Earnest Sweat 00:02
Welcome to Swimming with Allocators. I’m Earnest Sweat and each episode Alexa Binns and I give you a VC podcast from the LP perspective. You ready? Let’s dive in. On today’s episode of swimming with allocators, our guests is Sam Sadowsky, a partner at 1200 VC, which is an early stage investment platform that invests in both fund managers and founders. This was a great conversation today, where I really feel that Sam really incorporated all the different hats he’s worn as an LP GP and former founder.

Alexa Binns 00:37
He gave us great advice for LPS on some of the differences and opportunities if you’re doing fun level investments as well as direct investments. And some cool lessons learned from his early days investing in climate one point out to now two points.

Earnest Sweat 00:51
Today while swimming with allocators, we had the pleasure of speaking with Sam Sadowsky. He’s a partner at 1200 VC, which is an early stage investment platform investing in fund managers and funders, founders building companies shaping the future of humanity. The long term vision of 1200 is to be a systematic value creator by becoming a leader at partnering with the seed stage towards regional global and planetary impact. Wow. That’s a huge mission. Sam, thanks for joining us on Swimming with Allocators.

Sam Sadowsky 01:31
Oh, it’s a pleasure to be here, guys.

Earnest Sweat 01:32
So first, I wanted to start off with your journey into this asset class. Sam, your background is intriguing. It has a combination of operational experience in digital marketing, and a deep understanding of the capital markets. How did this unique mix lead you to the world of venture capital, specifically with both direct and fund investments? Yeah,

Sam Sadowsky 01:57
It’s interesting, I kind of had an untraditional foray into the world of VC. I mean, in college I got really into self educating myself on capital markets, in addition to private markets as well. And I was fortunate enough that I had friends and family that were quite active in predominantly VC, some but mostly VC. And I just spent a lot of time having a curious mind and wanting to learn more about a What are you looking at? Like what’s the near frontier? Now at that time, it was climate one point? No, it was a lot of bio. And I basically wanted to just absorb as much knowledge as I could. Then, you know, I wore a bunch of hats and just career path from working in the family business to leading digital marketing at a big PE backed firm, to being a founder, which was a whole different peek into another world in and of itself, I really got to understand and see how the VC played a role in not only enabling us, but also helping us with decision making processes, whether beneficial or detrimental. And as that started to wind down, I got a call from who’s now my Founding Partner Esteban on and he had this grandiose vision to build a standalone firm, and asked me if I would stop what I’m doing and come join this journey with him and help co build this alongside him and right, within one hour, I made up my mind and I was like this is what I want to do. This is what I want to dedicate the rest of my life to and that’s how that happened. We

Alexa Binns 04:08
see a lot of founders think oh, yeah, I should head to the other side at some point and to put on the investor hat. What’s the parallel with doing direct investments and running a fund of funds?

Sam Sadowsky 04:24
So the way I kind of view it is that you’re both at the end of the day underwriting for Financials, you’re also underwriting for human beings and at the end of the day, this is like a human based business. I view this as a we business, not an I you business. And the interesting thing about about investors that have worn the operator hat is there’s I don’t know if empathy is the right word, but there’s a lot more understanding like the trials and tribulations of a founder and what they have to go through past learnings you know Any type of transferable knowledge set to help avoid past mistakes, get other perspectives. I think as an investor, you’re just better suited to empathize, understand and work directly with founders on core business problems. And if you’ve only been in the allocator hat, and only cut checks that

Earnest Sweat 05:22
Sam, adequate question, Alexa, so, Sam, we’ve heard a lot of like, just people, GPs who had that operator experience, and that makes this right in line and what you said about the empathy or just understanding that experience, but you rarely hear about allocators on the kind of LP investing in funds. Having that perspective? What advantage do you think that gives you when underwriting a fund manager,

Sam Sadowsky 05:54
when underwriting a fund manager, it just augments your ability to understand kind of how, you know, you hear the word value add tossed around a lot in our industry. And there’s, you know, it’s a very broad spectrum. But I think at the earliest stages of investing, the most concrete form of that value add kind of occurs from operator to operator, especially at the pre-seed, that’s going to be the toughest time for people to solve things I mean, if you’re a founder, you’re wearing whatever hat needs to be worn at any given time. If you’re not an engineer, you’re going to be working with your engineers, you may be loved. But no matter how you slice, you got to wear every hat. And I think it’s nice to have people on your cap table that have either been through that or can empathize with that and are not going to tell you how to do your job, but just be a I don’t know safe space is the right term, but a space where you can really just ideate bounce ideas off each other, roll up your sleeves, if they have a problem that that is difficult to solve internally right now and and and be that support system.

