134. The Importance of Storytelling, VC EQ, and the LP-GP Dating Game, Part 2 (James R. ‘Trey’ Hart III)

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Trey Hart of Northern Trust is back to cover Part 2 of the GP-LP relationship. In this segment we address:

  • GP LP Relationship with Trey HartKey mistakes that GPs make
  • The key characteristics that successful GP’s share
  • The importance of an ownership focus
  • What winning really looks like for GPs, in terms of metrics (ie. DPI, TVPI, IRR, cash on cash, bulge bracket follow on, etc)
  • Trey’s final thoughts on the GP-LP relationship and who he’d like us to have on the program

Guest Links:

Key Takeaways:

1- The General Partner – Limited Partner Dance

We kicked off the conversation by discussing the importance of storytelling. This transcends the LP-GP relationship and even the venture business. One’s ability to synthesize their experience and craft a compelling narrative is essential in relationships and in sales. Ultimately, a VC pitching an LP is a sales process. Both capital and expertise are for sale. Trey emphasized the importance of timing, during this engagement. He said that one needs to know when a sale is going to happen. The people that stand out are those that understand the cadence of fundraising the best. They need to know when to push and when not to push. And the reality is that a lot of LPs don’t know what they’re looking for, which can put a lot of stress on the GP.

Trey suggested that the most important component is framing the conversation. He aims to have an open and transparent meeting where he, the LP, is clear about what he’s looking for so as not to string along the GP and waste everybody’s time. As he said, there are way too many people to meet with in this business. It would serve everyone to clarify intentions upfront and engage under the right pretense.

2- GP’s that Stand Out

Trey thinks of GPs in two groups:
1-Those that are easy to give money to but are hard to get into and
2-Those that are hard to give money to but are easy to get into

In the LP community, this is what separates the bad from the good and the good from the great. Trey cited Lindel Eakman as someone who has routinely given money to the latter and enjoyed tremendous success doing so. The best in the LP business are those that make money by giving to managers that are yet unproven. I’d venture to guess that there is a similar parallel with GPs giving money to entrepreneurs. Proven founders often raise at very high valuations early on, limiting return upside. While first-time founders may be much harder to assess, the upside opportunity is higher for those GPs that take the risk. Hence the return profile for the earliest stages in venture capital is often the highest.

Trey said that the truly great GPs have mastery of stage, sector or geography… and in some cases all three.

A few unique characteristics that he’s looking for includes:
-An actual track record
-Unique relationships within the geographic center of their investment
-How integral of a part of the ecosystem the GP is to all the most important things that spin-off; including companies, entrepreneurs, and technologies

And to finish this point, Trey said that Northern is trying to invest as much around those clusters and centers of influence as possible.

3- GP Red Flags

In any engagement, Trey is looking for cues that a GP may have an integrity issue or an emotional intelligence issue.

The following are red flags that he’s observed over the years…
-Do they push too hard, too early trying to close the sale before a relationship has developed?
-Do they misrepresent their track record? One of the most difficult parts of being an LP is figuring out who truly led investments and deserves credit. Misrepresentation and inflating one’s accomplishments rarely have a positive outcome.
-GP does all the talking. They don’t bother to find the points of commonality. Whether it’s family, hobbies, background, investment philosophy, etc… the points of commonality are a great way to establish rapport and build a relationship. Remember this is going to be a long relationship.. one where it’s not easy for the LP to get their money back if they have second thoughts.
-And finally, Trey mentioned that with the good ones you’ve got to make sure they’re not having strategy drift and that they have a team succession plan.

And I’ll leave you w/ a quote from Trey, on a clear disqualifier. He said, “when you’re trying to make judgments where you’re thinking ‘I don’t want to give people money if I think there’s an integrity issue,’ you’ve got to trust your gut because it’s almost always right.”

Tip of the Week:   What Winning Looks Like in VC

*Please excuse any errors in the below transcript

Nick: Let’s talk a little bit about mistakes that, that GPs make. You’ve written a little bit about this in the past and you’ve met with, with many GPs at this stage. What are some of the, the common red flags or mistakes that, that jump out at you that you see GPs making?

