Lisa Calhoun
Welcome to the Atlanta Startup Podcast. I’m Lisa Calhoun, co-host for this episode and I am excited to have a Kauffman Fellow here with me today. Welcome, Chris. I’m really excited about you here.
Chris Keller
Hi, Lisa, good to see you again.
Lisa Calhoun
I’m gonna brag a little bit. Christopher Keller and I met in Silicon Valley. It’s been years ago now, when we were both going through the Kauffman Fellows Program. He made a hugely strong, terrific first impression, then, as a multi-asset investor, extremely familiar with family office strategies, needs, and entrance. But recently, he’s also been doing a lot of research. And so before we get into some of that, Chris, let the audience know a little bit more about you and sort of the arc of your life as an investor.
Chris Keller
Sure, I’ll start with what to do now. I’ll go backward in time. I run a fund now called Catalyst Partners, we’re a part of Moelis Asset Management. Our specific investment focus of our thesis is seeding or anchoring, new private equity firms’ growth equity buyout is kind of our core strength. And what we mean by that is providing pretty strategically sized large LP commitments to the first close of a new firm. And then we structure those investments so that our LPs, our investors get a share of the underlying GP economics in a way that enhances the LP returns. So we’re sort of trying to create a higher rate of return for our investors by way of investing in these firms that we think have a lot of potential role for a regular LP and then enhancing those returns with some seed economics. And we can probably get into that a little bit more. And then I arrived, I came here from a background as an investment consultant. So I worked at kind of a mid-tier institutional investment consultant advising, like pension plans and endowments on their investment programs, running the private equity strategies for them. And that was informative to what it did, you know, partly because of the scale at which we invested and kind of seeing kind of the breadth of the market. And, identifying areas of the market that we found compelling. The sort of specific touch point to what I do now is we didn’t have a first-time font or a seeding thesis there, we became interested in managers for a bunch of other reasons, they had a highly unique kind of specialized focus on something or they had a very unique operating, the team earned value add component to their strategy, we liked small pools of capital, we’d like teams that were aligned. So a lot of things that we liked, that were not related to being a first-time fund, when you throw them all into kind of a Venn Diagram, the overlap of those tended to be highly stocked with first funds. And, sort of by accident, we’re doing a lot of first-time funds in that role, which is a little bit unusual for investment. And so it’s sort of an accidental emerging manager, first time on track record. I woke up one day and sort of questioning, what it is I wanted to do next in my career and tried to think first and foremost about what I enjoyed, and realized I really enjoyed working with young firms and moving into that phase of life, or maybe you can be a coach as well as a player and, you know, figured that was an area where I can utilize more coaching skills because they’re kind of want to, they’re gonna need a partner to help them build the business, and then cut the data for the first time. And those first funds were, like killing the rest of the portfolio, like just massive outperformance. And I, had the same team, the same processing fee, everything was the same except they just happened to be young firms.
Lisa Calhoun
So Chris, when you say killing it, just, broadly, are we talking about three percentage points? What’s killing it in your world?
Chris Keller
It was over 2000 basis points of IRR.
Lisa Calhoun
Got it? Okay.
Chris Keller
It’s meaningful, it’s meaningful outperformance, yes.
Lisa Calhoun
Especially, over the longer-term horizons that you’re using in private equity.
Chris Keller
Yeah, so and then, so that was kind of eye-opening moment of like, something you’d love doing, and you think, and then and then hopefully, that match is something you might be kind of good at. So that was kind of that side of it. And then, clients were reluctant or sterk, can continue to have some degree of concern with first funds, we had to always kind of prove it, you know, it was almost like the bar was higher in some way. And so that kind of to me was a proxy for the market and an observation that these first funds are challenged. And that’s what led me to do what I’m doing now to bring, sizable early Capital to help firms get in business and try to help them grow and be successful.
Lisa Calhoun
Well, that data set on emerging managers really caught my eye, because while everyone says, all of the big guys, and all the consultants, as we both know, they say they have an emerging manager program. And to some extent they do. But it’s more of an introduction to the emerging manager program. And it’s not actually investing in first-time funds, and often not even second-time funds. So the data that those programs have, is it doesn’t have a lot of depth. And I noticed right away that yours does. And so I’d love to have you explain two or three of the big trends you’re seeing in your long-term emerging manager data, aside from results, that’s the key. But what are some of the drivers? What are some of the stronger correlations that are really standing out to you?
