Earnest Sweat 00:03
On today’s episode. We have Brian O’Neill. He’s the former Chief Investment Officer at Robert Wood Johnson Foundation. He brings over four decades of investing experience in private equity and allocator Strategy Development. Today, he’s going to share with us from his vast experience on what it means for the venture capital environment today for allocators, also how allocators should approach venture in the light of the current cycle dynamics and put it in historical context. And lastly, he’s going to give advice for fund managers and alligators allocators and navigating co-investment liquidity and structural shifts in the market.

Brian O’Neil 00:58
I have worked in the investment business since 1980. It’s kind of a long time with only two places, though, because I hate changing jobs.

Earnest Sweat 01:08
That is, that is fascinating. And says, Well, I just can’t wait to dig into the topics today, because you’ve forgotten more than I’ve ever learned in this industry.

Brian O’Neil 01:23
Well, I will say I did have a meeting with Mr. Kleiner and Mr. Perkins in 1981 and they were pitching their idea for venture capital to the equitable and we turned them down. And it was one of the issues which, you know, actually it wasn’t a terrible thing that we turned them down because we were a large financial institution. We would have invested 5 million in their fund, and they would never have really moved the needle. And right from the beginning, that’s one of the biggest differences between venture and leveraged buyouts. Equitable was a big player in leveraged buyouts in the 1980s because we had a lot of money to put to work. We wanted to put it to work in equity, but even more so, we wanted to lend money to LBOs. That was the thing that we were really seeking to do. And so had some exposure, quite a bit of exposure, to the leveraged buyout area, and less so to venture. And then in 1992 the insurance regulations were changed, and it really cut back on our ability to invest in, quote, risky things. Remember, we did a big study of all the things that we did that were now going to be subject to this onerous haircut. And the best asset class turned out to be LBO equity that in the 80s and into the early 90s, it did very well. So we said, Okay, our small amount that we can have we’ll have at LBO equity. And the leverage buyout business has always been in a state of people saying, Yeah, this has done well up till now, but can it continue to do well in the future? And I would say 40 years later, people are still saying that. So that’s kind of an interesting perspective. In 2003 I moved to the Robert Wood Johnson Foundation, which had, that time, about 8 billion in assets, so it was actually quite a bit smaller than the equitable and we did invest in venture capital, and we were of a size where venture capital could make a difference, but even so, venture the issue with venture has always been if too much money goes into venture capital returns suffer. In fact, I put it this way, if too much money goes into leverage buyouts, returns shrink. A little bit too much money goes into venture returns. Yeah, and we saw that in the late 90s, and I think we’re in the middle of seeing this happen again from the excesses of the late 2010s and with the growth of growth equity into the hundreds of billions of dollars and funds actually bragging that They didn’t read company write ups they just invested.
Earnest Sweat 07:25
I want you to kind of share like, you know, working at, you know, the equitable to, then the foundation, Robert Wood Johnson Foundation. There are different things people are looking for, and you guys are considering all different asset classes. What takes me back to how, you know, given the landscape you’ve painted so well, how do allocators even approach, you know, first starting privates versus publics, and then, you know, double clicking on privates. How to go and approach that?

Brian O’Neil 08:30
Right now, every endowment and foundation, and those are the group of investors I’m most familiar with, is virtually in the same boat that their private allocations got a little bit to the top of their range, or maybe even above the top of their range, partly due to performance in the late 2010s partly due to this appeared to be an even more attractive investment opportunity, and now they’ve had three years with Very little return of capital, and meanwhile, a steady stream of capital calls, so they’re now looking at our private portfolios bigger than we want. It hasn’t done well compared to the public markets, and we’re faced with what should this year’s commitment budget look like, and where should it go? And basically the first thing that happens is commitment budgets shrink because you’re not trying to make the private portfolio even bigger, and then within that budget, priority always goes to the RE ups for the funds that people like. And it doesn’t take too much of a cut in your commitment budget and too many re-ups to discover that you’ve got little or no money left for any new funds. And I think a lot of folks are in that situation right now, and they really this was supposed to be the year that the leveraged buyout business really returned capital and kind of hit restart, and it looks like it isn’t going to happen.