Trey: Well, mechanically speaking, definitely when somebody leaves a firm and joins another partnership and takes the track record with them, when that isn’t tight or really well papered, and, you know, well I did this deal and I did that deal and somebody says otherwise, when LPs, when you, you know, you give them a little itch they will scratch. And they will scratch until they get the truth. And if they don’t get the truth they’re not going to give you money. And if when they keep digging down that hole trying to find out are you lying to me or is somebody else lying to me who’s sandbagging your track record because you’re really good and they’re pissed you left, pardon my language. That’s where LPs, one of those things we get paid to do and love to do is, is not catch people in the act but, but find the truth. Right? This isn’t a gotcha thing. Because at the end of the day if, if we are on the side of yeah we did amazing work and this person’s suggesting they didn’t do that track, that wasn’t their deal, well we have the proof that it was. And we’re going to be the best LP to that GP possible because we did all of this work. And we’re happy to share with other people because we found the truth. But when people, when GPs aren’t on the right side of that, and they make mistakes either due to an unintentional oversight or sometimes with malcontent, that is, it’s a, that’s a big problem for building a, a relationship based on trust that’s going to last for a very long time. And you see that more often than not,

Nick: Really?

Trey: Yeah

Nick: How?

Trey: more often than not. So. Or I shouldn’t say more often than not, that’s just like 51% of the time. But that happens frequently. So, and that, that’s, that’s disappointing I guess. That’s a challenge for sure. I talked a little bit about, you know, just understanding the kind of fundraising cadence and, you know, the, the art of the, the sale, right? The art of getting an LP to open up and talk about themselves. The best GP calls that we have, if, if I’m a GP the best call that I have is the one where I do the least amount of talking.

Nick: Yep, right.

Trey: Where I’m learning as much as possible about this LP. Because then I’m saying to myself okay, okay, they like this and they like this and they don’t like this and they’ve done this and this, okay, they, you know, oh and this LP loves to do these things outside of the office, right. I’m thinking, I’m thinking to myself wow, you know, there are a lot of points in contact where we have similar philosophies, we have similar investment strategies, similar, you know, passions, similar family structure, whatever those points of commonality are. Those are opportunities to find likeness in people.

Nick: Sure

Trey: And when those, when like, you know, when it starts most, I swear most introductory calls start with, with this, this awkward who’s going to talk first about their own stuff, right. Well, why don’t, I’d love to tell you more about our firm but Trey why don’t you start giving us a little bit more information about, you know, whether or whether not to trust us and what you guys like to invest in. And when that happens, I’m always happy to. And I give so much detail that, or at least try to, it doesn’t always happen, sometimes like you’re in a bad mood because of the how this whole chicken dance goes. But trying to give as much information as possible so that there’s no questions. It’s like was that helpful? Yeah this was amazing. Like couldn’t, you know, you, like let’s go back. Let’s just, this is table stakes for how I want a relationship to be. I’m going to answer every question you have, give you as much information as possible. Because at the end of the, end of the call I don’t want you to be like, you know, well, boy, you know, we just wasted an hour when you told me you have no interest in this, in being, investing in a UK block chain fund, you know. Why did we just talk for an hour?

