325. Finding Alpha in Emerging Managers, Common Mistakes & Pitfalls, and Sources of Differentiation (Sara Zulkosky)

Sara Zulkosky

Sara Zulkosky of Recast Capital joins Nick to discuss Finding Alpha in Emerging Managers, Common Mistakes & Pitfalls, and Sources of Differentiation. In this episode we cover:

  • Why Sara Started Recast and the Enablement Initiative
  • An Exploration of the Fund of Funds Model
  • What Questions She Asks an Emerging Manager
  • Common Mistakes and Pitfalls in an L.P. Pitch

Guest Links:

The host of The Full Ratchet is Nick Moran, General Partner of New Stack Ventures, a venture capital firm committed to investing in the exceptions.

To learn more about New Stack Ventures by visiting our Website and LinkedIn and be sure to follow us on Twitter.

Want to keep up to date with The Full Ratchet? Subscribe to our podcast and follow us on LinkedIn and Twitter.

Are you a founder looking for your next investor? Visit our free tool VC-Rank and tell us about your business. We’ll send a list of possible investors right to your email’s InBox!

Transcribed with AI:

Sara Zulkosky joins us today from Washington DC. Sara is co founder and managing partner at Recast Capital, a platform for investing in and supporting emerging managers in venture. They also have a focus on diverse partnerships at recasts. Sara, welcome to the show.

Thanks, Nick.

Such a pleasure to be here.

Yeah, it’s pleasure to have you on. Tell us a bit about your background and your path to recast.

Yeah, happy to. So originally from Minnesota, daughter of a very entrepreneurial parents, they ran a family owned business to provide me and my siblings with opportunities that they weren’t afforded. Growing up. I’m actually an engineer by educational background. So I have a bachelor’s and master’s in engineering, and spent the first almost eight years of my career working as an engineer for a venture back startup. Third person hired full time for that company and ended my time there as Director of Engineering and Director of Product Management. I didn’t pivot to the investor side of the table until I was partway through my MBA sitting at Georgetown and was awarded a fellowship from foundation capital, called the Young Entrepreneurs Program where essentially serving as an early stage scout in my local area, alongside a handful of other graduate students across the country, and was bit by the bug, you know, fell in love with the idea of a career in venture as a way to support multiple companies as opposed to just one as an operator. From there, I joined a family office in the DC area, one of a four person team focused exclusively on venture and private equity opportunities on behalf of the family sector and stage agnostic. So very fun place to be investing, to say the least, and a wonderful family to be supporting. But unfortunately, while I was there, the patriarch of the family passed and with that set off a bit of a strategic shift within the organization as it does when that occurs, but in our case, it was actually towards philanthropy. And as a principal at the time, I really wanted to continue actively investing and my managing directors understood that. And so with their blessing, I started looking for new opportunities, which is what brought me to my most recent role, which was with Greenspring associates. Greenspring, now stepstone, very large venture platform located outside of Baltimore, have a number of products investing in both funds and companies on a primary and secondary basis. While I was there, I spent the bulk of my time on the fun side of the house supporting a number of the different fun, different products that the firm had. And throughout my time in venture, I’ve sat in a number of different seats around the venture table and had a really interesting vantage point to many of the dynamics taking place and over time, became increasingly interested in kind of the power of emerging managers in venture the power of greater diversity within venture. And you’ve started wrestling with how to spend 100% of my time on that. And it was kind of through that process of exploration that the idea for recast emerged.

Amazing. Well, I want to hear more about that. But first, you know, you spent the summit green spring, I’m sure you saw data on many managers in many portfolio companies as well. Sara, if you had to summarize the two or three most important takeaways from the performance data, what would those be?
So I would say if I take a step back, and frankly, much of this is what we’re building recast upon, right, it’s, you’re seeing that it’s earlier funded durations, you know, smaller funds, sizes, and more diverse partnerships that are really generating the alpha that everyone’s looking for from their venture portfolio today, that data has been backed by Cambridge associates, Harvard and many others. Right. And I think that that is critical in thinking about how to build a successful venture portfolio and should be a strong part of it. And one of the core tenants of recast, frankly, is that we believe that any well built venture portfolio needs that thoughtful, diversified exposure to emerging managers and venture to get those returns may be hoping to get.

Awesome. So tell us more about Recast, you know, what are you building?