Alexa Binns 08:09
We’ve got a question on how you think about monopolistic outcomes. Yeah. So I think it’s, it’s relatively easy for me to sort of understand where that what that looks like, when you’re doing that direct, direct company startup investments, does that also come into play in selection of managers?

Sam Sadowsky 08:36
Yeah, I think when you’re looking at emerging managers, they should be taking firm building approaches to build it, you know, and, look, you get a lot of people that want to scale and run the AUM game, like really quickly. And I think that a lot of emerging managers outperform at their sweet spot of fun size: 25, 50, or 75. But their, their goal is trying to build a category leader firm, you know, whether they’re hyper specialized or generalist, they’re taking the same path as a founder to capture as much market share and grow their their firm to be a tier one partner, the same way a founders growing their business to be a category leader and in their field.

Alexa Binns 09:23
So it says that fewer investments, more conviction, and, and really swinging for the fences?

Sam Sadowsky 09:33
100% And I mean, what I speak to GPs, oftentimes, I really like to dig into their vision for their firm and how they’re going to scale their firm over time. And you know, these things are one thing now and then there’s something else later in the future. And I think the ability to see that vision speaks volumes to where their heads are at as an entrepreneur themselves.

Alexa Binns 09:58
Yeah, yeah. So if you can get like 1.6x with T bills right now, but yes, managers need to offer

Earnest Sweat 10:09
On differentiation, where do you come out on? Emerging managers product offering of being more of a generalist versus a specialist, and specialization can come out a lot of different ways, you know, talking to a number of allocators on this podcast and just, you know, in private conversations, there’s very different views on which style they really think outperforms.

Sam Sadowsky 10:38
For sure, I think it’s, look, there’s a place for both generalists and specialists managers, there’s always going to be I think, different technological environments in terms of the innovation curve could prove advantageous both ways for the generalists that has more flexibility to really just capitalize on opportunistic opportunities, as well as specialists that are so dedicated to certain verticals, that they have just unparalleled knowledge, and that they can do highly technical diligence where a generalist firm may have trouble conducting that type of diligence or they’re going to outsource that diligence and not have the core understanding of it. I’m big on personally on specialists VCs, for certain types of technologies, I think for really high technical hurdles you need people that are specialized to even understand these businesses, because a lot of people think they’re backing something between the space of improbable and impossible, where the domain expert knows that it’s more probable than improbable should the science the risk

Alexa Binns 11:46
1200. Has you been in the market for a bit, has your perspective changed since getting started? Since you all open shop?

Sam Sadowsky 11:59
I don’t think our our perspectives have changed, I think you need to have a degree of sensibilities around everything going on both venture landscape, both macro, but the underlying theme is that good businesses are built in any environment, great GPS, and great firms are built in any environment, there isn’t a single time where opportunity is not going to be plentiful, you may have to turn over more stones to find it. But that being said, the traditional path of knowing what makes good businesses, knowing what makes strong founders, completely ignoring whatever is going on in the macro, always is going to hold true. There hasn’t been a single time in history where that’s been not the case. You look at ‘08 and you look at the draft class of companies that came out of ‘08 2010. Excellent companies, you saw this thing, the early 2000s, late 90s, as well, when the VC market was way more nascent than it is today. But I think, yeah, you have to be cognizant, you always gotta be learning, you’re going to see things you’re going to see the Matic shifts and where capital flows are going to, I don’t think that you should absorb yourself in in chasing what the what the hottest thing at the moment is, there’s a place to be cognizant of it and to deploy into those those sectors, but I don’t think the the chasing strategy is beneficial, I think removing the noise and understanding what you’re good at remembering how, you know, you were trained to understand businesses, how to underwrite businesses, you know, is always gonna be where where, where the real value can be extracted out of your strategy.