Nick: Yeah

Trey: Well, when you reach out to me and you say hey Trey I’d love to pitch you my UK block chain fund, the first thing I’m going to do is say Nick thanks so much for reaching about your UK block chain fund, this is really cool but we don’t have a mandate to invest in this. Either because we never invested in Europe or we’ve never invested in block chain, or I don’t know what block chain is. And say back to you, I’d love to have a call but I don’t think we’re likely going to make a commitment here, but I don’t want to waste your time. And so if you don’t want to have a call, I totally understand, but I really appreciate you reaching out. But I would welcome the opportunity to have a 30 minute call with you to learn about what you’re doing. Because that’s what at the end of the, I’m just trying to learn and be proven wrong that yes we need to have a UK block chain fund. And if you take that as a mission of I’m not going to sell you something but I’m going to educate you and make you smarter about what I’m doing and make you share the same belief that I have about the importance of European block chain type analogies, I’m going to make you a believer. And that’s, like I said before, that’s, that’s one of the things that gets lost right out of the gate in the relationship between the LP and GP if you cut the friction out and make sure everybody understands what’s trying to be accomplished before you start the, the dialogue, if you will. Those are the things that, that kind of most drip on people I guess, those LPs, you know. And the the thing most LPs like to do the least is to turn people down. You don’t have to if you, if you say before you even talk to somebody, we’re not going to invest in this fund, you know, because we don’t have a mandate for it, we don’t know anything about it or x, y and z. And that’s incumbent on both the GP to ask and the LP to offer. And so it’s kind of a two way street.

Nick: So I want to revisit this point about what separates good GPs from great GPs. Can you talk more about the key characteristics you see in the exceptional fund managers?

Trey: Well, they’re in that two buckets. The hard to get into, easy to give money to, and that’s all focused on just I would say mastery of a certain stage or sector or geography. And sometimes all of the above frankly. And that’s more of a you lose, you lose sight of, you know, they are awesome people or, and this isn’t to say that they aren’t, but those kinds of firms where you’re investing because of past successes and hoping for the past performances indicative of future results, you generally are going to get there, you’re trying to mitigate as much or minimize as much friction in the fund raising process and with the relationship with the GP, where you generally know those managers maybe less on a, in a intimate personal level than you do the other manager where you’re spending a ton of time trying to figure out are they good or you’re taking a risk that they aren’t. Or else with the managers that have done really well and, you know, you think that they’re a life cycle brand and they’re going to be around for a long time. And you just keep throwing money at it. And I don’t mean that like casually. But you keep allocating capital to them smartly thinking that, you know, that they are going to continue to grow as a firm and keep up the historical success. There you are, you’re making sure that they aren’t doing strategy drift and, you know, are making sure they think about team succession and that the younger folks are getting carry and all those things, and, and feel like they have a voice in the future. And at the other side of the house, the folks that are harder to give money to but easier to get into, I think things that are, you know, uniquely identifiable, at least in our camp is not, like we’re not looking generally speaking for niche sub sectors, sub industry funds. Where to a certain degree the micro VC landscape has moved because it’s, you know, it’s easier to find unique shelf space if you are unique by some geography, sector, stage, what have you, edge, capital, structure, whatever, than it is to say well, you know, we’re, we invest both in consumer and enterprise but it’s all seed. They, you know, they, those funds are a little bit more difficult to find or they’re, you know, a little bit older by vintage of, you know, when the firms were started. But I think a few of the unique characteristics for those funds that we are looking for which are mostly, you know, seed or new things even if they aren’t seed, is an actual track record generally speaking. And just unique relationships to some of the more important centers of influence in your geography of investment, whether that’s Israel or Beijing and Shanghai in China, or in the US if that’s Boulder or New York City or San Francisco or, you know, the Palo Alto or now Los Angeles if you will. And so how integral of a part of the ecosystem are you to the most important things that spin off companies and entrepreneurs and technologies and all those things. And trying to invest in as much around those clusters of centers of influence as humanly possible, I think are the most important things that we are looking for when we’re investing in something that isn’t already obvious.

Nick: You and I have talked in the past about sort of the importance of an ownership focus for funds, certainly depending on stage, but can you talk a little bit more about what you mean by this and why it’s, it’s important even if, you know, some GPs aren’t, aren’t focused on it?

