128. Sector & Niche Focused Funds, p2 and Driving Value with a Regulatory Focus (Jordan Nof)

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Today we cover Part 2 of Sector & Niche Focused Funds with Jordan Nof of Tusk Ventures. In this segment we address:

  • Given the current regulatory environment, are there specific verticals that you find particularly compelling?
  • Do you expect more micro VCs, niche and sector focused funds to launch in the coming years?
  • Tell us more about the various ways that you specialize at Tusk.
  • When is the right time to start interacting with regulators?
  • What are your thoughts on working with regulators at the federal vs. the local levels?
  • Do you have any advice for founders and/or investors re. today’s topic?

Guest Links:

Key Takeaways:

1- Types of Specialties

1. Corporates: These are the venture funds created within large organizations with a focus on taking equity positions with early stage companies that pose a threat to their existing P&Ls or create opportunities to expand and grow their business.
2. Vertical/Sector: These include funds that invest exclusively in Real-estate, Insurance, Healthcare/biotech, or any other industry sector.
3. Niche Focused: These are funds with a horizontal strategy that offer some strategic value add. They may be bridging a gap or filling a need that hasn’t existed across the funding landscape. Bullpen is the example that Jordan cited, where they’re providing that pre-A financing need. In some cases, you will find firms specializing based on geography, stage or strategy. The key distinguishing element has to do with the value. Investors and founders alike should ask, “Is the firm investing in this niche because the GP can drive unique value?”

2- Benefits & Drawbacks of Niche-Focused Funds

-Allows the investor to gain access to deals that could be highly competitive… if you have a focus area, you can provide strategic value that other, generalist, investors can not. This can help a small firm earn an allocation in some of the most competitive deals.
-Tighter mandate reduces a lot of the dealflow noise that you see; creating significant efficiencies over the generalists
-Tremendous opportunity for knowledge sharing between niche fund portcos. Some of the best value exchange happens between founders operating businesses with distinct parallels.
-Jordan cited the benefits of information asymmetry. And he gave the example of an LP-base that can provide strategic value and insight during startup evaluation. Also, in some cases, the LPs may be potential strategic acquirers.
-Finally, on benefits, we discussed messaging and developing a brand. When an investor has a distinct mandate, they can message clearly to both founders and to upstream or downstream investors. This creates a brand association for the firm, allowing for much more targeted partnerships.

-Lack of diversification. When one invests in the same area over and over again, they will not have the same degree of diversification as generalist investors.
-There’s the risk of conflicting yourself out. I’ve heard many investors reflect on having to pass on investments in great opportunities b/c the timing is wrong or they believe another solution will be created to better address the problem. Imagine being an early investor in Myspace and having to pass on Facebook.
-Lack of noise that we cited as an advantage can also result in a lack of opportunities. One could miss out on the biggest and best deal that comes their way b/c it was not in their focus area.
-Jordan discussed how sectors can get hold and cold. When sectors get overheated, competition for allocations and valuations increase, while when sectors cool, there can be a lack of institutional LP capital interested in investing.
-Jordan’s final point on drawbacks related to the lack of track record that is often the case w/ niche focused funds. Because most specialized funds are new, micro-VCs, that also typically means that there is little or no track record for the GP. Or it could be a thesis on a new area that hasn’t fully matured, so LPs have to take a risk on a new fund manager in an emerging area, which can present too munch uncertainty for them to get comfortable.

And Jordan reminded us that a firm need not restrict itself too much preventing high-potential, opportunistic investments. In his example, if Travis Kalanick came to him with a new startup, regardless of the circumstances, Tusk would not hesitate to invest. So, even the best niche-focused funds build in some flexibility for situations outside of their mandate.

3- Suggestions for sectors with significant regulatory exposure

Jordan said that “regulation always lacks innovation” and in light of that he had a number of wise points to consider w/ regards to regulatory, including:
-Study the regulatory risks that exist in your vertical focus area. Risks can present opportunities if one is knowledgeable and prepared for those risks. But it’s not advised to be investing in a sector without an awareness of the regulatory climate.
-Get involved early. Here Jordan talked about the importance of working with the regulatory officials to establish guidelines for areas that aren’t currently addressed by the regs. When both sides understand each other’s needs, he’s found that strong progress can be made toward a common goal. The regulators do not exist just to maintain the status quo.
-Jordan mentioned that many of the regulatory battles are fought at the state and local level. While the perception is that most issues are federal but, from Jordan’s experience, he finds that much of the time these issues play out in smaller jurisdictions.
-Some of the industries that Jordan mentioned that really interesting from a regulatory standpoint included: Insurance, cannabis, 1099 workforce-related sectors,
-Where there is significant regulatory exposure, it may be best to partner with another investor or an agency that has real expertise in managing the reg environment.