Alexa Binns 13:40
Are there any trendy categories that you see an opportunity for that maybe there aren’t as many dollars? Um,

Sam Sadowsky 13:50
You know, what’s funny is that the narrative may differ from the actual capital flows. But if you look at things like construction tech, which are like, you know, I think are great verticals personally, like capital is stayed quite consistent, even in this year across those verticals. It’s not as you know, the narrative for it is not as sexy as something like Ai or something like genomics or something like, you know, that’s something more frontiers. But nonetheless, it has extremely high utility. The people that want to be deploying into that space know that extremely high utility construction is not going anywhere, it’s just going to get more and more efficient over time. And I think some of the non narrative sexy industries are really going to be built to last and are going to see a lot of steady capital flow into them.

Alexa Binns 14:37
And you’ve started out in climate 1.0 Investing. Now, now that that is this sort of one of the trendiest topics, any, anything where you’re, you’ve learned that lesson or any stories from 1.0, that could be valuable in 2.0. For

Sam Sadowsky 14:58
sure. I mean, I think Anytime there’s something that’s like a very, very frontier and breakthrough, you’re gonna have adoption risk, and people discount adoption risk. There’s a lot of variables that go into this, which are just existing practices, viability of the actual tech switching cost, does it cost me more money to actually deploy this over time? Will it actually save money? What are my intrinsic motivations to adopt this? Is it image based adoption? Like, I feel like I need to do this to have my image basically augmented in our favor? Or is it actually going to be beneficial to the business? And I think oftentimes nascent technologies, they need a bit to play out. I mean, I look at climate 1.0. And it’s like your two biggest winners are Tesla and First Solar. And then there was just a whole swath of companies that while they had viable technologies, they maybe weren’t as viable as the story that was being sold, even though the technical de-risking occurred, it occurred maybe too late. And I think there’s been a lot of learning since then. And obviously, technology doesn’t move linearly. So just on a tech basis, there’s a lot easier ways to deploy these things, de-risk them, pilot them quicker, faster times, the pilots help a lot. I mean, back then you would have, like, six years before you could get to a pilot for some of these things. And when that type of CapEx got too high, VCs stopped funding it. And I think now you can have less capex, and you can get things to market a lot quicker, de risk things a lot quicker. So the ability to trial and error has just drastically increased in terms of speed and efficiency.

Earnest Sweet 16:43
Now, we’re going to take a quick break to speak with our sponsor. On the show today, we have an industry expert and sponsor, Rachel Waddell, Vice President of Investor coverage at Silicon Valley Bank, an division of First Citizens Bank. Thank you, Rachel, for partnering with us on the show and being on the show today. So Rachel, continuing on the great research that you all put out, SVB publishes a great report on the state of the market for the innovation economy. What is your data show for unicorns? And the future of that?

Rachel Waddell 17:19
Yeah, so you know, despite there being a few notable collapses this year, unicorns are generally well positioned to weather this storm, since a lot of these companies loaded up on capital in 2021, and 2022, and have really since cut costs and are prioritizing profit, profitability. And when our data team last looked at the data in August, about 80% of these companies had two or more years of runway, at their current burn rate. So they’re definitely positioned to weather the storm. But it’s important to note that while you know a few unicorns are failing, there are really few that are being formed. We saw only about 25, established in the first three quarters of this year, compared to nearly 170 in 2022.

Earnest Sweat 18:12
Wow. That is fascinating. And says a lot about the market. So, you know, we’re in this game as VCs to not just have unicorns and, you know, retweet articles about our companies becoming unicorns, we want to get that moment of an exit. And so there are typically two options: IPO, or m&a, right acquisitions. Let’s first start, what do we see for IPOs? In the near future?

