Lindel: Well in particular I’m, I’m, you know, a big pension fund, I’m going to say a public entity at this point is what we’re describing. Because the privates, they move around a little bit more. You know, the public entities, there are a lot of public pensions that have zero allocation

Nick: Yeah

Lindel: to venture.

Nick: Yeah

Lindel: It’s just too small. It’s not something that they know how to do. It is perceived as very risky. And you know, they just, they just can’t do it. There are groups that have, you know, one to two percent in venture. Many of these larger public institutions are forced to use some sort of collective investment vehicle or fund to funds or another separate consulting group or staff group to help them invest in venture. Because they just don’t have the resources to do that.

Nick: Mmhmm. And, and what about the endowment side? Is it, is it pretty similar, the portfolio breakdown or is it, is it different for, for the large endowments?

Lindel: You know, for the very largest endowments like #UTIMCO, it, I mean, that’s part of the reason I left #UTIMCO is they had a challenge of scale. It’s very difficult when you’re trying to deploy 25 or 50 million dollar cheques into 25 or 50 million dollar funds. Turns out nobody wants that much, much customer concentration. But, you know, I’d say to generalize, well, for example, at #UTIMCO we had over a billion of NAV in the ground. You know, it looked like, depending on how you counted the total assets at #UTIMCO, somewhere around 4 or 5 %, the investable assets they could invest in a long term entity like that. That’s pretty high. And I’m proud of what #UTIMCO did and how they set the asset allocation and I’m pretty proud of how we executed when I was there. #UTIMCO’s been a good partner to venture and will continue doing that. They did suffer from, from the challenge of scale and being public. So having 4 or 5 % of a large amount of money is, is, is meaningful to the industry. I would say that foundations or smaller endowments are more apt to have, you know, 5 to 10% of their assets in venture, and have been the real squirters of the asset class over the years.

Nick: So in a large endowment like that, will there be dedicated personnel that focus on venture capital and/or private equity? Or do the professional folks at the endowment, do they have focus that spans across asset classes?

Lindel: Well, I’ll use my own experience by example. And say that I think endowments are generally better staffed than most of the other LPs institutions that we’ve, we’ve brought up. However, my old portfolio is about 5 billion dollars of NAV, and there were 5 of us managing. So sort of a, a billion, a billion per

Nick: Wow

Lindel: And that makes it difficult. Because we’re covering, you know, the world and different types of private capital structures. And, you know, in some ways you’re just a fly by investor. I used to say, and it’s probably still true, I spent way more time on venture than I should have when I was at #UTIMCO. But I did it because I liked it. And there’s a difference, I mean, when you’re forced to do it. I, I think that a credit manager is a great way to make money. But it just was not interesting to me. And so I would spend less time with that. They had, they had someone great working for me that, that worked on that area of the, of the portfolio. At #UTIMCO, I spent probably only about 25 -30% of my time on venture. And then I also had another woman that worked with me that spent a, a similar amount of her time on venture. So together we were not quite half or round about half of a full time employee, an FTE.

Nick: Okay. And #Lindel, I wanted to get your perspective on this sort of dynamic between asset classes competing against each other for allocation within an institutional investor, versus within a specific asset class like venture capital. You know, different fund managers competing against each other for allocation of that amount that’s been previously allocated to venture capital. Do you find that often the dynamic is a competition between asset classes? Or do you find that the institution will earmark a certain amount for these different asset classes and then the fund managers within those asset classes are, are competing for those dollars?

Lindel: You know, I think there are elements of both there. You know, I wish it were cleaner than that. But I, I think of any private structure is a structure not representative of the underlying exposure. So I, I think of venture as just a type of equity exposure in a particular structure. And you could think of that as different than your credit, it’s different than investment grade assets or different than hard assets like real estate and natural resources. That, there’s sort of all different types of risk and return profiles. But venture is really in my mind, venture is really competing with other equity exposure to justify it’s place in the portfolio.