Tip of the Week:    What’s Your Gateway Drug?

*Please excuse any errors in the below transcript

Nick: So daily fantasy sports, we’ve, we’ve touched on that, but, you know, given the regulatory environment today, any other specific verticals that you find particularly compelling?

Jordan: Absolutely. So, you know, insurance is, is another one. Fintech in general, I think you can go ahead and just categorize it. Insurance is just particularly interesting in the, in the sense that it’s a very, very highly regulated industry that has been just asleep at the wheel for a very long time. You know, we haven’t seen innovation take place in this industry in 50 years. And so there’s a lot of companies out there that are innovating on the product side. Because I mean, if you, if you think about it, you’re going toe to toe with an insurance company. If you want to out innovate them financially, they’re going to take you to the math every single time,

Nick: Yeah

Jordan: because the balance sheet is too big.

Nick: Yeah

Jordan: But if you look at how many great technologists want to, their goal is to work at an insurance company, you’re going to get an astonishing zero. So, but, you know, your best engineers don’t want to be at, at a place where they walk into work and people think that they’re from the help desk or something, you know. They, they want to be in limelight. They want to be at #Google, they want to be at #Facebook, they want to be at your next best startup. And insurance companies know this. They know that, you know, different ways to acquire customers than your traditional broker model, those are areas that are always very, very lucrative in terms of what you look at from a venture perspective and the opportunity for technology to really help scale their operations. So that’s one. I think that there’s one that, you know, a lot of people, it’s really, really, interesting, some people dance around it, but let’s just call it out, cannabis.

Nick: Yeah

Jordan: I mean,

Nick: Sure

Jordan: this is a, it’s a major, major industry that’s unfolding. There’s opportunity there. There’s a lot of opportunity there, you know, in various aspects, whether it’s delivery, whatever way you want to slice it. And it just really matters when some of the, the later stage institutions get comfortable around what’s, what’s happening in that industry. Those are three really solid examples. There’s quite a few though that are kind of piquing our interest, that we’re diving in deeper, that include, you know, some, some aspects of telemedicine and associated decoupling of doctors and the types of therapies that they can, they can provide, and also who can provide them, separating practitioners from doctors to be able to go work more autonomously. And probably a very, very large one that’s going to affect a lot of, a lot of companies is the way that the 1099 workforce actually evolves. So, you know, the On-Demand Economy has been, that’s a great example of something that came in and out of favor really quickly. But something that, major changes in the regulatory environment there could enable companies that fell out of favor to really take off and take advantage of the worker classification that would be kind of like a hybrid between WTO and 1099.

Nick: Yes, certainly I can imagine any time you get involved in an industry where the regs are being written with, you know, a potential huge market size, that that can be a pivotal time both from the investment side, the startup side. And not just being opportunistic and responding to the regs as they’re written but, you know, having some impact on what those regs end up looking like.

Jordan: That’s, you hit the nail on the head there. So, you know, there’s the time whenever you’re, you’re responding and dealing with a problem that has presented itself via a cease and desist or something of that nature. It’s always going to be more expensive than getting ahead of it and gauging with the political and regulatory bodies that are the stakeholders that you need to, driving the narrative to them because this is a completely different narrative than you’re used to telling an investor or, or your customer base. The way that you engage with them is really instrumental and you can have an impact on what the industry looks like from a regulatory perspective going forward.