Rachel Waddell 18:46
Yeah, I mean, there was, I think, definitely the beginning of this year and optimism that the IPO window would fully reopen, maybe in the second half of this year. But no, we kind of ultimately saw that fall a little short, with few VC backed companies completing a listing. And actually a large reason for this is the poor performance of many tech companies that went public in 2021, whose valuations are averaging about 50% of their IPO price. So that’s really contributing to the drop in valuations for later stage companies, and preventing a lot of them from wanting to exit. And then also, just in conversations with some growth investors and late stage investors, we’re really hearing that their expectation for the IPO market to reopen is now looking like the half of the second half of 2024, even Q1 of 2025.

Earnest Sweat 19:40
And what about M&A activity?

Rachel Waddell 19:42
Yeah, so I mean, to no surprise, it’s definitely a buyers market, as runway kind of declines for these companies and companies struggling to raise money are forced into a soft landing, such as an m&a or will face bankruptcy and liquidation. So expect that we’ll see an increase in m&a activity and continue to see that. And SVB actually has an internal index such as tracking troubled companies with less than 12 months of runway, high cash burn, low growth, and numbers have surpassed pre boom time wobbles. So this can serve as an indicator that we’ll see an increase in m&a activity in the coming months.

Earnest Sweat 20:24
Rachel, you’re such a good partner here in the venture ecosystem. For folks who are interested in getting in touch with Rachel and SVB. Feel free to email her at rwaddell@svb.com. And now back to our LP interview. Shifting gears to your model, a large audience that listens to our pod, are allocators both experienced as well as those interested in allocating into this asset class. Could you speak to first of all, like the decision to have a hybrid model of both direct and fund? And then I have some follow up questions on that?

Sam Sadowsky 21:07
Yeah, for sure. I mean, generally speaking, I guess fund of funds typically, like pure play fund of funds typically didn’t get the sexiest rap, you know, from people, it’s a very broad based way to index an asset class. And when you look at the performance data, it performs in line with what you’d expect of the indexes, you know, people are going to VC funds to outperform the index. And I think when you marry their diversified portfolio, which you could argue as a risk mitigator, and you marry that with the asymmetric upside of direct investing, you just get a more appealing product. Product that’s math is more favorable to what the average LP is looking for. You can oftentimes invest in things and try to cherry pick certain co-investment opportunities. But then you get stuck in the adverse selection conundrum, what if I’m only picking dogs in the coinvest side, you know, and I think it’s easier to have a blended vehicle of sorts than to try and basically make your own quasi direct portfolio by by cherry picking a coinvest that that you want out of fund commitments. You also see opportunity funds come out of direct VCs, and that’s similar. It’s a similar way, it’s obviously not blended. The other thing, though, with that is that sometimes I asked myself, is a preseed VC, going to be able to execute an opportunity fund strategy at the A, B and, and even potentially C stage. So I think being able to just bundle what you know you’re good at, getting the asymmetry on the direct side can be a lot more appealing to LPS that want a diverse exposure to an asset class.

Earnest Sweat 23:00
That’s a huge differentiator, from what I’ve seen, mostly, especially with fund of funds, having a direct investment is mostly just co investment. Like they limit themselves just to whatever their fund managers have invested in. And so this blended approach, what do you feel that your team and expertise has I can assume what it is, but what do you think that allocators who do choose to have more of this blended approach? What’s the, you know, what, what’s the type of expertise they need to have in house to be able to do that successfully? Yeah,

Sam Sadowsky 23:34
I mean, also, on that note, generally speaking, you need to be able to re underwrite these deals, for whatever that entry is, and understand that where you’re investing now is, is you investing directly, it’s not exposure on a fund level, you know, through the look through at the earliest stages, you have to be able to have sensibilities around, if I’m entering here at the A, this is going to be my cost base, or I’m entering here at the B is going to be my cost basis. And I underwrite this for the outcomes at work for whatever your strategy may be. When doing so the addition is that the asymmetry on the information side you get from being an LP in general into funds can really help you make informed decision making when you decide to go direct, especially if you’re investing in something from a look through, you may be invested in. I see a lot of LPs that will get co-investment opportunities, they’ll take the memo that gets circulated to them, they’ll make a decision off of that. I think the real way to be doing it is you as an LP whether you’re in an individual and institutional allocator, you need to be actively managing for that portfolio. Obviously venture is a lagging indicator, but you’re in this privileged position where you’re getting so much asymmetric information and being able to track these businesses from the inside, that you should be building that conviction over that 12 to 18 to 24 month runway. Window prior to the subsequent financing, so that when you do site to evaluate that you’ve had the past 12 to 24 months to really build that conviction independently of whatever conviction, the manager, you may be an LP into is building. And I think that’s an important differentiator is just generally when wearing an LP hat is if you’re gonna go direct, build your own conviction, do not rely on the GPs to build a conviction for you, you have the insights to do so you’re getting your LP updates, you can talk to those founders directly. And I encourage everyone that wears an LP hat to do so.