Earnest Sweat 10:00
Yeah, with lb you know, so much talk has been about from venture fund managers that this idea of a 10 year fund is false. many companies are staying private longer. Are you guys seeing a similar thing for LBOs as well, or is it,

Brian O’Neil 10:23
there’s a big debate in the LBO world about what are called continuation funds. Continuation fund is at the 10th year of the fund. The investment period ended five or four or five years ago, and the the sort of the selling period is supposed to have ended by the 10th year, and there’s still companies left in the portfolio, yeah. And some of the LPs are saying, Hey, this is the supposed to be the end of the fund. We would like our money back. Would you sell these companies? And the GPs have a number of reasons for not wanting to do that, yeah. And usually, you know, you can get a one or two year extension. But what they’ve started doing, and a lot of LPs really don’t like it, is called having a continuation fund, where they say, Okay, our portfolio is marked at 80, yeah. And we will offer anyone who wants to get out a price of 70, pay us 70, and we’ll find new investors who will come in at 70, and that creates this continuation fund where they can actually hit reset on their fees and their carry and whole bunch of reasons why it’s good for them. And the word for this, for LPS, is it’s coercive, because almost by definition, you are not getting a very attractive price, because it has to be a price where the new investors want to come in and invest, and there’s, there’s no way to balance off those two sides of the coin, yeah. And so the the only choice you have is to stay in so you don’t have to take that lower price. But a lot of LPs feel like we want the money back.

Earnest Sweat 13:03
you mentioned just kind of the state of the venture and how it’s in some trouble right now, as in the market. How would you compare it to previous downturns and like, you know, we’re not even technically in a downturn yet, but, but I feel like it is fast, fastly approaching, yeah. How would it compare to that? You know, SNL, dot, you know,

Brian O’Neil 13:28
The late 90s was a crazy time. And I, in fairness, even with the worst excesses of some of these big growth funds, we never approached the late 90s where companies would deliberately lose money because that made their value go up. Wow. There was this great commercial in the Super Bowl by one of these dot coms. And they had a commercial, and they just sat around and they said, We just spent a million dollars.

Earnest Sweat 13:58
I have to find this commercial. So,

Brian O’Neil 14:00
so we didn’t have those excesses, but the private for longer, and the free money and the very excessive, and also all the money coming in for sort of late stage ventures. Yes, that’s the moment in the cycle when companies are supposed to think about going public. And instead they got large checks that would allow them to stay private. And also got a message, grow, grow, grow. And then when rates did start to go up, they got the exact opposite message, we actually want you to start making money. It’s time to reduce head count and get this company into the black. I honestly feel that there’s a generation of those companies that Miss, they have missed their moment. Yes, and you know, I think if you know, if you’re an allocator, if you’re an LP, and you have an existing venture portfolio, you’re looking at it, it hasn’t generated. Much cash for three years or so, the valuations are problematic. I mean, not that they’re necessarily wrong, but how do you value a company that has really not kind of broken through? And they’re looking at that, they’re saying, What am I going to do with this? Because this is not like just waiting for one more good year to start returning capital, and meanwhile their venture other venture funds are raising more money. And I think this is going to be one of the biggest issues that existing venture investors are going to have to deal with is, what do we do with our existing portfolio? Right now, nobody wants to buy it.

Brian O’Neil 15:43
Yeah, yeah, but I think

Brian O’Neil 15:45
there could be an opportunity. You might say the bid asked is very far apart right now, but if you own something and you expect to get very little return out of it for the next five or six years, what do you know? What’s that going to do to the return of your whole portfolio?

Earnest Sweat 16:02
Ass more and more capital has come into the private markets, and it seems like a lot of institutions that historically would have just waited for the IPO have now kind of like leapfrogged that to get in earlier and earlier to get some of that, that that delta, it seems like there needs to be a reclassification of venture, early stage, venture versus growth equity versus whatever kind of that period before there’s an exit opportunity. Do you think you know foundations and endowments are thinking about it like that, or is it so much coming at them, so much change that maybe that’s not the right approach?