Chris Keller
Yeah, so to your point about defining when an emerging manager is, obviously calling a first-time fund is pretty obvious. That’s a fund 1. But everything else is slippery, with different definitions, depending on who you talk to. And I’ve talked to some, larger plans who define an emerging manager, anyone with less than 2 billion is the fund target. I have to that’s a pretty big range. And so, obviously, that has some people, [who] have different motivations as well. And it may be as a diverse mandate or something along those lines. So the way we have defined the way we focus on is exclusively Fund 1. And we don’t have an explicit diversity initiative within our strategy. But what’s interesting is that of the seven deals we’ve done, three are diverse. And so, I think when you focus on this into the market, by definition, you’re going to you’re going to, sample from more diverse teams, and that’s this kind of show.
Lisa Calhoun
That’s very population average, sounds like you’re seeing the population of people that way.
Chris Keller
Yeah, I think that’s a great way to say it, too. So we define it as Fund 1 the data that I have spent most of my time kind of pulling, you know, pulling data together from different sources to to analyze. I have, I’ve got data that includes funds, twos, and threes. But you know, what I have focused on is datasets where I can isolate the fund ones. And that’s why I think it’s pretty compelling. So we’ve collected from six different sources at this point, I think there’s don’t quote me on this, but I think there are 50,000 funds that are measured in those six sources. So it’s data going over, you know, 20-odd years. What I think is interesting is cutting the data a couple of different ways, which was, I’m a baseball, I’m not a baseball fanatic, but I like using sports as a metaphor for investing. And, there are two different ways you can better measure the effectiveness of a batter in baseball, which is their batting average, how often do they get it hit relative to their at-bats? And then there’s also the slugging percentage, like, how often do they hit home runs triples doubles, things of that nature. And what’s interesting as the emerging managers, the frequency of the outperformance relative to the market is like 81% of all vintage year. So if you just go back and look at Vintage years, first-time funds have outperformed the broader market 81% of the time. And so that’s Wow, that’s telling, that’s not good batting average concept. And then what’s interesting is when they outperform the slugging percentage, they can meaningfully outperform so similar to the, you know, the track record or the experience I had at Summit. If you just look at the top quartile versus the top quartile, the first funds, the first-time funds outperform first-quartile established firms by five to 600 basis points. And obviously, that cuts off all the stuff that happens above the top quartile that everything that gets to the top decile. And so if you average the top quartile of the first fund versus the average in the top quartile for more established firms, it’s more like 1500 basis points. So it’s just meaningful, meaningful outperformance if you add in some manager selection to the kind of general focus on this part of the market, so I think that’s compelling. A lot of people think there’s more risk in first funds risks, more dispersion, and the outcomes. But at every quartile, the first funds outperform the market, the only quartile in which they underperform is the bottom quartile and not by meaningful amounts.
Lisa Calhoun
So, they’re saying is you stand to gain a lot more and you don’t stand to lose meaningful more.
Chris Keller
In my opinion, data says you’re not taking a ton more risk. That means you don’t just throw darts at the board. But if you’re reasonably good at what you do, and you can cut off even the kind of the worst of the worst, I think you have a pretty good probability of being happy with the outcomes.
Lisa Calhoun
That’s surprising information for a lot of investors today who tend to feel that they’re going to be, there’s this thought and I we’ve seen it in many of the articles, the concept is a retreat to quality. And I think in a lot of private markets, investors are thinking, You know what, I’m going to go upmarket into larger funds more, Fund 17, Fund 15, and feel safe. And your data saying something very different.