Sure, so as you mentioned, Recast as a platform, we both invest in and support emerging managers and venture with the focus on diverse partnerships. Today, you know, there’s three core investment theses, we have one we just touched on, right, it’s really that power of the Diversified exposure to emerging managers. And the second is that the emerging manager space is so much more diverse than the incumbents. And by focusing on emerging managers and venture, not only can you drive returns, but you can also enable pathway to greater diversity within venture more broadly because these more diverse GPs are backing more diverse founders. And then finally, it’s many institutional investors and savvy venture investors understand the opportunity and the return potential provided by this space, but have a difficult time accessing it right and largely for structural reasons. It’s can’t read a check small enough to back some of these managers perhaps don’t have the breadth of team or bandwidth in To focus, you know, here and do this part of the market, well, we do believe that it requires some concerted effort in order to execute. Perhaps it’s a process that’s not nimble enough to move fast enough to grab some of these opportunities as they’re presented. Or finally, you know, just don’t want to be investing in names that people don’t recognize yet right, and would rather have that first fun risk be taken by someone else. And so it became very clear that institutional grade intermediary needed to exist to help those institutional investors gain access to this very unique opportunity within venture. And so that’s what we were hoping to create with recast. So leveraging those three kind of, for tenants, a recast today has two parts of the platform. The first part is a fund to fund focus exclusively on this space. So I think these are emerging managers and venture raising institutional funds one, two or three. These are US based us focused managers that are predominantly sub 75 million in size, though, certainly seeing some larger opportunities from spinouts of existing shops. And, you know, again, focusing on more diverse partnerships, because we believe that those more diverse partnerships are generating better returns.

The second part of the business is an educational program for emerging managers, which we call our enablement program, the concept of the enablement program was really born out of our hope to support more managers than we could out of just the funder funds, right? For any manager that we’re investing in, we provide very personalized support given where they are in their journey, right, these are funds one, two, and three, they have varying levels of challenges, right, that we can be helpful with and, and the idea was, can we productize that support and offer it to a greater set of managers at a time. And so we came up with the concept of a cohort based model where we could work with 12 to 15 managers at a time for 12 weeks, twice a year, bringing in our friends from the LP and GP community that could you know, help address hot button issues that these emerging managers are facing largely in and around fundraising and the building blocks for more successful fundraise to accelerate their success in market, the program itself is run exclusively on sponsorship dollars. So it is tuition free, which we believe is critical to maintaining it as inclusive as possible, right, we want this to be a program that is attainable for for anyone even coming from outside of the venture bubble. And you’ve found that there’s it’s been a really powerful tool. So with the support of our sponsors, we’ve been able to offer some pretty exceptional services on top of what they get just as a group and the curriculum, including executive coaching, which has been really powerful for the emerging managers development. Yay, we’ve actually supported including the cohort that’s going through the program. Now we’ve supported 52 funds, proud to say 81% of those funds have included at least one general partner that identifies as a woman, and 56% have included at least one general partner of color. So you’re really trying to support those managers that represent the diversity that we hope to see within the broader venture industry.

That’s amazing how many different cohorts have been run at this point.

So we’re currently working with our fourth cohort. So that 15 number includes who’s going through it today.

Any concerns amongst the managers for signaling issues, you know, if the fund to funds doesn’t choose to invest in their fund?

No, I mean, I think, unfortunately, the nature of any fund of funds is limited slots, right. And, and while, you know, we think that we’re supporting managers have incredible quality in the enablement program, I simply can’t invest in everybody that goes through it. So I don’t believe that it’s signaling. And a goal of ours is to really shine a light on the managers that are both within our portfolio and going through the enablement program, to hopefully, you know, give them more visibility, hopefully have limited partners that can invest in their funds are actively supporting emerging managers to find them early and invest with conviction, right to really help again, accelerate their process,

Got it. On the LP side, you know, the the institutions that are partnering with you, or some of these folks looking for the next, you know, breakout firm and fund and then wanting to go direct or, you know, how do you balance that with the fund of funds model?

Sure. Yeah. You know, I think an important part of any fund of funds is like the educational aspect you offer, right? And so I think what’s appealing about product like recast, is, you know, we do want to generate kind of this flywheel of the blue chip names of tomorrow, right, and we just believe that they’re gonna look feel a little bit different than than the incumbents have today. So yes, many, many are investing for that kind of look through right watch, to see who emerges as a winner over time. And eventually, we’re happy to help them go direct over time as they build out their own core portfolios.

Awesome. And then just broad strokes on the the thesis for the recast fund of funds. Can you give us a sense for plan deployment per year, you know, number of managers, amounts per funds, you know, core versus co invest? Can you speak to some of those?

Sure. So we’re we are still in market. But, you know, having said that, we’re looking for, you know, roughly 12 to 15 core positions within the portfolio. And we do want to reserve a percentage of the fund to support what we call pilot positions, which are those managers where we have the same level of conviction. You know, same diligence process, but they happen to be raising more modest fund sizes. So think anywhere from the 10 to $35 million range or so. And, you know, we believe that that space is incredibly important to driving relationships for the fund of funds over time, right. So in that bucket, you’re predominantly gonna see more of the fun one relationships over time, while perhaps more solo GPS. But of course, some of those may be core positions as well. But yeah, they’re, it’s a great way for us to build relationships, for fun to fun three, to really continue to support those that emerge as a great new franchise.