Brian O’Neil 16:49
I think the growth equity stage is the one with big question marks around that, that most endowment and foundation funds tended to be a little earlier stage. Yeah, and while there’s still there’s too much money everywhere, there’s not as much, too much money in these early stages, and new companies are coming along. But I do think it was that growth equity stage where maybe a company actually needed some money to build things, but or just really wanted to get a high valuation and raise money, and that really that has to shrink, that throwing money at those companies really is bad for the earlier investors, even though they put a high value on the company. At that moment, you can’t sell. And the ultimate fate of that company may be that it’s going to be lower in value, you know, the next time around, or maybe even as a company is not going to make it. So there’s not a lot of benefit there. And the people who are coming in at these high valuations, they, you know, the ones who did that in 2018 and 20 2019 they’re looking at real losses now,

Earnest Sweat 18:03
yeah, yeah, yeah. I think we were on the verge of some real learning and contractions thanks to kind of, you know, the zero and, you know, companies starting to stall a little bit. But then comes kind of like the White Night of AI, and we start to see some real gains, like the consumer anyway, seems like, oh, generative AI is really something. And so it’s really kind of conflated the natural contraction we were about to have to now. Nope, we still have some hope and hype here. And I’m sure that’s really made it even more difficult for, you know, larger LPs and endowments and foundations from making like, how do you re up or and then, how do you find alpha in this market?

Brian O’Neil 18:57
You know, those two questions are earnest. I mean, first of all, venture capital, if you look at the median venture capital funds returns, is not that attractive of an asset class, you know. And I’ll contrast it with leverage buyouts, where the median LBO fund is decent, yes, and, you know, and it’s not that hard to find people who are a little bit better than average, and then that generates some pretty good returns in venture. If you got the median fund, it would not be very attractive at all. And so we are all trying to find the top quartile funds. And you know, there is, there’s, there’s a lot of this decision analysis that people are overconfident. I mean, I think picking venture funds is the perfect example of overconfidence in action. And you know, I think you really should be thinking long and hard about this at the same time, people have learned that they all. Always have to invest in ventures. It’s nearly a near religious belief that venture is the highest returning asset class. Keep investing and you will get paid. And how long? I think it could take a long time for that learning to go away.

Earnest Sweat 20:15
Yeah, and it’s like a caveat. It’s like it is the highest earning asset class, if you pick in the top decile, top quartile, but if not,

Brian O’Neil 20:29
If not, it’s not even that great. But it’s sort of like those studies with rats, where they feed them, and then they stop feeding them, but they keep pushing the lever. I think we’re still pushing the venture level, saying we’re going to get returns. So, you know, I honestly think that money needs to flow out of venture, that a number of things need to happen. But one of them is that, yeah, and I feel as though, you know, I, the advice that I give people is you don’t need to invest in ventures. If you think investing in a venture is a good idea, fine, but you don’t need to. And you also, you mentioned the time aspect of it, because I honestly, towards the end of my time at Robert Wood Johnson, we’re thinking about need to have some kind of time component to our commitment budget, because committing to an LBO Fund, which is probably going to be done or nearly done after 10 years, should cost a different amount than committing to a venture fund, which in year 10 might still be growing its companies. Yes, nobody does that, but I think they should,

Earnest Sweat 22:38
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Earnest Sweat 23:35
You’ve seen enough cycles to it. I’ve been surprised, and not so much surprised at the amount of fragmentation that’s starting to happen in venture, not just the number of firms at their earlier stage, but the number of spin outs in a pretty stagnant industry today. And you know, people within the 1010, years of experience in the industry, 35 to 45 just saying, Hey, we’re going to start a new firm. There’s as much as you say, there’s a kind of, like gospel belief that you have to invest in a venture. I think another trend is happening, or it’s kind of bifurcated. It’s either you invest in the blue blood names, or emerging managers is the only place you can get alpha. How do you know, how should an allocator be today? Of like, I’m sure there’s probably, like, a balance between those two kinds of schools of thought. Or option three, you said you don’t have to do it at all. How do you think they should address those kind of competing