Nick: Mmhmm

Lindel: It is the case that many institutions will set a, an asset allocation target. That’s done both to help the staff build exposure. So yes it does allocate  a certain amount of money. In fact we can talk about why that doesn’t work well in a minute. But it does allocate a certain percentage usually of capital against that. But I also, you know, I also think that it’s a challenge for staff when you think about it makes investors more procyclical than they otherwise would be, because of the denominator effect. So think of it as equity exposure, think of it as competing and earning it’s place. It does have a different longer lockup. And because of that illiquidity we believe it should earn a higher premium to more traditional types of equity exposure or more liquid types of equity exposure. And that’s who it’s really competing with and earning it’s place. I would say it’s also high touch. One of the biggest challenges for institutional LPs is bandwidth, not capital. And, you know, when you think about your Return On Time Invested, your ROTI, is how do you justify the time investment with limited staff against the smaller opportunity set. Well only if it provides a higher return profile would you do that.

Nick: And then you mentioned some of the weaknesses of setting an, an asset allocation target. What would, what are some of those?

Lindel: I, I mean, I think the biggest is the procyclical nature of it.

Nick: Got it

Lindel: You know, I think the, I think the, the, the board and the consultants, the staff and, you know, everybody are well intentioned. But my goodness it makes you procyclical in your expansion or, or subtraction. Because it’s based on the denominator, which is the total endowment, which mostly grows or shrinks based on the equity exposure. So you’re doing what everybody else is doing all at the same time. And that, that ends up being a, a real negative in my mind. LPs ought to pick an exposure level and amount of capital they’re comfortable with or range. And as long as, so long as they’re in that range they should have a steady diet of investing in GPs every year.

Nick: And it, I assume that that’s the strategy you put in place at #UTIMCO as well?

Lindel: It largely is. I mean, we weren’t immune to the market movements. You know, and, in 2009 that was an eye opener for sure. But yeah I think we were largely able to support our managers, you know, when the, when the time came. I mean, the other reason they do percentage exposure is so they can bench mark staff, right. So it, it creates a, a portfolio and allows them to bench mark staff against. You know, on a year by year basis with this, with certain bench marks.

Nick: I think the, the other challenge was cyclicality with regards to venture is when you get a significant retraction in the market, how do you get the money out of venture to, to adjust that target down?

Lindel: Right. You really, I mean, there’s, there are people that, that do secondary buys but it’s, that’s not a good place. LPs don’t do that.

Nick: Yeah

Lindel: You know, my friends at a secondary world would, would kill me for that, but I, I, I don’t know of a case where the LP wins. Now there are reasons to do it but I, I don’t do that. You know, the only thing they could do is stop making new commitments. That, that really is the only lever you have as an LP is whether you make new commitments. And that might mean that you miss on your favorite group because they have to be fund raising at that point in time. And that is a real sad thing for an organization, say #UTIMCO that’s public that’s really fighting to, you know, to get their place at the table. Specially when they want to have, you know, a large seat or a large allocation of a smaller fund.

Nick: Sure. People talk about some of the best startups being built in recessions and, and I bet some of the best, most bullet proof funds were also built in down markets?

Lindel: Well, there’s a clear cyclicality of returns when you look at advantages, and largely correlated to fund raising. And too much fund raising and too many people just getting loose with capital.

Nick: Mmhmm

Lindel: And, you know, GPs get graded by LPs all the time on their pace, you know, on how, on how quickly they deploy the capital and they want to see them build, build time diversity, you know, in their own investment efforts and have a little discipline around it themselves. Unfortunately LPs are kind of the worst of that bunch, because, and I’ll put myself in that court, we are always chasing and responding to the market because you only have that one lever. So we always look for GPs that had some discipline about deployment.

Nick: Yeah. So I want to get into some of the fun stuff here. So you’re an LP and whether it be at #UTIMCO or at #FG Next, you have to assess VC fund managers and make choices about who you want to invest in. What are some of the key items that are factoring into your decision on whether to invest in a fund manager?