Classically, some have chosen not to invest in fund to funds due to stack fees. Yeah. You know, how do you guys address that objection from prospective LPs?

Sure. So there are discrete areas in which I believe that a fund of fund deserves to exist, and I believe in this part of the market, it absolutely does, for a number of reasons. One, we’ve it’s very hard to execute a strategy like this, if you’re not spending 100% of your time, living and breathing emerging managers and venture, you know, identifying the winners, it’s like finding a needle in a haystack, we today, we are tracking 1500 emerging managers in our database. And so spending the time to identify those you believe to be building, you know, the next franchise requires a lot of effort and time to execute. I think, too, you know, you’re the return potential in this space is such that if you get it right, the returns far outweigh the additional layer of fees. So that, you know, hopefully what what we’re seeing as essentially, as an extension of our limited partners teams, where we’re providing market intelligence, kind of where the eyes and ears on the ground helping identify the new opportunities that could potentially be a part of their core portfolio going forward. So we believe at the end of the day, we certainly earn our fees, but make up for the return potential.

Awesome. So you talked about sort of the diversity of the enablement platform, both gender and racial diversity, is there also a focus on funds that have diversity as a part of their investment mandate? Or is it more sort of the profile of the managers of those funds?

It’s really just the profiles of managers. You know, we do believe that are the managers in which we invest in which we support of the enablement program, are going to have just far more diverse portfolios based on who they are their networks, and that their decision making where they’re focusing their efforts. And, frankly, that’s also it’s borne out in data generally available, but we’re actually starting to see it out of our own cohorts, too, right. So as an example, out of the first 40, funds for the first three cohorts that went through our enablement program, of those funds that were able to respond based on where they were in their investment process, we found that 53% of the investments that those fund managers that were able to respond made, actually went to women led companies, and 29% of those investments made actually went to companies led by women of color, which I mean, that blows the stats of our industry out of the water, which is so it’s fantastic to see that kind of coming out. And the thesis itself being poured through through who we’re supporting, as well. But no, we are looking for, you know, practitioners in their areas of expertise. And we have no requirement for the demographics of the founders in which they invest.

Awesome. And you mentioned, you’re tracking a great number of funds at this point. Can you talk to us a bit about sourcing funds themselves? And then also your selection process? You know, what are the key factors that go into your decision making?

Sure, so sourcing is certainly not the challenge, you know, hang up, hang a sign on your door that says you back exclusively emerging managers, you get a lot of inbound interest, as I’ve mentioned. But you know, that being said, we do really want to be as accessible as possible. So there’s ways that GPS can share their information with us cold on our website, you know, as you can imagine, you know, my my network, my co founders network, and having been institutionally trained LPs, we do have kind of a number of folks reaching out from within the venture bubble that are considering spinning out of their firms to start their own funds. But you know, I’ll say also the enablement program has been a really strong complement to the fund of funds as well right at widens our top of funnel, we’re able to build relationships with more managers over time. And so that’s been wonderful as well. And we are building relationships with entities and organizations that are very focused on this space, too. So a number of different channels through which we’re sourcing opportunities. The selection process is the hard part. Right? That’s what I mentioned before. And really the name of the game for us is differentiation. I think you have a 1500 managers number growing all the time, right? That it can sometimes feel like a sea of sameness out there, unfortunately, and he’s really hard for managers to stand out. And so you know, at the end of the day, we’re looking for contrarian and you know, my partner has a funny thing. We’re looking for contrarian. Good which can often be confused with contrary bad. That’s where you spend your time kind of digging in. But you know, at the end of the day, it’s really finding someone or team that has really relevant industry expertise in their area that translates to their area of investment, right, such that they can identify the best opportunities in their space when those opportunities based on who they are and what they can offer. And then finally, provide that post Investment Support where it can really get their flywheel of entrepreneurial referrals going.

Here, we had the Nikhil Basu Trivedi on the program some time ago, talking about the solo capitalist. I’m curious, do you back solo fund managers, and largely speaking, most solos are spinouts, from large funds, you know, does that go into your evaluation criteria, those that have spun out from an established, you know, venture enterprise versus those that have not?

We will absolutely back solo GPS, you know, there, there are some limited partners that don’t, but we believe strongly in the power of them to move the needle, and we’re excited to support them. So you know, I think being a solo GP, it has, you know, certain challenges, but certainly some advantages, right. And we’re excited to offer what we believe to be a support network, I think one of the bigger challenges you have is you’re operating on your own. And I think having that peer network, or those relationships where you can kind of lean on one another is is important for those that are starting out, right, perhaps those are coming from outside of the venture bubble. Yes, many solo capitalists are also coming out of established shops. But I think there are great opportunities that fall in both buckets, both the blue chip spin out, as well as perhaps the operator Angel turned venture investor that has, you know, really a lot to offer and wants to start their own fund, operating as a solo GP. You know, I think regardless of whether it’s a team, or whether it’s a solo GP, much of the work is the same. And at the end of the day, we’re looking for the best opportunities, and that can fall in the bucket.