Brian O’Neil 24:46
Thoughts? Well, I do think, if you are in one of the really blue chip names that their next fund may or may not be good, but it’s probably a reasonable thing to stay with that fund. Yeah. Yeah, and then, you know, I think for emerging managers, the thing that I always liked was to invest with someone that I had seen working elsewhere, in other words, not just someone who spun out of a firm that you never heard of and or putting it differently, for those folks who I don’t know. What I want to see is that the first people who invest with them are the people that do know them. And so I think if you’re thinking about starting a fund, or if you started the fund, it is crucial that people with whom you have invested in the past are supporting you, because it is a very powerful statement to people who you are meeting for the first time, that the people who were with me before have stayed and you know. So I think that the other thing is to recognize that starting a fund today, a particular venture fund, is going to take you many years to have the chance to know whether you succeeded or not, yes. And you know, because there’s just not a lot of money available for new managers, and you’re going to have to start with a fairly small fund and try to have success with that fund. And if you do, then the next one can be bigger. And you know, you’re going to build a track record, but we know venture track records are long things. They’re not short things. And so I think that’s the perspective to keep in mind. And then if it still makes sense, great, yeah, um, but that’s, that’s the road that you’re headed down. But again, the most important thing to me is that people who’ve invested with you in the past want to invest with you today, because first of all, that will get you in business, size your business, so that that is enough and then have some success. Yeah.

Earnest Sweat 26:56
Another trend that I’ve seen a lot across private equity is allocators’ interest in CO investments. Do you have any thoughts on this trend? Well,

Brian O’Neil 27:06
co investments tend to vary by the size of the fund. Like the state and local pension funds, they are counting on CO investments because they have a zillion dollars to and they do when they sit down and they invest with the biggest LBO funds, and they say, here’s our deal, so much in your fund, so much expected in CO investments at a lower fee, and maybe also a separate specialty fund for just us, in something that you do that isn’t the fund In itself. So they have, like, multiple relationships with these big firms. And that also gives the firms the chance to go out and shop for virtually any transaction. Because if they need more money, they not only can get it, they have people pushing it at them, saying, hey, we want co investments, yeah. And so that’s at the very high end. Now Robert Wood Johnson was a much smaller organization than those funds, and what we decided to do is, if there was a co-investment where we had some industry knowledge of our own, we would invest in that. For example, Apollo sponsored a Fien, a life insurance company. So I thought I knew a thing or two about that, and so we looked at it, and we decided to invest in a theme as a co-investment. And that actually worked out pretty well. And I think the idea there is, you’re still trusting the manager to do the heavy lifting, but you also, you want to see if you can add a little something that says, Yes, this could be a better than average investment. Yeah.

Earnest Sweat 28:49
I’m not sure if you had any direct experience with co-investments and venture investments, but if you do, I’d love to hear that. Or if you don’t, then, like, what, where do you think the issues are, or challenges are for an allocator doing that?

Brian O’Neil 29:06
I think most venture funds really are not looking to have co investors, because most venture investments are small, I mean, and also, if the company wants to raise, say, 100 million, which might be too big for a fund, the first thing they’re likely to do is to find another investor. So I think it’s kind of a rare occasion when everything winds up and a venture fund would say, hey, we have a co investment. But I think people, on the one hand, like CO investments, lower fees, and the fund is already in. On the other hand, in buyouts, every deal is supposed to work, and it’s rare when they don’t venture, it’s kind of the opposite of that. And so putting a lot of money into one venture deal might not be the wisest perspective, if it’s. Really still in that early stage where there’s a chance it goes to zero,

Earnest Sweat 30:03
That’s that mentality just there, which I know, but like you, you saying it really just stood out to me like, when you’re investing in the LBO fund, do you expect, even the, you know, the fund manager themselves, they expect every investment to work out right? Whereas venture is like, hey, we have dreams of this working out, but we only need one or two to work out

Brian O’Neil 30:27
right, really well, and we know that several are going to be zeros, and that’s not even going to embarrass us exactly.