Nick: Sure. Sure, yeah. From my own experience, small fish here in Illinois, but we’ve had a, a $10M angel investment tax credit for a number of years that just went away this year, did not get renewed. And so for about 5 months now I’ve been working with the Governor’s office to not only get it reinstated but, but increased. And I, I can see the impact that being an active participant in regulation, I’m starting to see, you know, the impact that that can have on innovation and the number of startups that get founded, and the likelihood that startups get funded, and the success mainly that startups can have. So, you know,

Jordan: It’s really interesting that you bring that up, you know, because I think that now people are starting to see that the impact on businesses, a lot of that occurs at the state and the local levels. And for a lot of time people thought that everything was federal. And the state and local level really, I mean, the, the impacts of the regulations that are, that are happening there, you know, as you see with #Uber, as you see with #FanDuel. Like these are state by state battles, jurisdiction, you know, municipality by municipality.

Nick: Yeah, yeah

Jordan: And it’s, you know, the impact that you can have on a business is tremendous.

Nick: So do you guys have sort of a, a state or, you know, even, even a more micro view than that? Or do you operate more at the federal level?

Jordan: No, so, we actually, so we operate across the board. But the area that I think really differentiates us is that we drive a lot of value on the, on the state by state level. So going, you know, we have a multi state team that’s focused on doing exactly what you just described on crafting a, you know, on the regulatory affair side. But, you know, they look at a fifty state analysis, and they see how friendly, how hard is this going to be to pass in each state. And they will attack the, the math accordingly, and, and strategically marry the business case for entering a state with the regulatory environment, and help the C-suite determine what the market entry roadmap looks like. And that’s something that, you know, this is an, it’s always evolving given obviously the regulatory climate. And getting deeper in this conversation I would probably say a great segue would be to have #Bradley come on and talk, take a deep, take a deep dive into, into the regulatory aspect. But, you know, we, we definitely view this, there’s different times that our multi state team is involved. And we have an office in Chicago as well that, that actually that’s what we run out of. And so we, we view the local and state level as kind of a, a sweet spot to, to deliver for entrepreneurs.

Nick: Awesome. Yeah, I was thinking with #Bradley’s experience in Illinois, I should pick his brain on, you know, better ways that I can, I can look at the ecosystem and the environment out here. But, so #Tusk in general, you guys, you’ve got analysts and you’ve got associates that are specialists in, in various sectors as well as different geographies and such?

Jordan: So our, our break out is really kind of unique in the sense that we have scaled drastically. I mean, in essence it’s kind of like we’re venture firm but we’re also a startup.

Nick: Yeah

Jordan: And, and, you know, we’ve grown tremendously. So we have 17 people that are dedicated at #Tusk Ventures to working with startups to provide this regulatory and political expertise, the majority of which are on the regulatory affairs team. So my, my team, my investment team were a three, soon to be four person team, where the people are, are looking at what your traditional venture capital firm would be looking at. We’re looking at TAMs, we’re looking at risks, we’re looking at the founding team, we’re, we’re kind of evaluating it through the process that we grew up in. And then what’s great is that we have these other people that are trained in a completely different, different background that come from the world of politics, that will help us evaluate, you know, companies from a political and regulatory lens. And it’s something that really kind f changed the way that I view investments. So the regulatory affairs professionals are basically there’s a natural fit where their background is. So if they’re a non practicing attorney that used to do M&A transactions for energy, there’s obviously a natural fit that they’re going to be working with the energy companies. Or they’re going to be working with, you know, somebody that has a deep expertise in insurance, they’re the ones leading the charge for any insurance company that we may, might be working with, also on the 1099 side. And so, so yeah, there’s a natural, you know, areas where people specialize on the regulatory affairs side. And then there’s also areas that people specialize with, within my team as well.

Nick: Got it. And any further thoughts or any additional color you want to provide on, on sort of the way that you guys specialize at #Tusk?

Jordan: So the way that, the way that we’re specializing on, on the investment side, the break out of the team is kind of we’re looking like I said like we, we have to be able to add value strategically to the company. I mean, that’s, that’s a non starter for us. But I think that it’s all, all behind kind of the macro thesis that we have that, you know, regulation always lags innovation. And we’ve just seen a major technology boom. Hopefully not the largest one that’s in my lifetime but, you know, this is one that’s, that’s been unprecedented. And there’s only so long that you can go without, without, you know, somebody catching people’s attention. And no one really cares until you start turning a profit. And now we’re seeing a wave of regulatory, regulatory uncertainty that’s, that’s unfolding in the climate that we’re in. And I think that really we’re just kind of being nimble and trying to, trying to see where, where this unfolds and how we can best help our portfolio companies and, you know, focus on, on opportunities that we see emerge as identified by our regulatory affairs professionals.