Awesome. You talked about sort of supporting this group of managers that you’re backing, largely speaking, you know, many LPs are pretty passive, right? They ask for data, they ask for reports, they want returns, I mean, that’s why they’re investing. But it’s largely a passive endeavor. We had low Tony on the show, and he actually had some really original and innovative thoughts on, you know, how to accelerate and amplify the efforts of the managers in flexes portfolio. I’m curious, you know, what are some of the thoughts that you guys have at recast on how to support and accelerate the the firm’s and the funds that you’re investing in?

Sure. So you know, we believe that it’s kind of a combination of factors. So you know, out of the the fund of funds in the enablement program, we’re really trying to help provide the building blocks for a more successful fundraise on one hand, you know, certainly for the name of my program, and then as we invest in more successful franchise over time, I think on the enablement side of the house, you know, while our curriculum we feel is robust and exciting, I think some of the greater support elements we offer is frankly, the peer network, right? It’s it can be lonely, to be new in this business, trying to build your firm. And I think having a group of folks that you can lean on, that are at a similar stage in your firm building as you are, I think, is really critically important. You know, we try and make ourselves available, right? I think it really moves the needle to have limited partners, you can call at a moment’s notice when you’re wrestling with one particular thing, right? Not everyone is at the same stage of their journey. So while the curriculum itself is helpful, I think having someone you can reach out to for that individualized support and needs that you may be wrestling with at any one point in time, right? So really trying to provide that individualized specialized support, because one size does not fit all for what these folks are facing and building. And so that’s really, we really want to be the LP of choice for any emerging manager because of how accessible we are because of how, what it is that we can offer both from a network perspective as well as a support standpoint.

What you say is precious, I been running this firm since 2015. And it’s it is lonely. It’s like a founder journey, launching your own firm. And in doing this, it’s a startup, it just happens to be financial services, as opposed to a tech scale, in most cases, at least. And just having a cohort of other people going through the same thing. I could see that now as something that’s very valuable. I’m curious, Sara, like, do you see emerging managers you see in a lot, right, you’ve had over 50 in the enablement program now, and you’ve done a fair amount of investing in, in emerging managers. Do you see any common mistakes or pitfalls that young funds and firms make that could be fixed or addressed early instead of later?

Yeah, for sure. I think one of the bigger issues you see out of the gate is, you know, time is your most precious resource. Right. And I think a big mistake that some emerging managers make out of the gate is just not understanding funds. market fit. Not understanding that, you know, there is a particular LP archetype that will resonate with what it is that you’re quote unquote selling. And those are the folks that you should be targeting. Right? It’s great to get the call with large pension fund because a friend of a friend made an introduction and worth doing to build a relationship. But depending on what you’re building, that may not be an actionable relationship and should be prioritized as such. Right? You know, there’s depending on the strategy that these emerging managers are deploying, perhaps it’s high net worth family offices that are a better strategy, perhaps it’s corporates, perhaps it’s other venture funds, perhaps it is the more institutional Endowment Foundation pension fund to fund so forth. So I think having an understanding of that out of the gate and kind of building your fundraising process around that, I think is absolutely critical.

I assume that’s part of the value add of recast, is better knowledge sharing on you know, LP interests, sort of the classic example is that when startups source VCs, you can often go to a website, and you can find out what they invest in and what they like and the sector is of interest. At the same is not the case with the LP Right? Often it’s it’s not only hard to get information on what they’re looking for, especially without knowing their portfolio. In some cases they publish the funds they invest in, in most they do not. Then also connecting, like, how do you get connected with these folks through the right intro at the right time to send the right signal? Any thoughts on that how to understand and pre qualify these LPs and then figure out a way to connect with them?

Or Yeah, and again, I think this is really where your peer network is quite strong. And certainly programs like recast, we do try and address this, as you mentioned, right, we do want to build help build net new LP relationships by exposing them to different types of LPR types. And we do culminate our program, what we call an LP Day, which provides the managers an opportunity to practice their pitch in front of a wide array of limited partners, and so forth. So there’s interaction opportunities, certainly within within the program. But you know, I think that this is building out your funnel, and I think is one of the biggest challenges that emerging managers have. So yes, other GPS can help. Certainly, we within recast, are trying to help build, like a more actionable database for emerging managers that they can leverage for those that go through the program. So hopefully, that’s a strong resource over time. Certainly, once you have folks that have opted into the fund, right, even if it’s a high net worth, or a friend of a friend, asking them to make introductions on your behalf, I mean, a person that’s invested with you is the strongest reference you can have. Right? And so having having that outreach is extremely important in those warm introductions. The question we often get, though, taking it one step further, Nick is okay, fine. But like, great, what if I don’t have any, like rich friends? Right? What if I don’t have anyone I can, like reach out to right away. Like that’s the vast majority of people that are starting a fund that perhaps are aren’t spinning out of the venture bubble today. Right, and so guilty? So, so, you know, I think that there’s something to be said, for the research leveraging databases like PitchBook, and frequent and others when you can gain access to it to identify those that may have an investment thesis that makes sense for what it is that you’re doing. And then I wouldn’t shy away from LinkedIn, I wouldn’t shy away from people say, Oh, don’t waste your time on cold outreach. I don’t agree with that. I think that, you know, a well crafted, you know, cold email can be a great strategy, you just have to do it in a way that’s effective. And so there, there are ways to do it. And you know, that’s, this is like one of our one of my biggest focus areas with many net new GPS, is it how best to help kind of crack this nut and it is not easy, it is not easy. So I very much appreciate the question.

