Earnest Sweat 00:02
Welcome to Swimming with Allocators. I’m Earnest Sweat and each episode Alexa Benz and I give you a VC podcast from the LP perspective. You ready? Let’s dive in. Today our guest is Sarah Anderson, founding partner of the Vault Fund, a fund of funds focused on the Best Global venture studios and formation funds. Previously, Sarah earned her chops at the center fuse syndicate fund, JP Morgan, and the Royal Bank of Canada. Sarah and the team at Vault are the thought leaders when it comes to investing in company creation entities producing a wealth of resources on the topic. We’re honored to have Sarah today. Thanks, Sarah, for joining us.

Sarah Anderson 00:47
Thanks for having me. And also I was telling Alexa before you joined, but the name is fantastic. I don’t think anybody has a better name than Swimming with Allocators.

Earnest Sweat 00:57
That’s what we’d like to hear. We’re gonna put that on loop and it was all Alexa’s idea. I have to give her credit. Definitely talent. I was so jealous. To start off, just want to kind of get some background and understand your first position as an allocator. And so that role was at The Cintrifuse Syndicate fund of funds. What drew you to that opportunity?

Sarah Anderson 01:21
Yeah. You know, so central fuse just as an overview as an early stage venture fund to funds was focused mostly on seed and series A managers. All of our investors within Cintrifuse were large strategic partners. So Procter and Gamble was our anchor, we worked a lot with Kroger, or several insurance companies, including Great American, Western Southern. And coming from JP Morgan, one of the things I was really interested in because I was in their tech and Digital Media Group. And one of the things I was really interested in was seeing innovation, getting to market and being on the cusp of new innovation, right. So things like blockchain, or AI, or new capabilities that were coming to market tend to come to market through the venture channel. And I wanted to be on that cusp of innovation and central views provided that opportunity. And they were just getting up and running their LP base was so highly strategic. It was just this natural flywheel of innovation into corporate partners. And so that’s really what drew me to centric views.

Earnest Sweat 02:34
That’s, that’s an interesting first of all, makeup of LPs. Could you talk a little bit of how you get all of those strategic investors? What is the strategy on keeping all the strategic investors happy? Yeah. And was it focused on financial gains strategically?

Sarah Anderson 02:57
Yeah, so all good questions Cintrifuse really started a lot around proctor. And proctor is a strategy to other strategies. Right. So you know, Proctor sells into Kroger. And that’s kind of what brought Kroger in. The insurance companies were very interested in the innovation that centrifuges got started in 2013. Okay, like the end of 2012, early 2013. In that time period, insurer Tech was a big category, but it was emerging, right, and insurers who tend to be fairly deep-pocketed, were very interested in starting to find new ways to offset traditional methods of insuring consumers, or properties or commercial rights. And so they were very interested in Proctor’s interest or other corporate interest in this notion of early stage venture and getting to companies before they had massive scale. And so, you know, it kind of starts with just like, just like all fundraising, right? It starts with really one person that believes in you, and then that proliferates right and to others that are within there, I think of it always as concentric circles. You have your patient zero, right? And then it kind of proliferates within concentric circles from their outwards. And so, you know, the consortium of corporations we started working with just expanded over time. And, you know, your question around how do you keep them happy? It’s a really interesting one because innovation, innovation is so sexy. It’s a sexy term. Everybody wants to innovate, right? But it is hard. It takes a lot of money, it’s inherently inefficient, because you’re kind of on the frontier of pushing boundaries. And so within a corporate mothership, those are all elements that they just don’t like, and they don’t feel comfortable with. And so they’re the I would say that there is a wide spectrum of corporations that can tolerate risk, can tolerate losing capital on innovation. But then there’s this other end of the spectrum where a lot of corporations lie, where being at risk is just not their sweet spot. And, you know, I think one of the things that we ran into quite a bit is there was interest. And there was an initial hot and heavy kind of interest. And then over time, it kind of dissipated. But guess what, this is like a 10 to 15 year asset class, right. So you know, you’re married for a long period of time. And I think one of the things that we did really well was we had a team internally that was exclusively focused on our corporate partners and their innovation needs. So it was a push pull type of mechanism. We had a portfolio that had startups in it that needed customers. That’s the push mechanism, right. And so even things that our corporate partners may not know they wanted, if it was something that could help offset, you know, person to person broker or adjuster responsibilities, then it was something maybe the insurance companies might want to look at. But then the pull is, hey, as a corporation, what are your top priorities? And where are you trying to innovate? And then we would go out and canvass the market and try to look for those types of capabilities. That team was really, I think, the secret sauce in keeping a lot of our corporate partners, eager and interested,

Alexa Binns 10:25
Many of the people listening are raising a VC fund at the moment. Are there any other pieces of advice when thinking about strategic corporate LPs?