Nick: Got it. Cool. Any other advice for founders or investors regarding today’s topic?

Jordan: Yeah. You know, I think that, that for founders it’s a little bit different than for investors. So on the investment side, I think that looking at the traditional ICMs that I would write coming into this role. It was kind of the same language for the regulatory risk, you know, that yeah, there’s some associated with it could adversely affect this investment. And that’s about it. That’s being taken a lot more seriously now. I think that after we’ve seen some major headline news about companies that have undergone tremendous amount of regulatory scrutiny getting shot out of markets. Your #Airbnb’s, your #Zenefits, your #Uber’s of the world. These are things that have drawn a lot of attention and to companies that have tremendous valuations. And I think that we’re seeing that also at the earlier stage as well. And we’ve seen situations where this is one risk that can take a company to zero, you know. I didn’t think about it from that lens before. What needs to happen on the regulatory front that would make this company go to zero? And that’s something that, that’s just advice to anybody that’s looking at investment and assessing the regulatory environment. It can only be a grey area for so long, you know, do you have a chance to take a proactive approach. And really just thinking about, you know, who, who are the in tranche interests that are going to start paying attention. And taking one step further before the, you know, beyond the do I ask for permission or beg for forgiveness. And for entrepreneurs I think that what they can do is by taking a proactive approach and going out and, and, you know, there’s some times whenever you want to just build a business as fast as you can. And there’s the time to be laser focused on the product of element. But there’s also the time to start paying attention to this, to the regulatory aspect. And, and it’s one that we’ve seen a lot of startups and entrepreneurs start to do. And the trend that we’re seeing is that they’re getting, they’re starting to pay attention earlier and earlier, which is really, really important. So I think that just keeping that in mind and, you know, as people move into this kind of unprecedented regulatory environment is, is, is imperative.

Nick: Got it. So if I’m an investor and I’ve got a portfolio company that has significant regulatory exposure of some sort, at what stage should I be reaching out to #Tusk, and, you know, gauging your interest? Are you guys early, are you seed, pre-seed, are you series A, or do you invest even later?

Jordan: So that’s a great question. For you, you know, I would just connect you with the right person and just, no, but, I mean, the way that we work with venture capitalists or other VCs are look like it’s not, we are, we are collaborators.

Nick: Yeah

Jordan: And even if it does not fit my investment mandate, you know, I’m more than happy to connect them with the right regulatory affairs professional that understands that industry and can give them free advice, like it’s just okay. Because a lot of times what we’ve seen is alright some people think that they are dealing with a major risk, huge red flag, we may not move forward with this deal. And then after twenty minutes realizing that nah this, this really is actually not a big deal at all. Then there’s other things where that’s kind of written off yeah this is a no brainer, this is, this is a very small risk that we got here, I wouldn’t even consider it a risk. And actually this, this is a, this could be detrimental to the company’s success.

Nick: Mmhmm

Jordan: And so, it’s, it’s, it’s really hard to tell. But directly answering your question on if you’ve identified a risk there, you probably should have called us a month ago. It’s a, but if it’s still in an opportunistic stage, that’s the best time to engage with us. If it’s like okay there’s an opportunity here for us to, you know, to create a, a moat around our business, or, you know, by working hand in hand with helping craft regulation to make sure that we’re proactively thinking about this, the best way to, to engage with #Tusk. But, you know, for investors out there that just need just some advice on, on a particular company or, or a vertical in general, we’re more than happy to, to do that. 

Nick: I’m just glad to hear that you’re going to keep giving me special treatment.

Jordan: Absolutely, you know, you have your personal hotline. But, you know,

Nick: You’re the man

Jordan: it’s one of those things that, you know, we’re more than happy to, to help in the, in the ecosystem even if it doesn’t fit in our mandate. But also, you know, where we found that we’re most effective is really kind of at the, your fast growing institutionally backed like pre-A, you know, through the Series B. Obviously there’s later stage, later stage companies that would fit into this outside of the, our bucket, you know, the exceptions. But, you know, earlier than that, it’s kind of like bringing a bazooka to a knife fight, you know, you really need to be, some of these, some of these founders need to be focused on heads down building up their product and

Nick: Sure

Jordan: and being laser focused on that.