Yeah, it’s a tricky one, it’s tricky to know. Well, you got to identify the targets, you got to know what they want in order to prequalify. And, you know, at the startup level, it’s a little different than it is at the venture level.

Thing to that there’s another aspect of is even when you do get the call, the pre qualification doesn’t stop pre conversation, right? I think it also is important for managers to ask the questions of the potential LP, right? So just say like, Hey, you know, do you invest in fun ones, one, twos, whatever the case may be, you know, give me what’s the smallest fund you’ve back today? What’s a typical check size? You know, where are you in your process this year? Are you allocating to any net new names, which is critically important, at least today, right? Because so many LPs are inundated with reps, that it’s really hard for them to focus on new relationships. So any number of questions that can really help the manager feel like it’s a conversation worth spending a lot of time on in a relationship that’s actionable today, because again, you want to prioritize your funnel based on who can actually move within the timeline that you need them to. And then of course, build the relationships with those I can’t over time with the pre qualification continues well into the conversation too.

It’s so funny because I know many LPS at this point. I have kind of regular dialogues with many of them. And it’s such a paradox that VCs are paid to be curious and interested in learners and ask the great questions right to the startup founder. And if you talk to a lot of LPs, nine out of 10 calls they have, it’s like, the fund manager is just talking, talking, talking, pitching, pitching, pitching in, don’t ask him any questions, I find it so funny.

Yes, no, I I agree. And I think it’s a, it’s a lost opportunity to learn more about the LP the institution itself, right. And their strategy, certainly, but it’s also a lost opportunity to build a relationship with them, right? This is such a relationship business, building rapport with a potential LP is just as strong as a manager building rapport with an entrepreneur they want to support, right? I mean, it’s it goes both ways. So definitely lost opportunity, if you don’t do

Sure, I think like on a on a rare occasion, and LP commits on the first call, on most occasions, you’re getting to know these people over years before they build the conviction or horse, the right time and the right fit and the right fund size. And all these these various questions. Sir, I’m curious if you’ve seen, you know, aside from like, sectors, specialty, or thematic focuses, like, you know, future of work. Are there any other categorical sources of differentiation? Or have you seen types of differentiation that are very unique, and you think are potentially positioned, you know, for success moving forward, instead of just sector based?

Sure. Yeah. I mean, I think some successful differentiation that we’ve seen play out can also be around the value provided. So not just like, hey, I’m an expert in X, and like, I’m gonna share all my knowledge about X when I’m around the board table, but, you know, perhaps is someone that has like a functional area of expertise, that’s extremely critical to I mean, some have amazing networks for helping to source talent for the companies that can be super valuable, really move the needle, perhaps it’s, you know, individuals that have experienced go to market. So like, at a specific point, an inflection point in the company’s lifecycle like that can be extremely transformative for the company. And when you have examples of that can be really powerful. I think, too, and you’re seeing a growing trend around, some managers have building out communities as differentiation, right, like different sources of potential deal flow based on perhaps it’s an Angel Network that they’re building, perhaps it’s a group of operators that they leverage, as you know, whether advisors are for diligence support. I mean, there’s unique pockets ways where you build your brand equity, you get differentiated deal flow, and just didn’t really help sets you apart from perhaps the other enterprise focused or future of work focused fun down the street, I do think that those can be very powerful too.

You know, Mac Conwell was was on the program about a year ago, and he recently had an interesting tweet about GP commits. He said that the standard GP commit needs to be revisited. Sara, you know, what are some of the drawbacks of the typical structure in? You know, do you think GPS need the same skin in the game is as historically they’ve had?