Chris Keller
Yeah. And I think I didn’t come prepared to talk about this. But another research piece that I don’t think I shared in WhatsApp. The coffin WhatsApp you mentioned earlier is applies more to kinds of buyout and growth equity managers and does to venture capital. But there’s a lot of research from academics and others to show that there’s not a lot of persistence in private equity and persistence is measuring the ability of a manager that outperformed in one series, one fund series to continue that performance in the next fund series. And there was a theory in this market that forever that like really high quality, highly talented teams. They’re persistent. They persisted in that performance from one fund to the next. I think the data has seriously brought that into quiet into question. It’s roughly a coin flip on whether a top quartile fund can continue as a top quartile fund in the next and the next fund series. So I think that also sort of suggests you need to not use backward-looking track record information that often is like the most obvious thing that an established manager has, you really need to think long and hard about the current team, the culture, the investment strategy, the market dynamics, they’re operating in the asset base, they’re investing out of relative to where they produced the prior performance. There’s just a lot of other things you need to consider before making that decision. And not just reflexively, you’re automatically thinking that’s just because the track record is good that it’ll that are persistent into the future.
Lisa Calhoun
I definitely want to bring up some of the market dynamics we are all facing these days as investors. But before we get into that, I don’t want to leave the topic of some of your own research. Is there anything else that you think investors should be aware of, from your data? I mean, emerging managers going back 20 years and potentially as many as 50,000 firms?
Chris Keller
Yeah, the only other thing I’ll mention is that all about the investment outcomes, which I think is suggested that these are good, it’s a good place to go punting, so to speak. I think the other dynamic that is interesting as an investor, and particularly as an investor at scale is the ability is that the challenging fundraising dynamics create an opportunity to partner with managers and help them build their business. And that allows you, you know, some opportunities to negotiate better terms or something that’s, that’s maybe unique relative to just being a buyer in the market. So I think that opportunity is another instant another tool in the toolbox, so to speak, to try to create, you know, better outcomes for as an investor.
Lisa Calhoun
I’m gonna double click on that a bit, Chris, since we’ve known each other a few years, Kauffman has a lot of emerging managers. Valor is a firm currently, we’re just under $50 million AUM. And I will say that a lot of LPs, even inbound LPs, say when they find out the size of the firm, which is of course quite small, they immediately begin to feel that it will be difficult in some way to engage with us. And I’m sure that’s true. Because we don’t have a team of IR professionals just for example, you work with the managing partner. Hello, and yes, there’s a lot of hats. What have you learned about interfacing with first-time funds that you could perhaps advise other investors about? Hey, don’t worry about this, this, this helps. I mean, there’s got to be a lot there. That makes sense. Not dealing junkies is important because that particular personality type while incredibly important in a firm, and in my firm, they don’t do the cleanup. Portfolio analytics, shall we say? Absolutely.
Chris Keller
So, I’m not sure my answers are necessarily exactly what you’re asking. But I think, I get asked a lot about what’s different about the diligence process for a first fund versus when you’re looking at more established firms. There’s obviously a lot of the track records are often more complicated, the team dynamics are often newer and sort of emerging in some way. But I think one area that is, most specifically unusual to a first fund is obviously your interface with the managing partner, the founder of the firm, where I am, and when I’m having those conversations, and I’ve never met a first time fund that came from the operating side of the asset management business that wants to start a fund, it’s always do professionals that want to step out and start a new firm. It’s not the COO that starting a new firm, it’s the it’s the it’s the investment team. And so but there’s more to running a firm than just really good investment decisions and in pipeline and sourcing and stuff you got to know how to run a firm and that includes the ability to sell other talented investment professionals or operating professionals to come to join you when the AUM basis low and kind of take that career risk. You obviously need to sell capital, you raise capital from others and convince people that you’re someone worthy of investing in. Obviously, you got to build a brand and other things and you got to you got to recruit and train and you know, have an eye towards back office legal and compliance and accounting and financing fund administration. All these things are often not what motivates most people, that’s not exactly, why they got in the business. And so, there’s no formula to this, but when I’m interviewing folks, for potential investment, that’s a module in the interview process, which is trying to get comfortable with these people are not solely deal, they’re not just deal junkies. Or just legal compliance. I hate legal compliance too. But like, it’s part of the job. And so like, you have to have a commitment to it. And not just a begrudging commitment, but a desire to build an enduring firm. And that means getting all these elements, right. And so that is I think, the most important thing that I think differentiates talking to a founder or an emerging firm manager or fund manager, then relative to the broader market.
Lisa Calhoun
So, what I’m hearing you say is that you don’t invest in the deal junkie archetype alone, you’re investing in the firm builder. And of course, they have to show you their deal chops, but there’s a firm builder archetype that you’ve gotten used to knowing.