Sarah Anderson 10:38
So, strategic corporate LPs are fantastic for GPS, in my opinion, I think that they do have genuine interest, they can provide dollars as a partner, right, and they can provide advice, they can be customers, I would say, the sustainability of strategic partners in your LP base is something to watch out for. So if you’re raising a fund, you’re on fund one, and let’s say you’re doing insurer tech, or FinTech, and you have a financial partner that wants to come in and be a big part, an anchor, let’s say, that is awesome. I think there’s nothing bad about that. But as you’re moving into your fun to, let’s say, two or three years later, be very cognizant about that strategic LPS appetite to commit more dollars, right? They tend to fatigue faster. And they tend to really struggle internally with leadership transitions and priority transitions on being able to continue to commit capital fund after fund after fund.

Alexa Binns 11:53
Yeah, that loyalty was with the teammate who’s maybe not there anymore. Interesting.

Sarah Anderson 11:58
The executive may have changed positions, or like, let’s say they anchored your fund one with three to 10 million. And because you are still really scaling those companies, you haven’t returned any capital, they may have some fatigue, from a capital standpoint around that is not to say that they aren’t savvy on the asset class, but they may want some return of capital before they re recommit. So I think, yeah, just just it’s just something to be cognizant about. If you do have a big strategic anchor, just know, you may have to kind of offset their position and your next fund.

Alexa Binns 12:41
No, that’s very helpful advice, I think, because those strategies are sometimes considered this like, oh category that you got to be looking out, you know, you should go knock on all those doors, but to to have some expectations set of what they’re going to be helpful for and what they aren’t. When you were at Cintrifuse, it seems like you started to get the vision for the Vault Fund. What did you see there? That started to percolate?

Sarah Anderson 13:09
Yeah, as a really great question. So we sent her a few and started committing to early stage managers back in 2013. And it was around 2019, when we were a couple of years into committing our fund to where I was like, you know, what’s working and what’s not working, because traditional venture is a very distributed asset class, you have really good performance, and then you have really bad performance, but it’s long term. And so we had invested in some of these entities that they looked like a venture fund, but they were creating companies internally. And so when I think about it, the original business model that started doing this is in the biotech field. And they’re basically taking molecules and taking IP, and putting them through these really quick kind of kill cycles. And if they can’t kill them, then they’re putting resources around them building on scaling on IP ownership. And we had invested in a couple of these in our fund one and A, the scale, right, the proof points to value were much faster. The loss ratios were significantly lower than what we were seeing in some of our managers at the time. And the cash returns were actually significantly better, faster, more of them. And so when I started looking at this, I’m like, Hey, this is clearly a different business model than what we usually see in traditional ventures where it tends to be. You’re investing in a seed round for a certain percentage of ownership and you may be sitting on the board But you clearly don’t have full control. And I think a lot of that leads to inefficiencies like, hey, does this exist on the tech side? Right? Because at the time, you had Atlas and Third Rock and flagship, and like you have these big behemoth firms on the biotech side doing this. And when we started looking on the tech side it was like, yeah, actually, there’s quite a few. Yeah, and by the way, their performance is equally strong, I would say the distributions tend to take a little bit longer on the tech side, because you don’t use the public markets as a financing mechanism, which gives you natural liquidity on the biotech side, the tech side doesn’t have that option right now. But the performance and the scale, and the efficiency of getting to scale was there. And so that was my first aha was like in 2019, this is clearly a different business model, it’s clearly more efficient. And the Alpha returns, or at least from what we’re seeing in our portfolio, are much stronger than what we’re seeing, like, from the dispersion standpoint, you didn’t have the wide dispersion in performance that we were seeing in traditional ventures. And so I thought, I took some time and just did some research on the category. And once I saw how many were actually out there eons that their performance was fairly consistently strong. I was like, Okay, I think somebody needs to like, there were investors that were investing in the category, but opportunistically, right. So, and predominantly, in some of the larger firms, there is nobody that was really doing it systematically across the landscape. But it’s a prime category. And for a fund of funds to come in and do because it’s highly dispersed. It’s decentralized. It’s a global market. Its growing performance is strong. And so that’s when I was like, this probably needs to be something that exists.