Trey: So I think that when we talked a little bit about the ownership, one of the more important things I think we talked a little bit about, it was about the importance of ownership in, in newer markets where you generally are, let’s pick Illinois for example or Chicago, where you have newer vintages of funds and newer vintages of partners within those funds. And you’re trying to build out an ecosystem or further an ecosystem that already exists. More often than not the funds that are raised in that ecosystem are going to be smaller by total committed capital because they are less LP sources of capital flooding into those managers because they aren’t, aren’t yet proven or the market isn’t yet proven. And we can debate whether that’s true or not, certainly about the state of Illinois. But many times focused, the investment strategy then is focused more on lets prove that we can get access to good companies in the ecosystem, and then over time build to the ownership. And I think that the ownership is, is specially in smaller, in smaller geographic centers of influence where there are, there historically have been less big exits, that ownership is a very important thing to be focused on because, you know, with smaller exit outcomes and smaller funds, you need, you need to drive that value some way. And if it isn’t going to be lot of exits or a few huge exits or many big exits, that, the ownership will be one of those things that helps drive, you know, returns if you will. And specifically around I think Illinois managers I think that you and I have had a nice conversation and I think a shared belief around the importance of, you know, if there’s going to be a next #Groupon or #Braintree or #InnerWorkings or #Neutral Tandem or a company like that or #Cleversafe in Illinois, that the local investors are going to want to be the people that benefit the most from it. And

Nick: Sure

Trey: that’s where if you’re being perceived as taking a lot of risk for investing in a pre-seed deal in Illinois, well you should get paid for taking that amount of risk. Because until LPs start to march with their capital and, and risk appetite, you should be I think being compensated for the risk that you’re perceived to be, being taking by investing in such a company in a less proven geographic center. And that’s where ownership is what you get paid the most with I think frankly.

Nick: So I’m hearing a variety of different opinions on what winning looks like from a GP standpoint as I talk to various GPs that have raised first funds, second fund, you know, you hear the standard metrics like IRR, DPI or TVPI or, you know, bulge bracket follow on. When you’re looking at track records, what, what stands out to you? What are sort of the key things that you’re looking for to determine, you know, if, if a VC is winning, you know, during the, the life cycle of a fund before it’s, it’s fully played out?

Trey: Yeah, this is a tough, tough question because you’re going to get a lot of different answers and none of them are, you know, great from a scientific standpoint in helping solve for what does a good venture fund look like. And part of that is because benchmark analysis are only as good as the data that they’re, that are provided to them. And not everybody reports to #Cambridge Associates. And, you know, Net IRR is I don’t think is a great determiner of, of outcomes because it’s one thing that you can, you can change.

Nick: Yeah, sure

Trey: TVPI is one thing you, I mean, you can change on an unrealized basis under, you know, Topic 820 or whatever it’s called, the old FAS 157. But DPI is not something you can change. It is what it is. Once you give it out, you can’t, you know, you can’t call it back except for, you know, certain, certain circumstances around demarcation at the end of the life of a fund. But it’s not focused on boring issues like that. But the problem is right now so many people’s performance looks good. And so discernibly actually benchmarks are important because if everybody’s performance looks good and everybody’s got a 2x fund, a 2x fund is maybe on an absolute base is what people are hoping to get. And whether that’s gross or net I don’t know, depends on your, your risk profile as a, as an LP. But that’s where actually benchmarking is important. Because a 2x in 2013 may be kind of average versus a 2x in 2001 which could be killer.