Yeah, it’s an interesting question, one that we’ve spent a lot of time thinking about. And, you know, this construct started as a way, you know, years ago to address kind of tax implications for GDP over time. And while the regulations around that have shifted, the kind of market expectation did not right. And so today, the 1% GP commit say is, you know, in our opinion, kind of arbitrary at best, but actually can create some pretty significant barriers to progress. At worst, think about requiring emerging managers to commit large amounts of their capital to their funds, despite their personal financial circumstance, like penalizes those that aren’t from an affluent background. Right. And to be fair, the vast majority of new firms are led by those from outside the venture bubble. So they’re not spinning out an established firm, they haven’t, in many cases, built a successful company that’s exited, and so forth. So I think this, in turn, can really create barriers to exceptional managers from getting a shot at starting their own firm at all right? It can also create a really suboptimal dynamic LPS don’t want their GPS drowning in debt, in order to build their firm, right, their focus will be entirely in areas entirely outside of making good investment decisions. And then unfortunately, taking that one step further, it can also affect the industry at large, right, because if fewer diverse GPs are starting firms, fewer diverse founders may be receiving funding, which is exactly the opposite of what many are trying to do. So arguably, rather than a blanket standard.
The idea that we wanted to share is you know The GP commit being to a fund should really be what’s appropriate and meaningful for that particular GP. The actual amount doesn’t really determine skin in the game, but rather the significance of the commit to the individual GP is skin in the game. So as long as that percentage is meaningful, you’re incentivized to perform as such, right. And so interestingly, this may mean and Mac mentioned this at one point in the thread, that the most prudent way to create alignment for some is actually eliminating the GP commit altogether for the first or more funds. This also may mean that for very fluid general partners, should be contributing far more than the industry standard, right, because in some cases, the incentives are not in alignment when the GP commit is perhaps too low. Not only is that kind of something we focused on important today, but also as the firm’s evolve, right? It’s something that changes over time, it’s dynamic. So removing the barrier today is important. But also thinking about it over time is important. So as a GP raises more money, right, as he grows increasingly wealthy, the expectation is that they increase their commitment to the fund, right. And taking the those two parts together feels like a far more reasonable path to kind of supporting net new managers, but also doing something that’s reasonable for everyone. And so that’s the approach that we’ve been thinking about More more recently, and I think it helps not only address the quote unquote, skin in the game issue that many LPC with, hey, the only way to do that is to commit to the fund for the GPU to commit to the fund, when in actuality that that’s not the case. And you should take a broader view of what that could look like.

Curious to get your opinions on fee structures with different funds, right, the management fee and carry, there’s sort of a variety of different ways that VCs are setting economics these days, the management fee side, of course, you know, higher than 2%, or we have these aggressive, more aggressive step downs than historically. Right. I think, when we started our first fund at new stack in 2018, our fund administrator was AngelList. We were the first VC fund on their platform, and I remember talking to their legal team, and the standard set down was 2.5, you know, down to like 1.5. And I said, Why don’t we do three and a half and go down to you know, point five, because I need to hire a staff here. And the legal team just said that was unprecedented. So they rejected it outright. But now we’re seeing that we’re seeing it’s like more common to start at these aggressive fee levels stepped down. On the carry side, you know, you see tiered carry structures that ramp up, you know, as returns increase, you know, what are your thoughts on these different fee structures for emerging managers?

Yeah, I mean, I think, again, a lot of it has to do with the situation. So, you know, I hate to give the answer, it depends on the kind of depends, when folks raising more modest fund sizes to your point, you need the fees to pay yourself, Bill, the staff invest in technology, and so forth. And so it’s critical to have a more robust fee based so I can understand, and we’re starting to see certainly like two and a half to come far more common amongst emerging managers. And certainly, you know, the, the more aggressive step down, I can also appreciate because they, you know, your focus on investing, right, the heavy lifting of the fund evolves over time. So you would expect your, your fee structures have to step down over time as well. So two and a half has been more common for us more recently, or at least, as we’ve seen across the board. Above that, yes, I do believe that traditional LPS kind of raise their eyebrows and ask questions about why that’s appropriate.

Got it. And so if a fund manager comes to you guys that recast and they go through the program, and they have, you know, aggressive stuff on the carry side, for instance, you know, do you do you have standard feedback? Or is it all case by case?

I would say it’s case by case. I mean, I think, if you want to show alignment with your limited partners, and you’re looking to do something a bit outside of the norm, I think, you know, you’ve seen tiered carry and in some cases you’re very is an interesting way to kind of address this right to say, hey, you know, I’m gonna get my standard carry up into a 3x. Net, but anything above that I, you know, perhaps get a little bit more, I think it’s hard to do that, unfortunately, with limited partners. If you haven’t, you know, I think some will say quote, unquote, earn the right right have shown the performance in which to say, Hey, we’ve proven that we can do this. So let us reap the benefits of it. I do think that that is unfortunately sets a bar that is very difficult for many managers to attain and in terms of those that are net new. So clearly, they don’t have some not all have something that you hang their hat on. But teared, to me, in theory feels like incentives are still very much aligned. And so that would feel appropriate in the right circumstance.