Alexa Binns 17:06
Yeah, it’s like people recognizing that venture is not really just a younger sister to PE is like, oh, there’s this third character. On stage? Yeah.

Sarah Anderson 17:18
Yeah. Yeah. Yeah. And I think like one of our biggest struggles to your point is there, there are a lot of misunderstandings about this as a specific business model, right. I mean, it definitely is part of the private markets. But it is way different than traditional venture incubators, accelerators. And it’s incredibly misunderstood, right, when you really dig into it, there are very clear patterns for what works and what doesn’t, and which makes my job very easy, right? You can identify those points, then you’re going to probably have a successful outcome. And if you can’t identify those points, then you probably should not be committing, which is very different from what you see in traditional early stage ventures, right? See, precede it Series A, you tend to have a lot more track record because those tend to be larger firms. But seed in precede, there is such a wide dispersion. And there’s, there is some pattern matching, but it’s much harder to do, I would say in this category. It’s really track record, economics, you know, talent and process.

Earnest Sweat 18:37
Now we’re gonna take a quick break to speak with our sponsor.

Alexa Binns 18:41
On the show today, we have industry experts and sponsor one of my all time favorite founders, John Lang, co-founder and CEO of Canopy, Canopy streamlines the administrative process, legal wires, taxes, etc. For private equity co investments and SPVs. Thank you, John, for partnering on the show. Do you think the opportunity fund is going to be something that we sort of look back on as a 2020 phenomena and SPVs will be the way these coinvestments are done?

John Ling 19:11
I actually don’t know. I think it really depends on the fund and the GP. I think like, I don’t believe I am well educated enough to give that kind of prediction. I think all the different models will probably still exist. I think it’s probably in people’s best interest to leverage more SPVs. I think LPs want more control over the specific assets that they’re investing in. Right? Because they probably have their own sort of portfolio management expectations where they’re like, hey, we want more exposure to AI for example, right? So like if you’re raising the Opportunity Fund, maybe I don’t want exposure to like the late stage fin tech stuff that you’re doing. Right and obviously some people will have completely different takes. I just said that because I’m pretty sure that’s a lot of work thinking about it right now. Everyone’s like, oh, how do I get more money? AI? But yeah, it’s just kind of one example of like, Why do you think LPS specifically finds that, you know, SPVs probably will be more valuable in the opportunity funds. However, like, I think, you know, opportunity funds make it a lot easier on the GP to manage as well. So I do think there’s a balance. So what for some people won’t work for a lot of people? Like I think it just depends.

Alexa Binns 21:35
Yeah. Well, you’re a builder who’s also done the job. And so I think you’re, you’re in a unique position that you understand the customer? Because you’ve, you’ve been, you’ve been the VC before.

John Ling 21:46
Yeah. 100%. Totally. John,

Alexa Binns 21:50
you clearly are out ahead on the future of venture capital. For those interested in using canopy software to set up funds, manage capital, and report performance, you can please visit hay canopy.com, backslash allocators, and then Earnest, and I get credit for sending you. Thanks so much. And now back to our LP interview.

Earnest Sweat 22:10
So Sarah, you spoke about digging into this market. I know when I heard you speak, I was just blown by how many of these company creation organizations existed? Could you just talk about the market? And how big is it?

