Invest Like the Best with Patrick O'Shaughnessy
· Mitchell Green, Patrick O'Shaughnessy
And I had the pleasure of working for one of these firms, Bessemer Venture Partners. So when I was starting Lead Edge, I was like, why in God's name is anybody going to take my money? I could teach him how to ski, but that isn't going to be very helpful. But I said, you know what? Had I been the global head of HR at Procter & Gamble and my partner had been the global head of HR at Microsoft and the other one had been the head of HR at Nike – when I called Workday 80 times at Bessemer and Dave Duffield by the end was like, "I'll hire you as a salesperson, I'm not taking your guys' money." If I had been a world-class HR exec, he would've engaged with me. Because he would've known that I could've introduced him to those companies. I have tons of other HR execs. I know these people. In a world that's super crowded and undifferentiated, and I think it's exponentially the case more today even than what it was 15 years ago, it just like differentiates us and we do what we say we're going to do. [00:00:00] S0: How many LPs do you have? [00:00:00] S1: Probably like 800. [00:00:00] S0: Executives? [00:00:00] S1: 95% by number are these executives. Yeah. [00:00:00] S0: If you think about the level of returns versus the consistency of returns, how much does one matter versus the other for this 95% gross retention?
· Patrick O'Shaughnessy, Mitchell Green
[00:00:00] S0: If you think about the level of returns versus the consistency of returns, how much does one matter versus the other for this 95% gross retention? [00:00:00] S1: I think consistency is more important. On a per deal basis, we're trying to make a 2 to 5x in 3 to 7 years. That's like a 25 net IRR if you just actually map it on a curve. Put it into a fund, we want to generate you 2 to 2.25x nets with 20 net IRRs. Some of those deals aren't going to be 5x's, some of them might be 0.7x's, Our downsides have been very low. I think we've only lost all of our money in one deal ever, and that's because of the criteria we look for in a company and what our average company looks like, and the fact that very few of our companies have any debt on them. Now I'm trying to make a 2 to 2.25x net, which is more like a 2.5x gross. However, if something is a really big investment in the fund – and we do not run funds with like 100, 150 companies in them, we run funds with 20 investments in them. So if we've made something a 7, 10, 12, 15% position, and that goes 8, 10, 12x. That's how you can 3x net a fund. [00:00:00] S0: Yeah. And so, because you rarely lose money, does that mean you also almost never hit some giant grand slam?
· Patrick O'Shaughnessy, Mitchell Green
[00:00:00] S0: Yeah. And so, because you rarely lose money, does that mean you also almost never hit some giant grand slam? [00:00:00] S1: Correct. We're like Cal Ripken – doubles and triples. We're not Sammy Sosa or Mark McGwire. It's all about hitting doubles and triples. And if you do that with very little leverage in the portfolio – 90% of our companies or 85% of our companies are recurring revenue. So if you invest today and know what revenues are in July, I think it's a pretty good way to invest. 56% of our companies are profitable businesses. You may get it wrong, you may back the wrong team, you may overestimate the size of the market – but I think 70% of the time we own the pref, your downside's 1x. Now sometimes you need to recut the deal with the entrepreneur or the managing team, so you're making slightly less than that. But if you can avoid zeros and turn those zeros into like 0.8x or 0.1x, it massively helps returns. We'll sell. Probably a third of our exits have been secondaries. We will buy secondaries. We will also sell. We constantly underwrite. We've been referred to as traders or corporate hedge fund guys, and we're like no, no – we're just trying to actually make money. Because this company's about to be a living dead and you're going to be in this thing for the next decade. [00:00:00] S0: Maybe spend a minute before we go through the buy criteria talking about selling more. What is the process that you run to be able to sell well?
· Patrick O'Shaughnessy, Mitchell Green
[00:00:00] S0: Maybe spend a minute before we go through the buy criteria talking about selling more. What is the process that you run to be able to sell well? [00:00:00] S1: We have a divestment committee. There's 3 of us, myself, Brian, and Nimay. Been here all since fund one. We have a disposition committee, same thing. We think a lot of firms do a really, really good job on the buy. Very, very few firms do a very good job on the sell – like knowing when to sell, pressuring to sell. And I would tell you that the private equity funds tend to do a much better job on the sell than most venture growth guys. Hedge funds, if you do in invest public equities or long-only funds, you constantly can buy and sell. The 3 of us meet once or twice a month and just walk through the portfolio and just talk about it. Like "Hey, there's a round going down in this company, should we sell? How can we try to position this company for a sale over the next 12 months?" The fastest way to get fired at Lead Edge is to have a company and not tell us when there's a liquidity opportunity or just something's about to happen before it happens. [00:00:00] S0: What does the holding period end up being on average then?
· Patrick O'Shaughnessy, Mitchell Green
[00:00:00] S0: What does the holding period end up being on average then? [00:00:00] S1: I bet our average holds are 3.5 to 4 years probably. Everybody gets all excited by these 2015, 2016, 2017, 2018 returns. Our '15 to '18 returns look very good, but it's just multiple expansion and we sold. That's it. If you think you're going to make a 2x in 4 years and you make a 4x in 2 years, it's amazing what it does to net IRR. People forget the reverse happened in '20 and '21. Nobody's '20 and '21 funds – I think the venture growth ecosystem gets a bad rap, but it's going to be every alternative asset. Their '20 and '21 funds are going to be awful relative to earlier funds because people thought they were going to make a 4x in 2 years and are instead making a 1.6x in 8 years. And so that's going to drive, that's going to have a huge impact on the industry. [00:00:00] S0: What is the most interesting thing about the skill of selling and making the transaction happen? Like presumably it's easiest to sell in private markets when a lot of other people are really excited about buying. You can't just hit sell like in public markets. [00:00:00] S1: Correct. [00:00:00] S0: Maybe in like a bad, medium, good – there's different kinds of outcomes that you'd be selling into. Are most of your sales into everyone else is excited and you're less excited? [00:00:00] S1: It can be everything in between. Like if a company goes public, it's just hit a 2 to 5x in 3 to 7 years. [00:00:00] S0: And then sell.
· Patrick O'Shaughnessy, Mitchell Green
[00:00:00] S0: And then sell. [00:00:00] S1: So you're like, the company goes public. You're at a 3.3x in 18 months or 24 months. That annihilates a 12% or 20% net IRR. It's a great company, but we constantly are underwriting what's a forward net return from here. We made a 3x in 18 months. That's like an IPO. In a secondary sale, it's about underwriting the forward IRR. In Toast, which is one of our biggest investments, which we put like 12% of our Fund 3 into. And we'd always get crap. Our Fund 3 was a $290 million fund, and we put $36 million into it. And before the IPO we had sold $180 million. I think we made $350 to $400 in it total. People were like, why are you selling? You don't believe in us? We're like, no, no. All these other knuckleheads that invested alongside us – none of them put 12% of their fund in it. And by the way, somebody is paying us a price in the secondary markets that we think is just lunacy. We sold like in the secondary markets, like $40 or $50 in Toast. The stock today is $30, we think it's cheap, but it's just – by the way, we sold like 6 years ago. And so it's constantly underwriting forward IRR. [00:00:00] S0: Okay, now I get to talk about the 8 buying criteria. I don't know if you want to tick them off or give us some highlights or…