Lindel: Yeah, I think it’s, it’s worth noting this is tangentially directed at that question. It’s, it’s worth noting that almost all institutional LPs or even fund to funds have an existing portfolio. You know, and so you’re always in competition or being graded against that existing portfolio. And I use the analogy of a, you know, a, a, an athletic team, a pro sports team, where you know, the, the salary cap is the limit of the amount of capital you can deploy, based on your, on your percentage allocation we just talked about. And you’re constantly trying to upgrade that, that roster. So when a GP goes out to fund raise, the first place that they’re, that the person they’re, you know, competing against is the, the person is already in the portfolio. And so that’s, that’s important to think about when you’re, when you’re comparing yourself. We were public at #UTIMCO. People can request the, you know, the portfolio. And we would actually have people come in. And in some ways it was pretty smart. But other ways it was annoying. We’d have people come in and, and have pulled our portfolio and say oh I’m better than that guy and I’m better than that one and that one and that one, and look what we did, and how it compared to our returns. Then it was always the little apples and oranges. But certainly I have to give them credit for being aware that that was the competition they’re in. To, to directly answer your question that what are we looking for? In, in our case we have a, a list of sort of six broad categories. It’s, it’s, I call it sourcing advantage. So you know, what’s the ratchet? And, you know, each of these have sort of a small bullet points and I’ve actually thought about putting my, my score card online. I probably should. But then everybody would use it against me. So, you know, the sourcing advantage. One thing that, that I think we put a lot more emphasis on is internal team dynamics. And how the team works together and how they, how the decisions get made and the alignment and body language around each other. And how does that work. The third thing and, and probably more of importance for me is the strategy in the portfolio construction. You know, does the fund size reflect what their strategy is? And does the, you know, does do they have real sense for exactly how they want to build a portfolio? And will they hold themselves accountable to that? Again, getting to, to enforcing discipline on yourself. It’s not that you can’t evolve over time. It’s that you do it in a way that, that, that recognizes where you fit and what you said you were going to do. I think the fourth thing, and, and some people put this first on their list, is performance. You know, have, have they had multiple successful exits? You know, what, how do they, how did they do versus their peers? Are they on fund, you know, ten, you know, and, and, and what’s that performance been, or, you know, has cash really come back? You know, for us, we’re not going to have the benefit of, of that long performance record. One, just based on who we’re investing. Two, is we’d like to think that we can let the return potential of an unrealized portfolio. And we want to look at kind of the loss ratio. Is there a, a reasonable loss ratio or at the right distribution of returns? Is it, is it one, is it repeatable? What do they expect and how are they investing against that, you know, from a performance standpoint? The last two I’ll go over quickly is, you know, what’s, how is their external relationship both, you know, with, with their LPs and you know, with, with other GPs, you know, what kind of partner are they? Will they, do they overlap with #Foundry? Do we know a little bit about what they’re doing? Do we have a history there and know how they act inside a fund and, you know, do we have some perspective on how they act on a board of directors? Is there a likelihood that we’ll do some, some direct investments together? You know, what, do they want us involved? We don’t want to force our way into a relationship where they don’t really want us. So we’re, we’re really want to be both ways in that. And then the last thing is legal terms. And they, you know, they’re pretty standard at this point. But there are some things that are non-starters for us.

Nick: Got it. And does the criteria or the way that you’re assessing, assessing fund managers change if it’s a first time manager? I mean, clearly you’re not going to have the track record, but anything else?

Lindel: Right. I mean, I mean, the track record’s one thing. Actually, you know, I don’t think so. Yes I do like to have people that have experience, both success and failure. I think you learn a lot from failure. You’re a smart, humble person. But you know, I think that, you know, lacking the, the track record, but you need to have a very cogent message and very well thought out portfolio plan, and, and frankly how you’re going to build your business. You know, whether you’re going to build your business, be it through a podcast here or, or through other, other ways, you could create, you know, an edge. And do we find that edge compelling, do entrepreneurs find that edge compelling. You need to have some evidence of that.

Nick: Right. Right. You know, back to your analogy with the baseball team and, and draft picks, I’d imagine that the, the size of a contract is also a critical factor to you because if you’ve got an existing roster of, of fund managers that are all running 50 million dollar funds, you could find the hottest, new, first time fund manager in the midwest, but if they’re only raising a 5 million dollar fund it’s, it’s not really going to move the needle?

Lindel: Yeah. I, I mean, I think that’s right, you know. Everybody has got a portfolio construction theory. I do too. And, you know, we’re going to do 12 core positions or we’re going to do a number of smaller pilot positions. And, you know, for us that holds me accountable. You know, we’ve closed 8 fund investments this year and,  you know, that is, it’s, it’s a foot on the gas. You know, if you start early so time to slow that down a little bit, hold myself accountable to that time diversity and that portfolio construction we defined early