Sarah Anderson 22:26
Yeah. And you know, it’s a really good question, because I would say the definitions around what are really gray. So oftentimes, we see these market landscapes that I think the biggest one we saw was in the 1000s, like 3000. And so but when you start digging into it globally, right, because you have a lot that exists, like MENA has been an exploding region for this business model. As has Asia, but when you start digging into, okay, what’s on this landscape? Are they really like venture studios? And then what is the definition of a venture Studio, you start finding a lot of what I don’t consider a venture studio, so like agencies, brand agencies that maybe like creating new brands would be listed, or a lot of times, I think this is what leads to confusion of LPs accelerators and incubators are listed. And it’s like, Hey, you don’t need quantity, you need quality and quality is really defined by the business model itself. Right. And so by our definition, I would say that there’s probably around 800, globally. Now, there is a very long tail. And by that, I mean, it is such an emerging category, there was an explosion in new studio formation between 2015 and call it 2017 2019. Right. And if you think about the why, this is like a win-win -win for founders, instead of creating one company every five to 10 years and being married to that company. They can now scale their efforts. They create five companies a year or however they build their team. And they can. Investors like me can realize additional alpha from their talents, right? And other operators that come in to work with them on their team. Instead of having one company that they’re working on, they can work across multiple companies. And if that company, for whatever reason, gets killed, they have other companies within that same studio mechanism that they can start working on. In addition to it. I know I am biased when it comes to the advantages of this model. But they also when you look at the loss ratios, and the success rates inverted, obviously, but like, the loss ratios are significantly lower on capital, on ideas significantly higher, like 95 to 96% of ideas should be and usually are killed for very little dollars. And sometimes they don’t even test them, they just kill them. They don’t think that the market or the unit economics are right. But the success rates of those that they actually launch are significantly higher than traditional ventures, right? So for an operator to come in and work with a studio on building companies through a repeatable and proven process is actually a huge advantage for them. And we can get into some of the disadvantages too, but from our definition, and this is one of the reasons that we started calling them company creators and not venture Studios was just because of the confusion around everything getting thrown into this venture studio category. Well, if the entity is not creating companies internally, if they are maybe just funding them, or if they are just housing them, or if they’re just providing services, that in our mind does not constitute what we’re looking at for our fund. We want entities that are creating companies internally, they have to have bulk control over the company creation process. Right. And usually, that means that they have to act as a founder or co founder of the companies that they’re creating. So within that definition, we think there’s around 800, we think that about half of those exist in the US. Like I mentioned, regions like Mena and Asia, they’re just exploding. And this is a really great way to recruit talent, build companies locally and scale companies locally. So that’s where you see rain, Abu Dhabi, like they’re starting to create these machines that basically are creating new companies locally. So there’s more, it’s hard to pinpoint. But for our definition, we think there’s about 100.

Earnest Sweat 27:15
And then the question goes, how do you select managers and fund managers for this? Like, what criteria are you looking for? Yeah,

Sarah Anderson 27:24
You know, on the tech side, and I guess on the biotech side, too, there’s a core group of company creators that have been around for multiple cycles. They have a track record, they’ve proven their ability to get companies to scale efficiently. Those we know, and those we look at pretty readily. There’s a whole host of what I mentioned, like this long tail of emerging creators. And I think in that capacity, we’re really looking for good ideas, good industry insights, right, they have to have had experience creating companies. And one of the things that Alexa I was mentioning earlier. For us to commit to a manager, there has to be a very compelling reason, right? They have to have good, strong ideas in a good market, and really convince us that what they are building is going to create multiples of the capital that we’re giving to them. And so I think a lot of that comes through when you’re talking to them about their strategy, about their initial portfolio, oftentimes, we do require builds. So they have to have something and they have to have something that’s compelling to show us that the markets they’re entering into and the companies they’re building are going to provide strong value. Do you

Earnest Sweat 29:05
have any anecdotes on, you know, specific funds you’ve backed and why. So