Yeah, you know, well, capital is a commodity, VC funds and VC firms are not. So the the fact that they’re priced all the same is very odd, in my opinion, but, you know, such as the way of institutional LPs and capital, I guess. So, Sara, what about market conditions now, right, there’s so many different emerging funds. There’s a lot more venture capital coming in the industry. You know, when I started this, this show back in 2014, it was cottage industry, tiny, you know, unicorns were in the double digits, and number of total venture firms, you know, it was conceivable I could interview them all. Now, there’s no chance it’s become a mainstream industry, way more capital flowing into it, and valuations are climbing, you know, how do you think that affects sort of early stage investment? Right, we’re investing, you guys are investing in emerging managers, and they’re investing in startups that are commanding much higher prices. And there’s a lot more competition amongst VCs, which kind of changes, you know, the market dynamics, any thoughts?

Yeah, I mean, you we continue to believe that the early stage space is an extremely attractive place to be investing. And that’s where we’re finding the bulk of managers that we intend to be investing in from from recast, it’s no, while yes, you’re seeing some companies, even at the precede seed demand far higher valuations. I think that you’re not seeing that as prevalent as you are in later stages. Right. There’s a tsunami of capital coming in, and the later stages and, and they’re, I mean, more than ever commodities, that capital is the commodity right. And so that’s where you’re seeing a lot of large valuations. Yeah. And so, you know, there, I think it can be, interestingly, it seems not intuitive, but I think it could be more risky, almost investing in some of these later stage deals than it is early stage, because you’re somewhat insulated from it. So we continue to believe that’s a very attractive place to play. But yes, I mean, with the explosion of emerging editors in the space today are those generally kind of targeting the early stage space, it is extremely competitive. And while I think the pace of innovation continues to increase, and so there’s, there’s more to be focusing on that can, you know, justify more firms in existence, not all of them will be successful, not all of the firms are being started today will be around for a fun too, for a fun three. And that’s, that’s unfortunate. But at the end of the day, you know, the best practitioners with the most, you know, unique networks, differentiated deal flow, will, will emerge and be successful. And those are the folks that, that we hope to be supporting. And we just believe they’re going to look and feel a little different than those that are in the incumbent base today.

Sara, you wrote a piece called just how inclusive is your venture capital funds dei strategy? Any tips for for managers out there looking to build more diverse teams?

Yeah, absolutely. I know, first and foremost, that there is no pipeline problem. So there are exceptional diverse candidates available for all positions in a venture fund, and there’s no lack of resources, if you’re looking for a place to start, or for organizations to align with in order to start meeting with more diverse candidates, like examples are black, VC, HBCU, VC, Latinx, VC all raise PE when neic? I mean, there’s so many I could go on. But there’s definitely places to start if you’re looking to build a more diverse team. So that’s certainly the first thing I’d say. But the second thing is, you know, building a diverse team is really only part of it, keeping a diverse team is just as important. And we talked a little bit about this in in the piece, but you know, kind of like the missing eye and DNI so inclusion, right? The potential returns that you can generate based on the differentiated networks and perspectives and you know, improved decision making of a more diverse team that is not sustainable, if you can’t retain any of that talent, if everyone starts leaving, right. And so it’s incredibly important for for each firm to consider as they build the team to make sure that the culture they have is welcoming and that every member of the team feels valued. Take it one step further, though it’s extremely important for LPS to consider as well, you know, you really, again, without that sustained diversity, I think and retention issues, it really highlights for LPS, some significant red flags, right that there are there may be some deeply rooted cultural issues within the firm that are making those that are other underrepresented, that do not feel welcomed, valued. And so kind of focusing on how to create a very inclusive culture is extremely important to the piece itself mentioned something called the Gartner inclusion index. As a place to start, there are other ways to execute as well. And so I would encourage folks to think about that as they think about building a more diverse team to.

Very good. So Sara, this question is called three data points, I’m going to give you a hypothetical situation with a fund. And you can ask three questions for three specific data points in order to make your decision, right, because this is how it works. Let’s say your approach to invest in an early stage fund, the fund is based in Austin, Texas, it’s the firm’s first fund. It is so low partner, okay, she is focused on seed, let’s say the raising 25 million. Again, the catch is you can only ask three questions for three data points in order to make your decision, what three questions Yes.