Alexa Binns 25:43
Any other advice for allocators given the climate today? Um,

Sam Sadowsky 25:49
It’s tough. You know, I talked to a lot of my seniors and, you know, they tell me that this is the toughest environment in the past 15 or 20 years. But I think raw talent is abundant in both the manager space and the founder space. And don’t shy away from what you want to do. There’s a reason you have this thesis, you have to persevere whether you have to augment your fund size to get up and running. Don’t let it be a deterrent. Yeah, I mean, it’s tough. On that side, it’s tough. There’s capital is getting increasingly more competitive, efficiencies on the allocator side are like just rapidly improving, especially with with all the tools you can leverage for crunching big data and analytics that help make decisions faster, I think you’re gonna have to differentiate yourself, whether it’s it’s strategy based, whether it’s methodology based process based experience based of the team of the GPs, I think you’ve got to, you got to be able to articulate just why you’re going to win what you do best. And you have to prove also that you can maintain that discipline to execute on, on what your thesis is. And I think that’s going to be a big thing is that you’ll get a lot of people that move with the markets to kind of, especially if you’re fundraising. And I don’t think that’s the right approach, because it shows a lack of conviction and what you came to the table with. So I think if you’re building conviction around something, pursue it and be hell bent on pursuing it. You know, ignore the noise, show that you can execute your strategy. If there’s a certain LPs that is coming to you now, and it’s not the right time, just prove to them that it should have been the right time when you go out for fund 2 or fund 3.

Earnest Sweat 27:52
What do you think of allocators? It seems like you know, the tides are? The tides are definitely changing right? In the venture asset class. And a lot of people will be going to the market on the 24th and 25th. How should LPS manage this process? How should they take advantage of it? as well? You gave some great advice for the GPS just now. But for sure, yeah.

Sam Sadowsky 28:23
On the LP side, I think you know, there’s a lot of different types of LPs and whether you’re looking at established managers, it’s a lot different from the lens you’re looking through than if you’re looking at emerging managers. And you need to have sensibilities around the differences in them. After that, you need to be very aware of the actual asset class itself. If you’re a new LP to Vc, most likely you haven’t held something that’s basically illiquid for eight to 12 years. It’s not that common that you hold assets that are that illiquid, I mean even hard assets are relatively liquid. So I think that’s another thing is understanding that this is a long term asset class and your idea of you may see managers producing meaningful TPI in year six, you may see ones producing meaningful DPI and in your eight, you may see ones producing meaningful DPI in year 10. And I think that it’s an absolute value game, whether the DPI comes from your six, your eight, your 10 or your 11. Even your 12 performances are performances. And I’m looking for absolute performance as I think a lot of other LPs are and it’s getting them comfortable with these types of dynamics even the way you evaluate managers like a lot of LPs are not comfortable emerging manager investing because they feel like there’s lack of track record there’s there’s Angel track record. There’s a lot of variables that go into it and you’re more closely underwriting an emerging manager to the way you’d underwrite a preceding investment, especially if it’s things like Fund ones where obviously there’s a set of qualitative data. I don’t think there’s any manager going out to raise with no track record. That being said, Your underwriting heuristics a lot, your underwriting intangibles, your underwriting the inherent drive. Another thing with emerging managers that are quite interesting is that the intrinsic motivations to perform are a lot higher, there’s way less complacency in where they are. If they don’t perform, they won’t raise Fund 2. And I think being able to spot characteristics in managers that speak to that ability to persevere and work just relentlessly hard to perform for their LPs is extremely important. And I think new entrants to the asset class will have a hard time underwriting for things like that verse, someone that may be on a fund five plus.