Chris Keller
Yeah, I think good deals good track record is sort of the foundation, it’s it’s a necessary but not sufficient condition. You have to have it otherwise, we’re not having the conversation. But you have to have all these other, these other things fall into place, too. And that, that’s culture and team, its fundraising capacity, it’s its back office, it’s all those things like you take anyone away, and the whole store kind of becomes more challenging.
Lisa Calhoun
So, I’m going to ask you a question about your own strategy. And please feel free to just say, we really can’t get into that. But you did mention that was first-time funds. There’s an opportunity sometimes for additional GP or you didn’t mention it, but maybe even management company, economics. I wonder if you could speak a little bit more about that and some of your insights there about how that improves returns for you as an investor.
Chris Keller
Yeah, I mean, we start with DLP returns just like anybody else would so anything we do in addition to that, my definition increases that kind of return potential of the fund. I think importantly, without getting into the specific details of kind of what we do, I think philosophically, it’s important to differentiate what we do versus other people who might kind of traffic on our end of the market. And there’s, there are people who will invest early and maybe negotiate down the fees pretty heavily or the carry or something else and really focus on creating a better gross and net spread for themselves. And that’s fine, I have no issues with that and the right circumstances. I think others will take an equity piece of the business, like take an actual piece of the management companies, you as you refer to, look, I’m not going to, you know, there’s, there’s nothing, there’s nothing wrong with that, necessarily. But we have preferred not to do that. Because, what we think at the end of the day is most important is creating the right structure that works for really talented teams, and they look at us as an accelerant to their business not as like desperate, we don’t want to attract someone desperate, that you know, is not in the business without our capital. And so, in one of the ways to do that is I think, finding founders finding teams that really believe in the upside of their business, and leaving that upside, that kind of terminal value the business for them. And I think that’s really important for making sure that we’re attracting really talented people to our type of capital. And the last piece about that is creating a structure that works for us and our investors. And what we sold investors works for the management, helping them kind of build a hopefully successful franchise. But the way that sucks that franchise is built is by attracting other limited partners to the capital to the cap table. And if you create a structure that feels misaligned, or feels makes other LPs feel like there’s there’s an extra cook in the kitchen, so to speak, that’s kind of taking too much of the share, you’re sort of, you’re sort of running in circles, and you’re kind of cutting your nose off.
Lisa Calhoun
For real handcuffs, If you’re backing and firm builder, then that firm builder is not going to want to open the management company, because that’s part of the tools that they’re using to attract top talent, as well as the talent’s long-term perspective.
Chris Keller
You think we’re sustainable, because you know, you can attract talent. And if the economics are too heavily going away, it really becomes challenging to attract the talent. So we’ve done it without equity. It’s not permanent. But it enhances the return for our limited partners, which we think is kind of a win win win type scenario for everybody.
Lisa Calhoun
Super interesting. I also, you and I both speak with LPS almost on a daily basis. I know you’ve been on the road a lot recently. You mentioned being back on the road next week. So, thank you again, for this time. I’m curious about what you’re hearing, current reality, here’s where, just mid-year this conversation is in July 2024. How are LPs feeling about emerging managers across the asset classes you’re working in? And to the extent you’re hearing the conversations around venture capital as well?