Sarah Anderson 29:11
at Cintrifuse, and I can talk about what to buy but one of the I think best company creation firms out there as Atlas Venture, they’re in Boston, they are on the Biotherapeutics side, they’re creating molecules. They’ve been doing this, gosh, I don’t even know their inception. I think they’re, they’re on like their 13th or 14th cycle now. Wow, they know what they’re doing. And also, they’re not greedy about it. Like they value distributions, right? So they’re very much in line with their LPs. And they have a very repeatable process. They’re thoughtful. They are not just wasting resources. They’re putting resources where resources provide the most value in this molecule creation process. So that is one that has been tried and true and studied. On the tech side, we invested in a firm called Atomic Labs, we had invested in atomic at my former firm, Cintrifuse as well, we’ve invested in them. This is one that has a very repeatable process, they are systematic in their company creation work. You know, they’re able to, they’ve shown the ability to scale their team, which is another thing that it’s hard when you’re doing novel, company creation, finding talent that you can, that allows you to scale across a portfolio is very difficult, right? A lot of entrepreneurs want to go deep. But being able to find a team that can help with the ideation and the testing process to help scale is something that is unique. Atomic has been able to accomplish that. And we currently have six managers. We have two on the Biotherapeutics side, and three on the tech side, and then one in what we call hard sciences. So this would be like material sciences, chemical sciences, batteries, etc. So yeah, I mean, I think anecdotally, those that have a repeatable process and the scalability, efficient scalability is kind of like a consistent theme across our portfolio.

Earnest Sweat 31:38
Is there anything else that you see new venture studio company creation entities, you know, that are, you know, starting doing wrong? That is ultimately like, that’s a no go for us.

Sarah Anderson 31:55
We’ve seen a lot in this category is GPs that are operators and entrepreneurs, not being able to acquire talent, find talent, work with talent. And so they end up being CEOs for a long period of time for the companies that they are creating. And so then that doesn’t provide much scalability, right, if you have one or two partners within a company creation firm, and those one or two partners are both acting CEOs for a couple years, you can’t create a portfolio of companies. And so that’s something that we’ve become very careful about. I think it’s an easy trap for operators to fall into. We’ve been tabulating data on the back end, because there are some bad, I think there’s some bad behaviors that lead to kind of some of the misunderstanding in the industry. And I wouldn’t say what we see as bad behavior is normal. It’s more of an anomaly. But just as a, for instance, first time GPS, we regularly see north of 50% ownership targets, right? So Alexa, to your point, one of the biggest pieces of pushback for these company creation entities, companies that are created internally, when they go out to raise from VCs VCs are like, hey, like, if the founder only owns 10% of this company? Not interested, because guess who’s gonna create the scale into the future? Not the studio. It’s the founder. And so we test that quite a bit in the managers that we select, but if we see, like there was one we were looking at, and well, there’s actually been a few in the press. Unfortunately, like bad stories in the press, but deserved. It’s like you can’t expect founders to be incentivized when they only have five to 12% ownership just doesn’t happen. It is hard. And it’s even hard after the company has created and tested it like it’s hard to scale. And so oftentimes what we look at is like a 3030 30 benchmark, right? So we want to see this Studio should have about 30%, the founder should have about 30%. And then capital should have about 30% overall. And that changes and it vacillates, but the studio just can’t own too much. And then I would say, another big piece of pushback we get when we’re talking to other LPs that are not in the category is the arranged marriage aspect of a founder’s idea. And when you dig in, it is definitely not an arranged marriage concept within these studios, they aren’t necessarily coming up with an idea in a vacuum, and then finding a founder and saying, Hey, you are running this for the next five years. It’s much more of a collaborative build process within the studio’s kind of system. And so you tend to naturally have or should, when things go the right way, you should have a much more natural operating team that falls into place for that company and that technology. And some of these are just misnomers. But all of this, I think will ultimately be right sized. Because of the industry, normal standards will start to emerge. What becomes successful, will eventually take over on what is the formation and the structure and the ownership percentage, right, and the operating team? So yeah, there’s definitely challenges. But I think a lot of those challenges are misperceptions from the era of like an accelerator or an incubator, or maybe what a few loud voices in the venture studio category might be doing wrong. It’s definitely not industry standard. I don’t think from what I see,

Alexa Binns 36:57
anecdotally, I get introduced to a lot of female founders. And often they are given the responsibility of fundraising having been incubated. And a couple of things go wrong. 2% of capital is available to women. Like, right now, that’s sort of a harsh way to put it. But you think about how many banks have doors open. And so the incubating team, which are primarily men, will often say, you should expect a higher valuation, and if they turn down term sheets, they should say you should be able to raise more. And they frankly, end up in a really tough spot because they don’t have capital, they don’t have the support of their incubators, or their boss. Or the flip side is, I think, particularly in life sciences, women are in a lot of really great positions of leadership. But we still have a boss. And so there’s something interesting when you talk about recruiting, which is, oh, it’s tough to sometimes find somebody who’s willing to take a 10% founder ownership. And often those are women. So I sort of see this incubator model slightly as an opportunity for women because you get to be founder of a really successful company. But you’re having to take this sort of baby step in, like you ultimately still work for guys who own more of the company.