First question would be How have you been active in kind of the venture space to date? So you know, hopefully, that would encompass not only their operating background, but also an investment track record of any kind? And perhaps this is baked in there? I don’t know, if you’ll let this slide in is like this sub question that may, she may or may not address in her answer. But if not, my follow on would be helped me understand how you know, the investments that you’ve made today, or the support of the companies that you’ve given in the past that make up your track record? How does that map to this investment strategy of the fund that you’re raising? So by that, I mean, you know, is it you know, industry specific, does that industry map, right, but also check sighs? Right? Because if her answer is that her check is 10 times as high as perhaps what she had been doing out of her Angel portfolio, for example, then that’s going to mean that I have a very specific conversation with each of the entrepreneurs that she’s invested in previously to say, hey, what was the value she offered? But I just to start, do you know this person’s name? Because very often, when we’re doing this diligence, they don’t? And so clearly, it’s a that’s a signal, right? But second year, What value did they offer? And then third, would you have been able to accept that? Would you want it to accept 10 times the allocation from that individual or their firm? Right? And if not, that could present challenges for the strategy moving forward. Let’s see. And then you know, around around solo capitalists, right, you want to dig into the motivations for that structure? And how you intend to manage it manage governance, right? If there were something to if something were to happen to that particular individual, to help manage risks around the solo GP? Have I hit three, I feel like I have like 12 baked in there.

This is good. I mean, all the emerging managers out there at the edge of their seats.

Boy, it’s gonna tell me like around the investment strategy itself, of course, like, help me understand why you and not someone else pursuing the same strategy.

So I love your question about the 10x allocation. And, you know, I’ve heard this spoken about often, you know, the transition from an angel investor to a VC is very difficult. Another parallel would be the transition of a co investor, to a lead investor. Yes. And I feel like that is the ultimate chasm in the in venture capital, where where many funds and firms fall down, trying to go from a co investment model where they’re putting in 100k 200k 300k 400k, to being the lead investor of around you know, 1,000,002 million. It’s a completely different business sourcing is different selection is different diligence is different. When you’re just co investing, you’re already picking from a basket of really well vetted opportunities and choosing your favorites, right. How do you think about you know, that that leap from CO investor to lead investor? And you know, what should the emerging managers be thinking about that are pitching, you know, a fund where they’re going to start taking more ownership and bigger allocations and actually leading deals?

Yeah, I mean, so to your point, I think it takes a very different approach with the entrepreneurs. And so, understanding and appreciating that right, I mean, playing nice in a large Syndicate is very different than like the, in some cases, sharp elbows that are necessary in order to push others and kind of emerge as that lead lead investor. So really understanding how they intend to kind of pursue that new strategy based on how they’ve been conducting themselves previously. And then, you know, how, how do you intend to win? How do you tend to win? Right? It is to people that want to lead to firms that want to lead the seed, and you know, you, you have to sell yourself, right? How do you sell yourself? How do you think that you? How do you think the entrepreneurs will respond to the value that you say you’ll provide and why your check is more meaningful to lead than perhaps firm down the street? It’s a huge jump and it’s one that needs to be done very thoughtfully, very thoughtfully. I think. Obviously, a part of it too is for references when you know when when potential LPs are thinking About that, you know, speaking with the entrepreneurs in the portfolio to say, Hey, would you let them lead the round, right? And depending on where those answers come out, that’s going to shed a lot of light. So I would encourage any manager that’s thinking about adjusting their strategy to be leading to have a very frank conversation with the entrepreneurs in the portfolio, because know that folks like me will be reaching out to all of them to ask that question. And hopefully, we get positive responses from everybody. But that’s perhaps not always the case. So better you hear that first than me? Yes. Right.

Sara, if we could feature anyone here on the show, who do you think we should interview? And what topic would you like to hear them speak about?

Well, having supported so many managers, both before and during recast, it’s very difficult for me to pick a favorite, so I won’t, but one area that I would hope that you all can spend more time on, which I know you do is just kind of advice for emerging managers, I think the emerging manager space is so that group is just so hungry for more information. There’s been exceptional networks created in order to support them and to help provide that advice. But always interesting to see more limited partners share the share more kind of nuggets of information for that community, because I think every Everything they learn is something that they put into action right away.

Awesome. Sara, do you have any tools or hacks that are a secret weapon?

Living and dying by a CRM? I mean, I think yeah, not only is that important for the, you know, managers that we are tracking, right, so just like a database of just all the folks that are, you know, in our funnel, but you know, that’s also true for our enablement program. It’s true for our potential limited partner targets. I mean, it’s just a way for us to stay far more, far more organized. And so anyone that’s still living in spreadsheets, I would strongly encourage you to move beyond it, because I know that it can be a big jump, but finding one that works for you can just kind of Tenex your productivity.

What is the CRM of choice for you?

We actually use affinity and it’s been fantastic. Oh, cool.

Yeah. Awesome. And then finally, here, Sara, what’s the best way for listeners to connect with you and follow along with Recast?

They can connect with me on Twitter at Sara Zulkosky. Recast also has a handle at Recast Capital, and you’re more than welcome to reach out to us on our website RecastCapital.com or to me directly via email Sara@requestcapital.com.


Well, thank you so much, Sara, for spending the time today. I thank you on behalf of all the emerging funds out there for all you’re doing to help out and for sharing the knowledge on a pretty opaque sort of fundraising landscape. So thank you.

Yeah, absolutely. Thanks for having me.

Transcribed by https://otter.ai