Earnest Sweat 30:36
So are there any you’re still advising some organizations and staying abreast of everything. What are any lessons from your time at Equitable or Robert Wood Johnson Foundation that you still like to help guide you in these kinds of unprecedented times?

Brian O’Neil 30:58
Well, I think it’s really important to go back to the basics and understand why our investment portfolio is positioned the way that it is. You know, like most foundations, are very close to a 70% equity, 30% fixed income or non equity exposure, because that’s the only way that you’re expect to be able to earn inflation plus 5% without, you know, massive volatility is that that’s kind of the sweet spot, but that’s an important consideration, because when the stock market is down, if you’re going, Well, why did we even own it in the first place? That’s a very difficult decision. If you know that, yes, the market is going to go up and it’s going to go down. We’re prepared to work through all of that. Then it’s a much easier position to be in. And so that’s and then the other big principle is diversification, and understanding what is your theory of diversification, and how confident are you that your diversification is going to, in fact, work when bad things happen, and that is, that’s, that’s, in a way, the CIOs job is not to make the stock market go up. Okay, you can’t do that, but it is to make sure that the portfolio is diversified, yes, so that whatever happens, the performance is reasonably within expectations for that environment, and so that’s the biggest job.

Earnest Sweat 32:26
We have a lot of individuals who are younger in their allocator career, who listen for that for their organization. Maybe the asset class was only Publix, and now they’re going into private or only private equity. Now going to venture. Do you have any tips on how to get an edge up that learning curve?

Brian O’Neil 32:50
Well, you know that you just use the word learn. One of the great things about the investment business is that learning is prized. Learning is part of how you do your business, and you’re almost always going to be said yes to because I’d like to learn about this, or I’d like to learn about that, and so I’d say, learn as much as you can and see if you can get over walls and through silos. And, you know, learn horizontally as much as vertically. And because these different asset classes, yes, they are very different and have different dynamics in some ways, but then other ways, they’re not as far apart as it might seem. And I think really understanding what are the true differences and what are the similarities is really very important.

Earnest Sweat 34:53
And I have to ask you as someone who’s held the role of CIO, What’s is for people who are just stepping into that role, and maybe they had, they were deep in just Publix, or just deep in a certain asset class, how does, like, that first year or so, like, you know, how do you get your handle of what your role actually is to best position your entire team in the portfolio.

Brian O’Neil 35:22
I can say this. I have had several conversations with someone who had a CIO job and called me up and said, I can’t believe it. It’s never about investing, always about other things, and it’s usually about managing the Investment Committee. You know, particularly the endowment and foundation world, you have an organization. Maybe it’s a foundation like my first boss was a doctor who works with the elderly. I can’t think of the name for that. You know, she didn’t know a lot about the financial markets, but she was the head of the foundation, and then I had a very experienced Chair of the Investment Committee, but he’s an unpaid volunteer. And so how do you keep those two poles that are so different, you know, together and on the same page? And so a lot of it is the care and feeding of the Investment Committee. And I don’t mean that at all in a derogatory way. They have to really understand what you’re trying to do and be supportive and give you feedback, and then also managing an investment team inside an organization that does very different things that can be very complicated, and a lot of the bigger universities have separated their investment teams out completely to just try to get away from the governance of universities. But most foundations, you’re part of the foundation. I mean, I will admit that we gave the HR group headaches because we were maybe 5% of the head count. We were probably 20% of the stuff they had to do, yeah, and they didn’t actually like so, you know, I think the big surprise in CIO jobs early on is how much non investment work there is, and people just have to learn how to do that and and learn how to delegate more if they haven’t really had to do that very much. And then I think once you’ve kind of gotten through the first phase of that, it can be really fun, because now you can really start building the portfolio in ways that make sense to you and make sense to the organization, and you’re able to function at a level that is more powerful than anything you’ve done before, but in the beginning you have to learn about all this other stuff.