Nick: Mmhmm

Trey: And if everybody’s performance looks really good right now and everybody says oh everybody’s got a 2x fund or everybody’s fund has a fund to the top quartile, like how does that statistically make sense? I think LPs are spending a lot more time or at least should be spending a lot more time understanding how the companies underlying those marks are performing. And understanding, you know, what managers are paying in terms of revenue multiples or what they’re being carried at and when do the mangers carry a portfolio company at something other than the last round price. And what does it, what does it look like for that manager to go through an audit, and how much, how much change is that, and whether they have to write something above the last round price or below the last round price because of the capital structure or, you know, the financial performance of how a company is doing if you will. But more often than not, you know, the GPs provide a deck and they provide the legal documents and maybe some backup excel file of here’s cost and term record value and ownership and maybe initial per year current, you know, enterprise value or something like that. But where right now I think LPs, again except for those ‘hard to get into, easy to give money to’ managers, the other, you know, portion of the, the industry, LPs I think are trying to take more time and be a little bit more discerning simply because of the denominator effect of having a lot of capital that’s going out and not as much that’s been distributed. Where that denominator effect of needing more distributions to fund future uncommitted capital, is, is, is restrained on people’s ability to want to continue to do more and more and more, specially really quickly. And so I think that LPs are starting to do, look more beyond just what is the top line performance or how are the actual underlying portfolio companies doing in the, in the fund. Where if you’re looking for interim marks on how is a fund doing, you want to kind of know how the companies are doing.And that’s where, that’s where the diligence is, you know, not just are you first quartile, are you second quartile, or have you changed the strategy. Those kinds of things because there’s a lot of managers that are up for, you know, raising a roman numeral three right now, that got started in 2011 or even 2013 and are up for roman numeral three. And folks have been in for fund one or two, and fund three is kind of like where there will people taking a long hard look at the manager and making decisions about whether or not they continue to fund the unrealized dreams of what I think, you know, the manager is trying to build too. You know, it’s, it’s not a perfect answer. But I think with the number of new managers that have come into existence since 2011, that people are spending more time on the metrics of the portfolio company than they ever have probably in the, you know, first, in the years prior to that.

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

Trey: So before we recorded this session or started to record this session, we were talking about I thought it would be really interesting to do a podcast or a series of interviews with the first generation of, of VCs. Men and, both men and women who, you know, started some of the first funds. And whether that was 60 years ago or only 20 years ago or only, you know, 10 years ago. To capture those stories. And not because oh I want to learn, you know, what advice could you give a young VC today starting out. But really I think learn from what venture was like then and, and try and see what those anecdotes are that you pull out of their successes or their failures. Or probably more likely successes than failures, based on the folks I think we’re thinking about, you know, you were chatting about it would be fun to interview. But those are stories I think need to be recorded. And, you know, there’s occasionally some chapter in some book that somebody wrote over some period of time. But I would really cherish the, those stories and the ability to, to, to do that. So those are the folks that I think I would most want to talk or learn from right now.

Nick: Anybody in particular, like someone?

Trey: I would say probably #Pitch Johnson, #Arthur Rock, I mean I actually started, did this once on my phone and started making list of all the people I want to talk to. #Don Valentine for sure. But it’s all the, you know, the things that, the firms that don’t exist today either that aren’t at the tip of your tongue of like oh I’d love to talk to the most successful founders of the most successful firms. All the firms that have been very successful that we, you know, aren’t at the forefront of our mind or just top of the league tables of the Midas List or whatever, that were once very successful and changed or just decided not to raise new funds or whatever it is. But, you know, so I don’t have the whole list in, in front of me. But anybody that’s ever started a, a successful venture firm prior to lets say 2000 or something like that would be really amazing to, to talk to them about it.

Nick: And #Trey, what, what investor has influenced you most and why?

Trey: As a GP, I’ll say the people that I, I find myself listening the most attentively to and learning the most and being the most I guess mindful of their gospel is I would say two people, #Manu, #Manu Kumar at #K9. He’s the Chief Firestarter at #K9 Ventures. And, and #Brad Feld at #Foundry Group, also at #Techstars. Also like I have a litany of other things,

Nick: Yeah

Trey: So it’s hard to describe him other than on his investment and fiduciary duties. Those are folks when they speak I listen very attentively. And, and also about things that are completely unrelated to investing. I, I find myself listening to the, the tone in which they speak, the tenor of what they’re talking about. And learn more sometimes from everything other than the books that #Brad and #Jason Mendelson have written, and #Brad’s blog post about so many different things. But both of them I would are people that I’ve, I learn the most from today without a doubt.

Nick: Speaking of which, I think a very under the radar blog is your own, where you, you address a variety of, of topics.