Sarah Anderson 36:48
Yes, so So I do think there aren’t enough female partners at these company creation firms, right? There definitely is more diversity among the founder base. But there aren’t a lot of women right now starting company creation firms. There are a few and I think there are a few that are gonna be incredibly successful. So I hope that that change is going into the future. But to your point about the 10% founder ownership. So this is one of the misnomers and I think that there are anecdotes here. But there should never be founder ownership at 10%. Right, and that’s one of my points. It’s, it’s not something that we would invest in. Yeah. And oftentimes, when we’re looking at founder ownership, it has to be consistent there. What we’re seeing is that more and more company creation firms have a dedicated band of where, regardless of gender, race, sex, all of that there, there’s a band, their founders have to get between 30 and 50%. Right. Whether you know, and so If the 50% ownership is if they have a founder that’s coming in, usually that’s done multiple cycles, right? And their talent to scale is really strong. The 30% tends to be more founders that are newer, they have really good operating chops, but maybe they’re coming out of like a management team and weren’t necessarily the CEO. So there’s a lot of different variables that are encountered.

Alexa Binns 36:56
benchmarking is so helpful that if you are being recruited to take over as founder of a company creation company, that you’re worth 30%, if not more, based on your lived experience. Yeah.

Sarah Anderson 37:10
Yeah. 100%. And there, I mean, I would say there’s a lot of examples where that’s true. Right.

Earnest Sweat 37:17
Switching gears, I have a question about, given the state of the venture ecosystem, generally, we’ve always pushed for one type of exit: the IPO looking like there’s going to be, there’s going to be a flood of people trying to have IPOs not sure if it’ll actually work. Does this put your, you know, company creation entity is that a better play? If there’s more early exits, and PE acquisition?

Sarah Anderson 37:49
I mean, early exits are great. If you are realizing the value of the companies that have been created. A lot of these company creation firms tend to invest 250 to 500,000, or like 30% ownership. At the point where they might be valued at 50 million, or, you know, yeah, like 50 million, I mean, you generally are at a 10, multiple of your initial invested capital, and it’s a good time to sell some secondary, or get some money off the table. So early exits, I think in this category, in particular, you can still realize significant Alpha. But there’s been a lot of data around the compounding effect of value accretion and venture. And so I think this is something that managers have to weigh, based on the case, the use case, in the company creation category, specifically, there’s a lot of opportunity for secondary sales. While companies are still private, before they go through an exit transaction, whether it’s an IPO or an m&a. And we do see that in some of the stronger performing company creation firms, they might take 10% or 20% off the table once they realize a 10 Multiple, and then they’ll hold the rest of your exit. That’s a smart strategy. But to your point about early exits, I think it’s probably the same answer between company creation firms and standard ventures. You have to just weigh the value of creation and the compounding effect of the later years.

Alexa Binns 37:32
Any final parting thoughts for either allocators or venture studios? Company creators who are listening?

Sarah Anderson 37:42
Yeah, so I would say that this is a high potential asset class. It’s emerging, which is where the opportunities lie. But I think both for allocators and for entrepreneurs. This is an asset class that they’re going to want to know about. It’s worth the time to dig in. And if anyone out there wants to get in touch, we have significant insights at this point in the category overall, we’re happy to talk. And they should feel free to reach out.

Alexa Binns 38:20
Say that you are the thought leader on this entire asset class, I feel like you’re at the forefront of something that we all are going to say, Man, remember when that was just volts?

Sarah Anderson 38:33
It’s happening. It’s happening. There’s actually, since we launched, I think there’s been three or four other funds that have launched with this strategy, which is great.

Alexa Binns 38:45
Well, given the argument for this business model, I can see why so thank you. It’s been such a pleasure. Thanks.

Sarah Anderson 39:27
Yeah. Nice to meet you. And thanks for having me on. This is fun.

Alexa Binns 39:37
See you later, Allocator!