Nick: And for the listener’s benefit, does #Tusk have a committed fund by which they make investments or is it purely a bartering scenario where you’re providing services in exchange for equity?

Jordan: That is a great question that given that the tremendous user base that you have, you know, unfortunately I can’t really comment on the way that capital investments are being made just in, in light of certain regulatory restrictions on that. But I would

Nick: Got it.

Jordan: say that, that it is a two part venture business. You have an advisory side that works hand in hand with, with making capital investments.

Nick: Got it. Cool. #Jordan, if we could address any topic related to venture, what topic do you think should be addressed and who would you like to hear speak about it?

Jordan: Well, there’s a blog post that was written relatively recently that, it caught my eye. It was just one that resonated really well with me. And I’m sure the story’s been told many, many times, but the blog post was actually called ‘The Hard Raise’, and it was put out by #Fred Wilson. And he talked about his investment thesis and how hard it was to raise what we all know as probably the most successful venture, vintage venture fund of all time.

Nick: Sure. We talked to #Lindel Eakman about it.

Jordan: And so it’s, you know, kind of getting, getting that, the full story out of it and hearing about all the, the scars associated with, you know, we’ve all been out there, you know, standing in the rain, chasing a train to catch the last Acela back to New York from Boston or whatever it is. I think that that’s something that could be valuable for a lot of people that are out there, and, and starting their, their own funds or doing, doing in the midst of the fund raising process right now.

Nick: Awesome. I missed that one. That’s just at avc.com, ‘The Hard Raise’?

Jordan: Yes. So it’s been out about two months ago I’ll say. And it’s one that brings me back to my days at #Blackstone when, you know, I would hear, hear #Steve Schwarzman talk about whenever they founded the firm and being stuck in the Atlanta airport trying to get to a meeting. And then, you know, going through my own experiences and, you know, it’s, it’s, it’s definitely a story that is humbling to, to everybody that’s been involved in the process. And I think it’s, it’s good to hear and it’s good also for entrepreneurs to know that venture capitalists go, go through the same thing.

Nick: Alright. Cool. So what startup investor has inspired and influenced you most and why?

Jordan: That’s a great question. You know, I think that there’s, as far as it goes with individuals, there’s quite a few out there. And I, and I think that putting one name, you know, I might say that, you know, #Social Capital is probably one of those firms that, that has influenced me and just due to the ethos. And #Chamath is, is just a voice that’s out there that, he’s got the gravitas that people listen to. And he, he says what he wants to say. And a lot of times, you know, his thought process and his background and it kind of, his story in general just resonates really, really well with what we’re doing here and, and kind of the way that I think about the world. And that really there’s the, the impact side of what they’re doing. But the fact that they’re building businesses there and helping, helping drive value to companies that they’re working with in a way that most people are too scared to think about doing. And I think that’s, that’s definitely, it had the largest impact on the way that I think about investing. That, you know, everybody wants to build a billion dollar business, but that doesn’t mean that it, they can’t be solving a problem that’s important as well.

Nick: Couldn’t agree more. Those guys are awesome. Speaking of which, I think, I think their newsletter which flies under the radar, it’s called Snippets, is

Jordan: Yeah, you know what?

Nick: one of the best in the industry.

Jordan: Everybody needs to sign up for that newsletter. It is, it is one that does fly under the radar too much. And, you know, also just following those guys and, you know, seeing what they’re up to and, and their views on the impact that they can have just based on, on the way that they view the world and getting the, empowering the right people is, is phenomenal.

Nick: Cool. And then, #Jordan, what’s the best way for listeners to connect with you?

Jordan: Yeah, you know, they can connect with me, you know, some people, some people will always say yeah, you know, get a warm intro, don’t, you can just drop me an email. It’s jordan@tuskventures.com. Or you can ping me on, on Twitter, just @JordanNof. And that’s, those are the probably the two best ways to, to connect.

Nick: Awesome! Well, it’s always a pleasure, #Jordan. Thanks for much for sharing your time today and hit me up next time you’re in Chicago.

Jordan: Will do, and I appreciate you taking the time and, and good luck.

Nick: Absolutely. Thanks man.

Jordan: Thanks.