Chris Keller
Yeah, so I’ll take that. And there’s almost two conversations there the venture versus just broadly speaking, emerging managers, I think the emerging obviously, it’s been a tough few years for emerging managers, starting with COVID. And then lingering the years afterward, we don’t have to get into the reasons behind that. But it’s real. It’s been challenging for folks. But I think what I feel like and maybe this is more of a hopeful view than it is an actual, like data-driven view. But it feels like the conversations are turning, I think there are a lot of limited partners who are starting to see some of the established firms and they’ve got relationships with heavy to grow the AUM to an uncomfortable point, or they come back to market too quickly, or, in some cases, maybe returns it started to kind of decay here and there. And they’re starting to look for new things, or they’re just realizing that like, you know, having some diversified portfolio means not just by sector or by strategy or by geography, but also means lifecycle of the underlying firm. And I’m seeing I’m seeing more people begin to think about I own you know, a bunch of firms are in the two to whatever range billion and assets. And I want to start finding some stuff kind of back down market and they’re creating space in their portfolios for that, or they’re at least they’re taking meetings, you’re thinking about it, which is usually a good sign that their portfolio construction is going to change in the future. I think the one thing that’s still hanging that up from really becoming a reality is obviously distributions have been quite light for folks. And so I think as the distribution logjam begins to unlock, I think we’re going to see a kind of a rotation in the market over the next couple of years. Now venture is different in a bunch of ways. Obviously, venture lives on these kinds of super cycles that we’ve now been through, you know, probably three of them in my at least in my career where there’s super hype, it just gets over inflated and there’s this like valley of despair and depression and people question the asset class and really ratchet back their exposure. And it takes a while for those things to ride. And obviously, we’re in the early innings of the post the most recent supercycle. So, I have a strong opinion that, or at least my observation, it feels a lot like 2012, when the Marion Kauffman Foundation paper came out and basically said Venture is, is a terrible asset class.
Lisa Calhoun
That’s the last time that headline was really running, I think it’s really running again, quite a bit as well.
Chris Keller
Yeah. And so I think, we’re kind of in that doom loop at this point, but that the moment that paper came out was like a 10-year cycle of Venture, outperforming the market, pretty consistently. And especially if you looked at the early stage, funds, they’ve massively outperformed the market for the next 10 years. And so I think these doom cycles tend to have a narrative that kind of gets in front of the actual investment decision, I think, as investors, you have to be comfortable being contrarian, you have to be willing to do things that others aren’t doing at that particular moment in time.
Lisa Calhoun
Being non-consensus never gets comfortable.
Chris Keller
It’s not possible
Lisa Calhoun
Never
Chris Keller
Yeah, by definition, it’s not comfortable. But that’s what investors do. Like in my business, I have to be comfortable going first. I can’t wait for social proof that a manager is worth investing in because other people are investing in it, I have to go first. And I think that applies a lot to, people who are considering different asset class exposures, and venture right now is an uncomfortable place to go to keep adding to. But, I think, it’s hard to invest with those super cycles in mind, I think a disciplined approach to maintaining an allocation, the asset class makes sense. I think the other part about the Venture, unlike some of the asset classes I invest in, or most of the private markets, or even capital markets, in general, the venture is probably the least commoditized form of capital, like venture managers can differentiate their capital in so many ways. That is just unique to being a venture capitalist that a buy-out manager doesn’t necessarily have a credit manager, definitely doesn’t have. So I think there’s just so many ways that create interesting opportunities for investors who can find, venture managers who can differentiate their capital, they’ve got purchasing power because of that and that tends to be obviously a better way to invest than to invest in commodity.
Lisa Calhoun
As you’re talking and sharing so much sense. One of the things that is coming up for me is that actually going first is in and of itself, a bit of a differentiator and a strategy. I mean, it’s by definition, going to find non-consensus deals like the way you go first and first-time managers. And the reason you’re able to get upside economics is very much because you’re willing to take view risk of being wrong, and being the only one potentially at that first table. I feel that keenly and the reason it resonated so much for me is because we received lead-only investors. And we always go first, we always lead and there’s never been another VC at the table when we show up with a large round.
Chris Keller
Yeah, so many similarities to what you guys do and what we do, which is completely different ways in which we express it, but the core philosophy of being willing to go first, not needing social consensus. And I think the other part that’s probably very similar is the bet on people like, we’re you just obviously technologies and strategies and things that we both evaluate that we can analyze. But at the end of the day, what you’re betting on is the founder and the founding team, the culture in the people, because they’re probably gonna have in your business probably have to pivot a few times to really, maybe not always that you want to bet that’s certainly part of the path that they may have to follow. And you’re obviously betting on their ability to do that. And then my business I’m betting on, maybe it’s not a pivot, but it’s perseverance, they’re not gonna pivot the strategy, but it’s not an easy path, and they’ve got to recruit a team and they got to, you know, go get their teeth kicked in and for the next year and a half, and that takes a certain level of persistence and perseverance.