Earnest Sweat 30:59
Where do you think with all those trends, what are your predictions? Kind of like with the macro venture? Asset Class overall? Yeah, more funds, less funds…

Sam Sadowsky 31:11
I think there’s an ebb and flow. I don’t think we’re at a place yet where we’ve seen the full effects of the macro shift yet, I think we will see a lot of this start to manifest in ‘24. But I kind of parallel like restaurants in New York, when one closes, another one pops up the next day, I don’t think there’s going to be any shortage of new managers popping up, I don’t think there’s going to be any shortage of new great managers popping up, either. And I even think on the entrepreneur side, a lot of these guys at the earliest stages, they’re looking for someone that understands their business and wants to be on this cap table and help. And I think that especially non lead or co lead emerging managers have an advantage to being able to work their way and hustle their way onto some of the best cap tables, just sort of top

Alexa Binns 32:01
level when you think about the future of venture capital, what comes to mind?

Sam Sadowsky 32:06
Yeah, there’s a lot of things I see. I see liquidity becoming more abundant. Contrary to popular belief, there’s a lot of different mechanisms for liquidity to be generated that are being built right now. Vc is getting more and more democratized. You see it with a lot of these platform plays, you see it with a difference in 501 Bs 501Cs the ability for non accredited people to participate in these things, crowdfunding DOAs platforms where you can buy secondaries as an accredited investor. And there’s quite a lot of activity on them, you can see a derivatives market for VC showing up as well, that has traction. So I think there’s a lot of things going on right now. You have a regulatory landscape changing, which may deter new managers, as compliance becomes heavier, as you’re gonna have to offer more transparency. The back row obviously has an effect, when when there’s less of an abundance of capital, capital becomes increasingly more competitive. If you follow the money, you’ll see that it goes back towards very established managers during those periods yet, conversely, the emerging managers tend to outperform in those same periods if you look at historical data. So I think there’s just a lot of a lot of evolution occurring and asset class is becoming way more mainstream than it ever has been. I also think that the globalization of VC is still only at some of its earliest stages, I think emerging markets are going to become increasingly more interesting on the private side. You know, it’s been a narrative for a while, they’ve also had deterrence on the liquidity side, because the United States obviously has the most robust capital markets and liquidity environments. But you’re in a globalized world that doesn’t have a linear trajectory and markets are going to market and they’re going to need to find ways to support local businesses and they’re going to need to find ways to grow their GDP, and that’s going to start at a local level. Are you

Alexa Binns 34:15
seeing more of us? Managers investing in international markets are also considering taking meetings with some of those folks who are based in these markets? Yeah, I

Sam Sadowsky 34:31
have. I’ve seen us managers start exploring, you know, a lot more international markets are still predominantly US investors, because I think a lot of people, especially in this industry, know that without that local context, it’s quite hard to be successful solely in a foreign market if you don’t have that. That being said, a lot of people do have boots on the ground and the markets that they do deploy into even if they’re US based firms. And I, I do think you’ll see an increase of opportunistic buckets carved out that do tackle other parts of the world outside of their core geography.

Earnest Sweat 35:12
Any parting thoughts for our audience of other allocators and emerging managers?

Sam Sadowsky 35:19
Um, look, I think that we’re in, we’re in a very interesting time right now for venture, I think it’s one of the best times to be an allocator to be an investor to be an LP. I think it’s a tough time to be a GP and entrepreneur. But I think that if you can survive in this market, that it’s going to be a big testament to what you’re building and that people can get behind you and want to back you in this environment. And I think no matter how small the wind is, on that side, you should celebrate it because you’re in a period that just we’ve been numb to it for the past 12 plus years in terms of that being the macro. So I think that any small win in this environment should be celebrated and you should be proud of yourself and you should just keep tackling it with absolute perseverance.

Earnest Sweat 36:07
I love that gratitude, gratefulness. Yeah, acknowledging that success for sure. Sam, thanks again for joining us today on Swimming with Allocators.

Alexa Binns 36:23
See you later, Allocator.