Earnest Sweat 37:44
It sounds very similar to when people spin out and they say, I just want to get back to investing. And I was like, well, that’s not the path, because you’re gonna have to do investing and manage a team and manage LPs and manage brands and all these and lease providers, service providers, and, yeah, yeah, get all those things. So no, that makes a ton of sense to emerging managers, whether they’ve been experienced and you’ve seen them work at a previous fund investment or not. What advice do you have for them in, you know, developing that relationship and interacting with endowments and foundations? You

Brian O’Neil 38:26
Now, I think it is to be patient and to see every meeting as a step forward in a long term dialogue. Because the reality is partly just the factors right now, but partly just the way things are, you’re probably not going to get a lot of takers very early in your career. There are some entities that are set up to do that. And again, you have your sort of family and friends and your circle of people who know you and trust you, and that is where most of your fund fundraising is going to come from in the beginning, but people do have memories. And if you go in and you meet with an organization and you tell them, these are the things that we’re working on, and this is what we’re doing. Oh, and we did make this investment, and it’s looking really good. You go back there in a year or two, and you’ve shown progress on all those things that will make an impression and that will make a difference. And so again, if you’re going to start up, whether it’s a venture or an LBO fund, you have a long road in front of you, and cultivating future investors is a part of that. It’s not cultivating next fund or this fund, it’s cultivating future investors

Earnest Sweat 39:39
having that long term view. A quote I got this weekend from someone was success comes from doing consistently what others do occasionally. And I think that’s exactly what you’re speaking to.

Brian O’Neil 39:53
Yeah, that and the overnight sensation, who spent 20 years to become an overnight sensation. Hey, but, yeah, that’s really true. Showing that you have the right approach and the right work habits and the right understanding of how to grow your business, those are things that people will pay attention to.

Earnest Sweat 40:14
Well, I have one last question. We and I are why I wanted you to give a very real perspective of what allocators, like endowments and foundations are going through when assessing venture capital. But I wanted to end on a little bit more inspiring note. But are there any trends within venture that excite you about the future, and this is a very long future.

Brian O’Neil 40:41
Well, you know, of course, AI is this, you know, open door. It’s funny because I have at Robert Wood Johnson, we were investors in Renaissance, you know, the Jim Simons organization, and they were sort of doing AI before it was called AI. And, you know, first you use the computer to find ideas, and then you teach the computer how to find its own ideas, and then the computer tells you what it’s doing. And you know that cycle, I mean that. I mean people are now starting to use AI in their daily life? Yes, and it’s really interesting, because if it’s just a question of consolidating information, like you can consult an AI and every single data point about something they know, and it’s incredibly efficient, but it’s just the very beginning, and you know, I think it is going to come into our lives in many different ways and but, you know, the internet. I mean, the internet took 20 years, and it’s still changing things. I mean, yes, social media. I mean, nobody saw social media in the early 90s. You know, that was like, you know, Amazon was the big break,

Earnest Sweat 42:01
yeah, and it was just a bookstore, I think, yeah, hey,

Brian O’Neil 42:06
This is a good way. Yeah, no. Now the idea that you would shop from home for just about everything, and that people would bring things to your home every day, and that it is easy to return something, yes. I mean, I remember when returning something was like so hard, it wasn’t worth

Earnest Sweat 42:23
the trouble at all. Yeah, exactly. And so,

Brian O’Neil 42:26
You know, I think we’re just seeing the very beginnings of this. And just as an exciting thing is this idea of personalized medicine, and I think that would be great at the same time, I do honestly feel that our healthcare system is advancing technologically, but it’s regressing in terms of its ability to deliver services. Yes, and I that should be where the next big breakthrough comes is how to help people stay healthier, as opposed to doing a better job of fixing them when they break