Lisa Calhoun
Docket believes that you’re right. And, you know, if you’re in the business of creating the future, you better believe in the future you’re trying to create despite a few kicks in the teeth. I couldn’t agree more. Yeah, there’s so this has been an invaluable conversation. I know we’re coming close to the time when you’re crazy busy. I’ve only got one last thing I wanted to touch on. As a multi-decade investor yourself, I’m curious about how you keep yourself fat and yourself sharp because you clearly do. You’re leading your own research or leading your own strategy for the other investors out there who are also very engaged in being the best they can be. What are some of the practices the things you read anything you might share on? How do you stay at the top of your game?
Chris Keller
I think my answer is that I listen, I think that the most critical skill that we can all have is to try to ingest information from different sources and try to make sense of it and not be closed off to information from sources that may be non-traditional or just not someone you’re familiar with or view that you disagree with. And that I think that’s a real bias in the industry is we tend to look for confirming information. And so I think looking for information and listening and being willing to change your mind is it’s not really, I’m not sure I’ve like, solve this in some sort of like, I do this to stay this way. But I think that my biggest lesson or the thing that I worked the hardest at, is to try to let the information take me in the right direction, and maybe it’s the direction I wasn’t heading in. But, I think that’s, that’s core to make some good decisions.
Lisa Calhoun
Okay, I said it was the last question, but I lied because I’m going to quickly insert when you talk about data, of course, that made me think immediately of AI. We’re investing heavily in AI, as are so many people these days, I personally believe AI is eating software, and you can barely not invest in software that isn’t doing a great job of the AI side of of its game. How do you feel AI is going to impact returns and opportunities in this market? What is the information in the data very early innings, leaving you to think?
Chris Keller
Yeah, so I mean, I certainly read about AI and I try to follow it as much as I can. We’re kind of a step removed from it because you guys are really at the tip of the spear so to speak,
Lisa Calhoun
Always exciting, and it is fun.
Chris Keller
How it is being implemented and news disrupting businesses, for the end of the market I participated in, we’re probably not directly investing in AI technologies. It’s more like how is AI impacting, more cash flow, eat-oriented mainstream type businesses. So I think for the world I operate in, it’s more likely to be a tool that helps companies with operating margins, which probably means, just a higher profit margin for the business at the end of the day. But at the end of the day, it’s also probably when it reaches that point, it’s probably a commodity type thing and other businesses are doing so I’m not sure it’s a competitive advantage necessarily. It’s more of a keep the playing field kind of even. So, I don’t see it necessarily as an investment thesis for us. At least it will replay where we have been spending a little bit of time. It’s related to AI, but certain strategies out there are adopting kind of a tech stack, whether it’s AI or other technology solutions. And they’re experts at implementing those at scale and different enterprises. And they take that background that that experience and they apply it to kind of sleepy year. That I think is kind of an interesting trend that we’re looking for an idea and we haven’t found one yet, but I think that’s kind of unique.
Lisa Calhoun
So, Chris, I’m hearing your call out for the first time AI private equity roll-up buyer coming your way.
Chris Keller
Definitely, give me a call.
Lisa Calhoun
Exactly! Thank you so much for your time today. This has been a fun conversation and I appreciate it.
Chris Keller
Thanks, Lisa.
Thanks for being a part of the community of courage by listening to the visionary founders and investors on the Atlanta Startup Podcast. Subscribe now so you don’t miss a single episode of the over 200 investors and founders sharing their insider tips and secrets to growth. Our regular listeners tell us we’re the briefing room for the innovation economy in the fastest-growing region of the country, the South –and when you subscribe, you become part of the inside circle.
The Atlanta Startup Podcast is proudly hosted by Valor VC. Valor is a venture capital firm that leads seed rounds in AI and B2B SaaS startups. If you like the podcast, check out more of Valor’s programs for courageous founders and investors, like Startup Runway.
Over $100M in early-stage venture capital and counting is catalyzed through Startup Runway’s grant-making program for pre-seed startups. Go to StartupRunway Dot ORG to learn more and apply directly for non-dilutive capital.
Valor celebrates VC DAY, the largest early-stage private capital conference in the region, at the end of the year. The top founders in the region, leading VCs, endowments, and family offices focusing on venture capital outperformance attend. Learn more at VC.Day.
At Valor, courage is the currency of innovation and the heartbeat of our culture. Thanks for listening and come back next week.