Trey: Oh this is, you set that up as a plug. You know, it’s # LP2LP2VC. It’s kind of like

Nick: That’s right

Trey: not so clever like LP fund to funds, like LP2LP2VC.com. I’m not sure there’s a lot of learning that will come off that, although you’re, you’re right to flatter because I’m blushing. That’s one thing that LPs love. Just flatter us.

Nick: Well one of your readers suggested you as a guest, and I’ve known you for a while. But he was right. I read some of your work and,

Trey: I didn’t know you lift people that live under bridges. I thought so highly of you until you told me that somebody that reads my blog suggested that they should be, I should be on the show. But it’s, you know, it’s, I definitely feel like I took inspiration from #Brad specially. Sometimes I write about things that aren’t venture related. I’m not talking about some, you know, great Italian food I ate last week or whatever, stuff like that. But the intersection and specially in venture of the personal and professional, the, the lines are, can sometimes be so drawn. And for me it’s particularly acute because I, I work a lot and I’m gone from the home quite a bit. And I think building genuine relationships with people, whether you give them money or not, is so rewarding because I’m learning a lot about people and have friends in other cities wherever I travel. And it doesn’t ever feel like work because what I do is something that I absolutely love. And regardless of how tired I am or what a terrible flight I had on United or whatever, it’s very gratifying because I never forget how lucky I am to get to do it. Because this is a job that’s hard to define what it is that I do, or hard to define why I have one listener or actually it should be one reader of my blog, or one day hope to be considered good at it. That’s something that is I think always so important to keep in mind when you think about what it is that I get to do for a living. You know, it reminds me when I’m tired or when I’m cranky or whatever, like I’m really lucky to get to do what I do, and so don’t screw it up.

Nick: I think we’re all pretty lucky. And then, what’s, finally, what’s the best way for listeners to connect with you?

Trey: Well, for those of you that are unfortunately listening to this, it’s just over email. I’ll close with this that I always hate it when people, I shouldn’t say hate, that’s too negative a term, but I really don’t prefer when, you know, people say well I only talk to people that are introduced in from, from people that I already know and trust,

Nick: Right, right

Trey: this and that. And I’m like well, I hate asking people for favors. So like why am I asking you to ask somebody for a favor, and use something on it for something as simple as just sending an email.

Nick: Mmhmm

Trey: Right? And so I’ve said this a number of times at other conferences or whatever, when somebody says like what’s the best way to get a hold of you? I’m like email. Don’t call. Please don’t call. I hate talking on the phone. Email is great. I’m on it. I’m a Blackberry user so you know I’m a power user,

Nick: Wow!

Trey: of email. But email. It’s as simple as that.

Nick: Okay

Trey: I mean, it’s,

Nick: Find it on the blog then?

Trey: It’s a humbling thing to do is to ask people for money. Right? I mean, specially if you’ve never worked in the service industry, you’ve never sold boy scout popcorn or girl scout cookies, asking people for money, specially millions of dollars to go out and do something no one knows if you’re good at, and invest in startups, is a humbling experience. So let’s not make the whole how do I get to you thing any more difficult than it needs to be. Just send an email. And I’ll be so flattered that you have had the courage to do that if you’re a person that doesn’t like to, you know, do things like that or put yourself out there. Or just excited to hear a new story. Now as I said before, it may not be a story that, that we are yet ready to, you know, purchase, but as I’ve said now that you should be expecting at least some guidance on what the point of that conversation is frankly. So that we don’t, you know, lose sight of what we’re both trying to accomplish and lead either one of us on, if you will.

Nick: Well, I’ll reiterate in the intro, that you’ve been one of the most generous people to me, so I appreciate you coming on today. And appreciate all the help that, and guidance you’ve given me so far, #Trey.

Trey: Oh thanks again for having me. And I apologize in advance to the folks that actually listened to this because I’m, I’m worried that it’s going to now hinder your ability to get #Don Valentine here, so.

Nick: I love it. Thanks #Trey!

Trey: Alright, thanks! Take care